Transfer Pricing Risk refers to concerns that a company may be providing goods or services to a related entity in a manner that is not arms-length.
Businesses may have affiliates for a number of good reasons:
- Tax advantages: Certain types of assets may receive beneficial tax treatments (e.g., depreciation) which are of more value to certain business owners than others. Those assets may be held in a separate legal entity owned just by the parties who benefit most from the favorable tax rule.
- Capital contributions: Some owners may have made disparate financial contributions to the various entities which may have led to varied equity interests in each.
- Risk isolation: Diversity in operating or financing risks may have dictated separating the activities into different legal entities.
- Differing business models: The owners may have decided to simultaneously pursue distinctly different strategies, products, services or markets, and thus created separate companies for each.
While having affiliates can provide substantial benefit to the owners, they also introduce Transfer Pricing Risk for the buyer, especially if the buyer is not acquiring all the affiliates of the business. Examples of buyer concerns over Transfer Pricing include:
- Did the various entities deal with each other at arms-length? Are intercompany contracts on market terms? What evidence exists to prove this?
- Are all entities necessary to operation of the business being offered for sale, or are certain critical elements being retained or sold to others? If so, long term contracts may have to be part of the sale transaction.
- Have the financial statements been generated by certified accountants using the appropriate methods for dealing with Transfer Pricing under GAAP?
Transfer Pricing Risk can be a substantial concern for buyers in due diligence. For this reason, we recommend owners become well prepared to justify intercompany transactions with affiliates, long before selling.
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