Transfer pricing plays an important role in business operations, and therefore can have a significant impact on the success of a merger or acquisition.
Nearly every stage of the acquisition process requires some degree of attention to transfer pricing policies, whether it’s to evaluate possible risks and opportunities or to integrate the policies of both companies effectively. It all starts with due diligence, and a proper evaluation of the risks.
Due Diligence: Identifying Transfer Pricing Risks Before An Acquisition
To ensure the acquisition goes as smoothly as possible, transparency is critical. It’s important to do your due diligence in the early stages of a deal, before the acquisition takes place. (Tweet this!) If a company has risky transfer pricing policies—or no transfer pricing policies at all—there can be major financial repercussions for both parties that extend far beyond the acquisition. If you’re unaware of the risk factors, you could be caught by surprise. (And there are no positive surprises in the world of global tax and transfer pricing.)
Your due diligence process should include a thorough review of the target company’s documentation pertaining to:
- Existing transfer pricing policies
- Documentation for controlled transactions
- Audit outcomes
- Legacy Advance Pricing Agreements (APAs)
Be on the lookout for red flags as you proceed. Discrepancies between intercompany agreements and the way controlled transactions are conducted, the absence of transfer pricing policies, and failure to comply with OECD guidelines are all risky business. Organizations that operate in this manner may bear significant risks that can have a major financial impact on the global enterprise.
Here’s one potential scenario: let’s say your company is considering acquiring a company that currently manages its own transfer pricing documentation. Your evaluation reveals a number of issues with the target company’s transfer pricing documentation and policies that would be readily apparent to tax authorities in the event of an audit.
You determine there is a potential risk of at least $200 million in income that tax authorities will likely identify as being allocated to the wrong jurisdiction. (This can occur when companies shift profits to countries with lower tax rates—a practice that could result in the need to pay back taxes and possibly penalties.) To minimize the financial impact and protect the acquiring business, you decide to put a contingency in your purchasing contract to account for the prospective transfer pricing adjustments and how they’ll be treated.
In the above scenario, had the acquiring company not done due diligence it would have potentially been liable for millions of dollars in additional taxes and penalties—not to mention increased audit risk, time spent dealing with tax authorities, and potential litigation down the road. This is just one example of why it’s so important to do your homework before an acquisition.
Besides due diligence, two other components are critical for successful transfer pricing policy integration: integrating and optimizing transfer pricing policies and ensuring compliance with global transfer pricing regulations during an acquisition.