Are uncertainties about how to price internal fees between exchange entities causing regulatory risk or unexpected tax bills? This guide resolves Transfer Pricing for Exchanges with concrete methods, worked examples and a documentation checklist tailored to UK crypto firms.
What follows is a concise roadmap to set arm's length fees, value liquidity provision and defend positions with HMRC.
Key takeaways: what a finance director needs in one minute
- HMRC treats crypto exchanges like other financial institutions: transfer pricing must reflect functions performed, assets used and risks assumed, and be documented to a high standard.
- Arm's length fees should be evidence-based: use comparable independent exchange fees, profit splits for shared intangibles and TNMM for low-risk entities.
- Liquidity and market-making require specific valuation: include spread capture, inventory financing cost and adverse selection in models.
- Cross-border profits must be allocated where value is created: matching engine IP, order routing, and customer-facing activities drive profit allocation.
- Documentation is essential: maintain a Local File with intra-group fee schedules, benchmarking studies, and day-to-day operational logs to survive HMRC queries.
How HMRC views transfer pricing for crypto exchanges
HMRC applies the arm's length principle adopted in UK law and aligned with OECD guidance. Receipts from trading fees, spreads and ancillary services must be analysed by function, asset and risk (FAR). HMRC will focus on economically meaningful activities: custody, execution, matching, market data, KYC/AML, and risk management.
Key HMRC considerations for exchanges:
- Characterisation of activities: Is a UK entity merely a commission agent or the principal taking market risk? HMRC treats principal activity as generating larger taxable profit and higher risk profiles.
- Allocation of trading inventory and crypto custody: Where are servers, wallets and signing keys held? The location of operational control affects where profits arise.
- Treatment of algorithms and matching engines: IP ownership and routine vs non-routine returns must be separated; IP generating significant value typically attracts residual profits.
For further reference to HMRC's wider transfer pricing approach, consult HMRC guidance: HMRC. OECD’s framework for transfer pricing remains authoritative: OECD transfer pricing.
How HMRC treats inter-entity fees versus spreads
HMRC expects inter-entity fees to reflect economic reality, not simply be a means to shift profit. Where one entity records retail fees and another records liquidity costs, the policy must show consistent allocation (invoices, service agreements, and evidence of services performed). Absent clear substantiation, HMRC may reallocate profits under s.13/ s.17 TIOPA style principles and transfer pricing adjustments.
Setting arm's length fees between UK exchange entities
Determining arm's length fees involves selecting the most appropriate transfer pricing method and supporting it with benchmarking. For exchanges, the following approaches are common:
- Comparable uncontrolled price (CUP): Use where independent exchanges charge similar fees for comparable services (e.g., taker/maker fees).
- Transactional net margin method (TNMM): Suitable for routine entities such as payment processing arms with predictable margins.
- Profit split: Appropriate where unique intangibles (matching engine, user network) are shared across group entities.
Practical steps to set fees:
- Map functions and identify routine vs non-routine profits.
- Choose primary method (CUP/TNMM/profit split).
- Run benchmarking using public comparables, internal comparables or controlled adjustments.
- Document selection rationale, data sources and sensitivity analysis.
Example: setting taker/maker fees within a group
If a UK retail-facing entity collects a taker fee and a Malta market-making subsidiary provides liquidity, fees charged by the liquidity entity should approximate the market cost of execution plus a routine margin. Use CUP where similar execution-only firms exist; otherwise model expected P&L impact with TNMM and test against independent broker fees.
Valuing liquidity and market-making services for transfer pricing
Market-making and liquidity provision are primary value drivers for exchanges. Valuation must consider multiple revenue and cost components, not merely an hourly rate.
Components to include in valuation:
- Spread capture: Historical average spread captured by the market-maker per instrument.
- Volume risk and adverse selection: Losses from informed traders must be estimated and allocated.
- Inventory financing cost: Cost of holding crypto inventory (funding rates, borrowing, hedging costs).
- Infrastructure and latency advantage: If low-latency matching is provided, incremental value from speed should be recognised.
- Operational overheads and capital charge: Servers, cold wallets, security and capital required to back positions.
A hybrid approach is recommended: build a cash-flow model for market-making P&L, then apply a residual split or margin benchmark to isolate routine remuneration.
Valuation methods for market-making
- Cost-plus for purely operational market-making desks with routine returns.
- Excess returns analysis where matching engine or strategies generate residual profits, splitting returns between routine remuneration and residual profit to the IP owner.
- Option-analogue models for order-flow liquidity where optionality in execution is significant.
Allocating profits on cross-border Bitcoin trades
Profit allocation must reflect where value is created along the trading chain. For a cross-border Bitcoin trade the value map typically includes: order origination (customer interface), risk-bearing (inventory/custody), execution (matching engine) and post-trade services (settlement, custody).
Rules of thumb:
- The entity that bears principal market risk (inventory losses/gains) should retain the majority of trading margin.
- The owner of the matching engine IP and proprietary order-routing algorithms may claim residual returns.
- Customer-facing activities (sales, KYC, local support) justify routine distributional returns.
Worked example: UK customer buys BTC executed on Malta pool
- UK Ltd (sales & KYC) receives retail fiat and records fee income.
- Malta Ltd (execution & market-making) supplies BTC from its inventory and assumes price risk.
