Governments looking to limit tax avoidance are taking a closer look at how companies owned by the same parent entity sell and buy from one another in low-tax jurisdictions, including private equity firms and their portfolio companies, tax experts are warning.
Accordingly GPs are being advised to polish their transfer pricing policies and better monitor any tax efficiencies achieved, especially when structuring vehicles in Ireland, the Netherlands, Luxembourg and other popular private equity domiciles.
For private equity groups, a “comparables method” is fast become the transfer pricing practice of choice to satisfy tax authorities’ expectations. Under this approach, GPs executing an intercompany sale gather information on what outside market participants are charging for the same service.
“Tax authorities are keen to see firms using comparables methods as it demonstrates the firm is doing greater analysis of their transfer pricing and comparables show more justification of why a transaction should be a certain price,” said one UK-based tax lawyer.
For instance, a firm with a management entity located in the UK, but whose fund administration is taking place in Luxembourg, would need to price the fund administration service so the Luxembourg office can record a profit. However, tax authorities will expect the profit margin to be calculated by referencing profit levels achieved by independent third-party administrators providing similar services.
Using a comparables method can be challenging, sources warn. For instance there could be limited data available to benchmark a transaction. And comparing transactions can be difficult because some tax authorities prefer firms strictly use local pricing data, which is not always readily available.
GPs are being urged to review their transfer pricing policies in the short-term. In September, G20 world leaders gave their backing to plans by the Organisation for Economic Co-operation and Development to create a new set of tax standards to ensure that companies are prevented from abusing transfer pricing rules.