Transfer Pricing Due Diligence For M&A Transactions [Checklist]
Posted by Valentiam Group on February 24, 2020
Transfer pricing should be an important consideration during any merger and acquisition (M&A) transaction. However, despite the important role transfer pricing plays in many key business operations—it impacts everything from research and development to procurement and distribution—it’s often overlooked during the due diligence stage of an acquisition.
Why is transfer pricing due diligence important during M&A?
Due diligence presents the opportunity for an acquiring company to look at the transfer pricing policies and activities of a target company before completing an M&A transaction. Doing so helps identify potential risks that should be taken into account; it also forms the basis for analyzing potential future opportunities for policy integration once the acquisition is complete.
Identifying and addressing risks early on in the process allows for sufficient planning, and paves the way for a smoother integration. By anticipating future transfer pricing challenges, the acquiring company can put contingencies in the purchasing contract to account for adjustments. On the other hand, lax due diligence has a high price: It can have extensive financial implications down the line, including garnering unwelcome attention from tax authorities.
M&A Due Diligence Checklist For Transfer Pricing
If your company is planning M&A activity and you’re tasked with managing tax due diligence, review this checklist to ensure that transfer pricing is being taken into consideration. (Tweet this!)
Learn how to manage transfer pricing policy integration and ensure compliance with regulatory guidelines during a merger or acquisition.
1. Evaluate whether formal transfer pricing policies are in place.
The first step is to learn if the target company has any formalized transfer pricing policies in place. If so, do those policies align with the actual business operations?
If a company has risky transfer pricing policies—or no transfer pricing policies at all—there can be significant financial ramifications for both parties. This is also an important consideration when planning for future policy integration. How well do the target company’s policies align with your own? Keeping this in mind will ease the integration process after due diligence is complete.
If transfer pricing policies are in place but are not being followed, this may raise some red flags as to whether the policies are in line with the business operations.
2. Review the target company’s transfer pricing documentation.
Next, the acquiring company should review the target’s existing transfer pricing documentation: Does it demonstrate that the policies in place actually work and produce arm’s length results? Evaluating the target company’s transfer pricing policies and supporting documentation can reveal issues that would be readily apparent to tax authorities in the event of an audit.
When reviewing transfer pricing documentation, also identify any internal and third-party comparables and benchmarks used to establish arm’s length pricing. Determine whether any significant changes will need to be made to avoid an audit or penalties.
3. Assess the target company’s country-by-country reports.
If the target company is a large corporation, check to make sure its country-by-country (CbC) reports are up to date and filed for each jurisdiction where business is conducted. Reviewing CbC reports is a great way to identify potential risks and red flags during an M&A.
For example, if a target company’s CbC reports indicate outsized profits relative to the operations in lower tax jurisdictions like Ireland or Switzerland, it may not necessarily mean anything is wrong, but it certainly warrants further investigation, as a tax authority would likely think the same.
4. Review any existing legal agreements for intercompany transactions.
Another important step on the transfer pricing due diligence checklist is to ensure legal agreements are in place for the target company’s intercompany transactions. To the extent that legal agreements exist, do they accurately reflect the target company’s transfer pricing operations and transactions?
Discrepancies between intercompany agreements and the way controlled transactions are conducted can be a major red flag for tax authorities when conducting a review of transfer pricing activities. (Need help managing your related-party contracts? Download our free guide, 6 Best Practices For Related Party Intercompany Agreements.)
5. Perform in-depth analysis to determine if transfer pricing risks exist.
After completing the previous steps, perform a more in-depth analysis by evaluating financial statements and outcomes alongside the information you’ve acquired. This will help you determine if any transfer pricing risks exist, and help you quantify those risks from a financial perspective.
Along with looking at financial statements, make it a point to review any audit outcomes and existing penalties applied by tax authorities. It’s important to go into every M&A transaction with a holistic view of the target company’s past transfer pricing activities and challenges. Doing so will help ensure you’re prepared with the right provisions in place to help mitigate potential tax liabilities future audit risk.
Minimize Risk During An Acquisition
Even with these tips in mind, there are still many other important considerations during a merger-and-acquisition deal. To learn more about how to manage transfer pricing policy integration during an acquisition—including the most common transfer pricing challenges companies face during this time and how you can prepare for them—download our free guide, Transfer Pricing In An Acquisition Environment. Or, if you’d like to speak with one of our experienced advisors at Valentiam, schedule a call.
Topics: Transfer pricing
There are no guarantees for avoiding transfer pricing audits, but taking these steps will reduce your risk—and ensure you’re prepared if you are audited.