Two unrelated businesses negotiating a price both push in their own interest, and the result reflects market value. Two companies under the same ownership have no such tension: the price is set internally, and it can be set anywhere.
That freedom is the reason tax authorities examine these transactions, and understanding why makes the rules feel less arbitrary.
| Issue | internal prices shift profit between entities |
|---|---|
| Standard applied | what unrelated parties would have agreed |
| Applies to | goods, services, loans, intellectual property, guarantees |
| Requirement | documentation supporting the pricing |
The mechanism
Consider a group with a company in each of two countries. The first sells goods to the second, which sells to customers.
If the internal price is set high, most of the group's profit appears in the first country. If it is set low, most appears in the second. The group's total profit is unchanged; only its location moves.
Where tax rates differ between the two countries, the internal price directly determines the group's total tax bill — without any change in the underlying business.
That is the problem the rules address, and they address it with a single standard: related parties should price transactions as unrelated parties would have.
Note what this standard does not say. It does not require a particular outcome or forbid profitable arrangements. It asks a comparative question: would two independent businesses, each looking after its own interests, have agreed these terms?
What counts as a related-party transaction
Wider than most people assume:
- Sale of goods between group companies
- Services — management, administration, technical support, shared functions
- Loans — and the interest rate charged on them
- Intellectual property — royalties for brands, technology or know-how
- Guarantees given by one group company for another
- Cost sharing arrangements
Two of these are worth singling out because they are the most common in small groups and the most commonly undocumented.
Management fees. A parent charges subsidiaries for head-office functions. The questions asked are: was a real service provided, did the subsidiary benefit, and is the charge proportionate? A round-figure charge with no description of services is the classic weak position.
Intra-group loans. Two things are tested: whether the interest rate is what an independent lender would have charged given the borrower's circumstances, and whether the amount of debt is what an independent lender would have advanced at all.
The second point catches people out. Funding a subsidiary almost entirely with debt rather than equity generates deductible interest and reduces taxable profit; many countries restrict this specifically.
What documentation is expected
Requirements scale with size, and small businesses are not expected to produce what large multinationals do. But even at small scale, the basics are:
- A written agreement for each type of related-party transaction
- A description of what is actually provided, in concrete terms
- The basis for the price — how it was arrived at
- Some comparison to what third parties charge, where obtainable
- Evidence the service was delivered — reports, correspondence, time records
Point five is where most challenges are won or lost. An authority disallowing a management fee usually argues that no real service was received, and contemporaneous evidence answers that directly.
The word contemporaneous matters: documentation created at the time is credible; documentation created after an enquiry begins is much less so.
Why this matters even for small businesses
Founders often assume these rules apply only to large groups. Three reasons they do not:
One: the rules generally apply regardless of size. Thresholds may reduce documentation burden, but the underlying pricing standard applies.
Two: small structures are common. A founder with a company in their home country and one where they operate has a related-party relationship, whether or not they think of it that way.
Three: adjustments can create double taxation. If one country adjusts profit upward, the other does not automatically reduce its own assessment. Without a mechanism to resolve it, the same profit is taxed twice.
The third is the practical reason to get this right in advance rather than argue afterwards.
Sensible practice for a small group
- Document every related-party arrangement in writing, however small
- Charge for real things and be able to describe them
- Use a defensible basis — a cost-plus method with a modest margin is often reasonable and easy to explain
- Keep evidence of delivery as you go
- Review annually, because circumstances change
- Be consistent — pricing that moves each year without explanation invites questions
And the general principle worth carrying: the objective is not to find the cleverest structure but to have an ordinary, explainable one. Arrangements that are simple to describe are simple to defend.
Frequently asked questions
Why are related-party transactions scrutinised?
Because the price is set internally rather than by negotiation, so it can move profit between countries without changing the underlying business — and therefore change the group's tax bill.
What standard is applied?
Whether independent businesses, each acting in their own interest, would have agreed the same terms. It is a comparative question, not a prohibition on profit.
Where are management fee challenges usually won or lost?
On evidence that a real service was delivered. A round-figure charge with no description of services is the classic weak position.
Do these rules apply to small businesses?
Generally yes. Thresholds may reduce the documentation burden, but the pricing standard applies — and a founder with companies in two countries already has a related-party relationship.