- Transfer pricing policy: allocate routine service fee to UK Ltd for customer onboarding; allocate trading margin (spread and inventory gains/losses) to Malta Ltd; residual profit linked to matching engine IP retained by owner jurisdiction.
Documentation must evidence the flow: contract terms, settlement records, wallet controls, and daily P&L reconciliation.
Transfer pricing documentation checklist for UK crypto firms
Comprehensive documentation is often decisive in audits. The Local File should be focused, evidence-rich and specific to crypto operations.
Mandatory checklist items:
- Intercompany agreements: clear scope, SLAs, fee formulas, termination clauses.
- Policy statement: rationale for method selection and business reasons for group structure.
- Benchmarking report: comparables selection, adjustment logic and statistical outputs.
- Operational logs: matching engine deployment, order routing records and custody key access logs.
- P&L allocation schedules: daily/weekly reconciliation of fees, spreads and inventory revaluations.
- Valuation models: market-making cash-flow models, sensitivity analyses and assumptions.
- Master File elements: group organisational chart, financing arrangements, intangible ownership.
- Transfer pricing policy for VAT and withholding tax: analysis of how intercompany fees interact with indirect tax and domestic withholding rules.
Practical file structure (recommended)
- Folder 1: Corporate structure and legal agreements
- Folder 2: Functional analysis and FAR matrix
- Folder 3: Benchmarking and comparables data
- Folder 4: Operational evidence (logs, screenshots, reconciliations)
- Folder 5: Valuation workbooks and sensitivity analyses
Managing BEPS and OECD guidance for crypto transfers
OECD guidance on transfer pricing and BEPS remains the international reference. Apply OECD principles to crypto-specific features: digital platforms, intangible ownership, and value generated by user networks.
Practical compliance pointers:
- Adopt OECD’s functional approach: document and map digital interactions that generate value.
- Consider permanent establishment (PE) risk for local operations that solicit business or maintain order matching in a jurisdiction.
- Use Advance Pricing Agreements (APA) where feasible to lock in methods for high-risk allocations.
For OECD material consult: OECD transfer pricing guidance and the digital economy reports on nexus and intangibles.
Advantages, risks and common errors
Benefits / when to apply ✅
- Reduces audit risk where management can demonstrate consistent, evidence-based pricing.
- Improves capital allocation by clarifying where inventory and capital costs are borne.
- Supports negotiations for APAs and mitigates double taxation.
Errors to avoid / risks ⚠️
- Using arbitrary intercompany fees disconnected from market evidence.
- Failing to record operational reality (e.g., where signing keys are held).
- Ignoring indirect tax consequences of fee flows (VAT/GST).
- Under-documenting market-making valuation inputs such as funding rates and adverse selection costs.
Comparative table: recommended TP methods for exchange activities
| Activity |
Recommended method |
Why |
| Customer onboarding & KYC |
TNMM / cost plus |
Routine activities with comparable margins |
| Market-making / liquidity |
Cost-plus or profit split hybrid |
Complex P&L and residual returns to IP |
| Matching engine / algorithms |
Profit split / residual allocation |
Unique intangibles creating non-routine returns |
Quick flow: how transfer pricing on a trade is allocated
💡Step 1: Customer places order (UK Ltd records fee)
⚡Step 2: Execution by market-making pool (Malta Ltd bears inventory risk)
🔐Step 3: Settlement & custody (entity with wallet keys records custody fees)
📊Step 4: Reconciliation and TP allocation (daily/weekly P&L splits)
🧾Step 5: Documentation uploaded to Local File (benchmarks, logs, agreements)
Checklist for a defensible position in an HMRC audit
- Maintain contemporaneous benchmarking.
- Keep operational evidence for every material trading day.
- Reconcile intercompany invoices to order-level data.
- Produce a valuation memo for market-making which includes funding cost, spreads and adverse selection.
- Consider an APA for high-value intangibles across jurisdictions.
Frequently asked questions
What is transfer pricing for exchanges?
Transfer pricing for exchanges is the process of setting and documenting prices or profit allocations for services, trades and intangibles exchanged between related entities in different jurisdictions.
How does HMRC treat crypto spreads and fees?
HMRC expects spreads and fees to be allocated according to who bears market risk, performs matching/execution and owns the intangible assets that generate trading advantage.
Can a UK exchange entity be paid a simple management fee?
Yes, but the fee must reflect actual services and be supported by time records, SLAs and benchmarking to justify the margin.
How should market-making compensation be modelled?
Model market-making P&L including spread capture, expected adverse selection, inventory financing cost and overheads; then split routine vs residual returns.
Is VAT payable on intercompany exchange fees?
VAT treatment depends on the nature of services and place of supply rules; firms should obtain specialist VAT advice as part of TP planning.
When is an APA advisable for an exchange group?
An APA is advisable where large residual profits are attributable to unique intangibles or where double taxation risk is material across jurisdictions.
What records will HMRC request in an audit?
Expect FAR analyses, benchmarking, intercompany agreements, reconciliation logs, custody proofs and daily P&L records.
How to handle volatile BTC revaluations in TP models?
Include formally documented revaluation policies and sensitivity analysis; align accounting revaluation practices with TP position to avoid mismatches.
Your next step:
- Run a quick FAR map of the group and identify the entity that bears principal market risk.
- Commission a short benchmarking study for taker/maker fees and a market-making valuation model.
- Compile a Local File with intercompany agreements, daily reconciliation logs and the valuation memo.