Transfer pricing is becoming an increasingly discussed topic in the financial services industry, and has important implications for PE Funds and their portfolio companies, as outlined by Jessica Joy (pictured), managing director, and Stefanie Perrella, vice president, in the Duff & Phelps Transfer Pricing practice.
Growing importance of transfer pricing
Coinciding with the continued globalization of businesses, as well as fiscal pressures on national economies, there has been an increasing focus on tax issues, including transfer pricing. Prominent examples include the Congressional examination of Apple’s international tax practices and whether transfer pricing has been a means to reduce tax liabilities, and the Organization for Economic Development and Cooperation’s (“OECD”) increased focus on base erosion and profit shifting. In July 2013 the OECD released an action plan to address needed changes, in which transfer pricing is viewed as a major contributing factor. In addition, earlier this month draft legislation was published in the UK, which puts forth anti-avoidance rules concerning tax-motivated profit allocations, including a thorough review of partnership structures (commonly used by PE Funds). As PE Funds and their portfolio companies expand operations internationally these issues are becoming of increasing relevance.
PE funds and transfer-pricing
Transfer pricing establishes the price charged for cross-border transactions involving related entities, or taxpayers under common control. While specific transactions are unique to the facts and circumstances of each PE Fund, transfer pricing can be an issue at one or more of the following levels:
- Within a PE Fund with multinational operations, transfer pricing issues can relate to the provision of services (e.g., sourcing, qualifying, and managing investments) by a related party to the fund manager, or to the provision of centralized corporate services to global affiliates. Sourcing and use of capital as well as allocations of carried interest may also be relevant.
- Within a multinational portfolio company, transfer pricing issues can relate to the intercompany transfer of intangibles, tangible goods, services, and financial transactions (e.g., loans). Assessing related transfer pricing risk is of ongoing importance, particularly prior to the acquisition or sale of a portfolio company by a PE Fund to mitigate risk.
- Between a PE Fund and its portfolio companies, transfer pricing issues may also exist if a portfolio company is considered a “related party” to the Fund itself or to any partners under the broad definition of “common control.” Other tax issues related to economic interest/ownership such as permanent establishment and tax liability risks may also exist, specifically in light of recent rulings in PE Fund-related court cases (e.g., Sun Capital Partners).
The arm’s-length principle is the basis of most transfer pricing regulations, which seeks to price a transaction between related parties in the same manner as if the transaction occurred between unrelated parties. Supportable pricing policies, as documented through a transfer pricing analysis, offer a PE Fund and its portfolio companies a first line of defense in the event of a tax audit, minimizing the risk of costly adjustments and penalties that can be imposed in most jurisdictions absent such documentation.
