Transfer pricing is a tax topic that often does not get enough attention during the M&A due diligence, as well as afterwards when a deal is closed and the post-merger integration is in process. Buyers and sellers need to ensure that it is clear what the current and the future TP systems look like.
Transfer Pricing matters in the context of the M&A process
Transfer pricing (“TP”) is an often overlooked and lightly treated aspect of the tax due diligence (“TDD”) during the M&A process. However, given that the integration of the target company is often part of the post-merger proceedings, clarifying the TP system of both buyer and seller, and getting clarity on risks and opportunities should be considered a necessity as early as possible.
What should buyers watch out for?
From a pure tax perspective, TP can generally be considered to be one of the main risk factors. Tax authorities spend increasing amounts of time and resources on scrutinizing TP setups. Evaluating whether there is legacy risk in the target and getting appropriate coverage for it therefore makes sense. In addition, the target then will be integrated in many cases, which raises questions about the location of key value drivers within the target’s business model and synergy potential and redundancies.
Potential TP risks can be broadly grouped into the following categories:
- Potentially non-arm’s length TP concepts
- Missing TP compliance
- Operational TP issues
Each of these topics comes with its own impact and considerations that need to be made, and they should not be overlooked by the buyer.
Transfer pricing concept
A non-arm’s length TP concept comes with risks for the past, but also potentially poses challenges to a future integration of the target.
To identify issues, buyers can have a look at the following points:
- IP: is the IP located where it should be, i.e. are the returns from the IP aligned with the relevant DEMPE functions?
- TP methods: what remuneration methods are applied for the different intercompany transactions, and is it possible to defend/justify these as being at arm’s length?
- Intercompany agreements: are there agreements in place for the major intercompany transactions, and do they correspond to actual behavior and arm’s length requirements?
Transfer pricing compliance
Transparency and compliance requirements are increasing worldwide. Pure monetary penalties for missing compliance obligations are often not high enough to have a significant impact on the deal itself. However, the non-availability of compliance documentation or non-compliance with obligations such as country-by-country reports (“CbCR”) or TP returns can indicate that the topic is not well managed. In addition, non-availability of such information usually leads to limited transparency on potential issues during the due diligence process. It can also mean that there will be a more significant effort required to integrate the target into the buying entity once the deal closes.