UK subsidiaries of overseas groups – commercial and transfer pricing warning on audit exemption
Care should be taken before a European parent guarantee exemption is considered for a UK subsidiary.
All UK companies, including UK subsidiaries of overseas groups, require a statutory UK audit unless they can take advantage of one of the specific UK audit exemptions available, which primarily relate to size or to obtaining a guarantee from a relevant parent company.
Size must be measured with reference to the worldwide group, not just the UK subsidiary, leaving many UK subsidiaries of even modestly-sized international groups unable to take this exemption.
Consequently many UK subsidiaries have explored the latter exemption, which is relatively new under UK company law.
Under UK company law a European Economic Area (EEA) parent company of a UK subsidiary can provide a guarantee, exempting the UK subsidiary from having to embark on its own UK statutory audit. However, the potential commercial and transfer pricing effects of taking this exemption should be carefully considered.
Equivalent to any commercial guarantee
A lesser known fact is that under current rules for claiming the subsidiary audit exemption, the parent company guarantees a subsidiary’s debts including all liabilities, contingent liabilities and future claims, whether recognised at the year-end or not. This guarantee remains in force until those liabilities are settled and importantly, electing to have a local UK statutory audit in the following year does not extinguish the guarantee previously given by the parent company.
Therefore legal advice, both in the UK and in the parent country, should be considered before committing to the guarantee
Transfer pricing consequences
Depending on the transfer pricing design applied to the UK subsidiary, including risks borne from a transfer pricing perspective, the commercial risk of a fully underwritten UK subsidiary could be significantly reduced.
When completing the transfer pricing analysis and documentation for groups involving UK companies that take advantage of the audit exemption, the risk analysis should consider the effect of the exemption on both the UK subsidiary and the group entity assuming the guarantee. This could affect the transfer pricing outcome leading to lower profits for the UK subsidiary (and higher profits for the guarantor). Alternatively, a separate arm’s length valuation of the guarantee might be necessary by the guarantor.
Advice should be sought on both the commercial aspects and transfer pricing impacts before an EEA parent guarantee exemption is considered for any UK subsidiary. Note that even if audit exemptions are taken, filing of the (unaudited) UK subsidiary accounts on the UK public register is still normally required.