Restructuring usually involves changing an MNE’s organizational set-up or business model. This requires proper documentation and might induce changes to an MNE’s Transfer Pricing (“TP”) model, require compensation and/or trigger exit tax. Such TP implications must be assessed early in the process.
Cross-border restructuring transactions are carried out by MNEs to streamline their business model, achieve growth or re-align their core activities. Such transactions often have TP implications that may lead to costs in the form of exit tax or penalties if not properly documented. Therefore, TP aspects of restructuring should be considered early in the process.
Assessing potential TP implications
In analyzing whether restructuring activities may be relevant from a TP perspective, taxpayers may consider the following aspects, based on the OECD’s Transfer Pricing guidelines1.
i) Reallocation of profit potential
If profit potential is reallocated, a compensation payment to the entity giving up such potential in the form of transferred functions and/or risks may be warranted.
Such reallocation often takes place when the functional profile of an entity changes. This may particularly be the case when converting an entity’s functional profile from fully-fledged to limited risk, e.g. for distribution or manufacturing activities.
However, the mere transformation of an entity’s risk profile does not warrant for a compensation payment by itself. Rather, the historical performance pre restructuring as well as the projected performance pre and post restructuring should be analyzed. A compensation payment would only be considered at arm’s length if aforesaid analysis leads to the conclusion that actual profit potential has been reallocated. In addition, the entities engaging in the restructuring transaction need to assess options realistically available to them. The restructuring adopted will only be considered at arm’s length if no other options offer commercially clearly more attractive opportunities to meet their objective.
ii) Transfer of something of value
A transfer of “something of value” may include tangible assets, intangible assets (or the rights to such assets) as well as business activities.
Amongst tangible assets, the transfer of inventory may be particularly important to consider in the case of the transformation of a manufacturer’s risk profile as mentioned above.
The determination of whether an intangible asset has actually been transferred requires careful analysis. This is because the profit potential inherent to an intangible asset is not merely allocated based on legal ownership but according to the relevant functions. These DEMPE2 functions may not fully be transferred along with the legal right. Further analysis is therefore needed to determine the post restructuring arm’s length distribution of intangible profits.
The transfer of an ongoing concern, according to the OECD, means the transfer of assets, bundled with the ability to perform certain functions and assume certain risks. The transferred activity constitutes functioning, economically integrated business unit and the restructuring activity might therefore share features with an M&A transaction between independent parties. In practice, besides the diligent valuation of any transferred activities, special attention must be paid to local regulations within the jurisdictions where such activity takes place.
iii) Termination of existing agreements
If agreements are terminated or renegotiated to the detriment of the restructured party, it has to be assessed whether an indemnification needs to be paid to ensure arm’s length conditions. Hence not only the terms and conditions of agreements between related parties need to be arm’s length, but any change, renegotiation or termination of such contracts needs to be carried out under arm’s length conditions. In addition, the termination or renegotiation of intercompany agreements might inherently lead to a reallocation of profit potential or transfer of something of value. In such cases, the above considerations apply, and the question of indemnification has to be answered separately.
1 Chapter IX of the 2017 OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.
2 Development, Enhancement, Management, Protection and Exploitation
What it takes from a tax perspective to successfully restructure
In the light of the above, the entire restructuring process, from the transaction analysis and valuation, through implementation, to the proper documentation needs to be planned and carried out diligently:
- In order to avoid unnecessary costs and unwanted surprises, involve an interdisciplinary team of experts that covers Legal, TP, VAT/Customs and Corporate Tax early in the process;
- Consider pre-discussing and confirming the tax treatment with Tax Authorities in the form unilateral or multilateral Advance Pricing Agreements (APAs);
- Remember to appropriately document any restructuring transaction in order to avoid penalties and the reverse of the burden of proof (in the TP documentation’s Master File and Local File and potentially in a separate report, as frequently required by local laws and regulations).