Inherited Transfer Pricing Risk in Cross-Border Deals

This article explains how a target's transfer pricing (TP) position affects valuation, approvals and post-closing liability in a cross-border merger or acquisition, and what diligence, structuring and integration steps reduce the exposure.

It matters because the buyer takes the target's historic related-party pricing along with the shares or business. A pricing adjustment raised years after closing becomes the buyer's cost, and the tools that tax authorities now use, including hindsight on intangibles and minimum-tax modelling, make late surprises more likely.

The governing principle

Related-party transactions must be priced as they would be between independent parties in open-market conditions. Deviation leads to adjustments and penalties, and authorities look harder at dealings with low-tax jurisdictions. A buyer inherits the target's historic anomalies, and the risk is greater where the target's own deal departs from its standard TP policy.

Where adjustments commonly arise

Management and shared-service fees

A deduction for a fee is disallowed where the paying subsidiary cannot tie the charge to a quantifiable benefit. The result is double taxation: the recipient is taxed on the income and the payer loses the deduction.

Centralised arrangements are examined closely, including shared staff, accounting, IT licences and regional management charges. Take a parent in Europe that negotiates vendor pricing for an Indian subsidiary and charges a fee as a percentage of spend. An Indian tax officer would ask for line-item proof of the services, the benefit received and the cost-allocation method, and might substitute a different method of his own.

Intangibles

Intangibles moved to a low-tax hub at an artificially low value can be revalued by authorities at fair market value, with back-taxes. Under the OECD's DEMPE framework (development, enhancement, maintenance, protection, exploitation), legal title alone does not entitle an entity to the profits of the intangible. Profit follows the entity that performs and controls the functions. If a subsidiary holds title to software while the parent's engineers maintain and enhance it, profit may be reallocated to the parent.