Fri, Sep 20, 2013
There are significant differences that may arise between intangibles valuations undertaken for financial reporting purposes (specifically in a purchase price allocation, or “PPA,” context) versus valuations undertaken for transfer pricing.
Comparison of PPA and TP Valuations1
There are significant differences that may arise between intangibles valuations undertaken for financial reporting purposes (specifically in a purchase price allocation, or “PPA,” context) versus valuations undertaken for transfer pricing. Stakeholders need to understand why PPA valuations should not necessarily be used for a transfer pricing analysis (for example, for integration of acquired intangibles into existing tax structures).
The OECD and various tax authorities have indicated that while valuations of intangible assets prepared for financial reporting may provide a useful starting point for a transfer pricing analysis, such valuations may not be sufficient if an intercompany issue exists. While there is some similarity and overlap in the data gathering and identification of functions, assets, and overall scope of the analyses, there are also key differences that need to be taken into consideration:
Despite the potential differences in financial reporting versus transfer pricing valuations, companies should perform valuations of acquired IP for PPA and (potential) transfer pricing purposes jointly. This practice can save time and money (e.g., through joint interviews and information gathering) and, though the valuation results will likely differ, helps ensure consistency of the basic data and assumptions used. Consequently, a joint analysis can reduce both domestic and foreign tax exposures and audit risks.
Transfer Pricing in the Energy Industry2
Transfer pricing is one of the most important tax issues facing multinational energy firms. Given the complexity, integrated nature, and capital intensity of the energy industry, an extensive amount of intercompany activity takes place, particularly within large, vertically integrated multinationals. Consequently, transfer pricing can have a substantial tax impact, including potentially sizable adjustments to reported income. We highlight here the more common intercompany transactions in this industry, including issues that may arise in complying with transfer pricing regulations (from a US perspective).
In terms of revenues, the sale of tangible products is the largest type of intercompany transaction found in the energy industry. We must consider the following issues:
The second largest type of intercompany transaction, which is embedded in all aspects of the energy business, is the provision of services. Relevant issues include:
Other notable types of transactions in the energy industry include:
With transfer pricing audits increasing in significance, intrusiveness, and scope, and given the unique aspects of the energy industry in general, multinationals have a greater than ever need to support their transfer pricing policies in the context of value drivers in their industry, through comprehensive documentation and planning.
Court Decision Could Lead to Tax Risks for PE Firms
A noteworthy legal decision over the summer could have far-reaching ramifications for private equity (“PE”) firms. The First Circuit U.S. Court of Appeals (“the Court”) held that a Sun Capital Partners fund can be held liable for unfunded pension liabilities incurred by one of its portfolio companies (which went bankrupt). The Court found that the fund was not merely a passive investor in the company, but rather was engaged in a “trade or business” by virtue of its (the fund’s) economic interest in the management of that company. In this case, the Court focused on the fact that management fees paid by the portfolio company to a subsidiary of the general partner (“GP”) resulted in offsets to the management fee payable by the fund to the GP, hence the direct economic interest. Even without such an offset, however, any PE fund directly benefits from the activities of the GP and its subsidiaries, and so might in the future be deemed as having a trade or business via its investments (i.e., piercing the “passive investor veil”).
Although this decision did not address tax issues, some relevant questions are raised by it:
The First Circuit decision is limited to pension provisions under ERISA, so its extension to tax and transfer pricing is speculative at this point. However, this could be a step toward holding PE funds and their investors to greater accountability for the activities of portfolio companies, including those related to transfer pricing. In addition, there could be tax exposure for the fund itself, based on its structure and investments.
India Issues Draft on New Safe Harbor Rules5
On August 14, 2013, the Indian Central Board of Direct Taxes (“CBDT”) issued a draft of proposed safe harbor rules (the “CBDT Draft”) in an attempt to reduce the number of audits and prolonged disputes between taxpayers and tax authorities. For the purposes of the Draft, a safe harbor is defined as a stated margin or rate at which the CBDT shall accept the transfer price declared by the assessee. The CBDT Draft is limited in scope, as it applies only to the following sectors/activities (“eligible transactions”):
We highlight the key circumstances under which the transfer price declared by the assessee in respect of such eligible transactions will be accepted by the Indian tax authorities in the table below.
The provisions summarized in the table above would be effective for assessment years 2013 – 2014 and 2014 – 2015. Furthermore, in order to be eligible for the safe harbors proposed in the CBDT Draft (i.e., an “eligible assessee”), a taxpayer must meet the following criteria:
All taxpayers, regardless of whether they elect to use the safe harbor, must continue to comply with the existing documentation requirements. However, if a taxpayer elects to use the safe harbor provisions proposed in the CBDT Draft, the taxpayer must also complete and submit Form 3CEG (a copy of which is available as part of the CBDT Draft). It is important to note that by accepting the transfer price given in the CBDT Draft, assessees will forfeit all additional comparability adjustments or allowances, as well as lose all claims to invoke mutual agreement procedures.
Comments on the CBDT Draft were accepted until August 26 of this year, and the CBDT is expected to issue final rules based on received comments. No official timeline has been released for the completion.
1.For more information, please see “Bridging the Divide between Financial Reporting and Transfer Pricing,” Nathan Levin and Jill Weise, Financial Executive, July / August 2013 (www.financialexecutives.org).
2.For more detailed information see our contribution in BNA’s Transfer Pricing Forum, 07/13, ISSN 2043-0760.
3.The IRS has developed a handbook specifically for examining taxpayers within the oil and gas industry. See, IRS Oil and Gas Handbook – Chapter 41 of Internal Revenue Manual (http://www.irs.gov/irm/part4/irm_04-041-001.html).
4.See US Regulations Section 1.482-7.
5.The Draft can be found on the CBDT website (http://www.incometaxindia.gov.in/archive/BreakingNews_DraftSafe_14082013.pdf).
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