Checklist for Transfer Pricing in M&A Exits

Transfer pricing is critical in M&A exits because it directly impacts valuations, tax compliance, and deal success. Missteps can lead to tax audits, penalties, and reduced valuations. Here's what you need to know:

Key Takeaways:

Transfer pricing involves setting prices for transactions between related entities (goods, services, IP licensing, etc.).
It must follow the arm's-length principle to reflect market conditions.
Poor transfer pricing can lower valuations, trigger audits, and delay deals.
Buyers scrutinize transfer pricing during due diligence for risks and compliance.

5 Steps to Get Transfer Pricing Right:

Review Policies: Ensure agreements align with actual practices and regulations.
Run Benchmark Studies: Compare internal transactions to market standards.
Align with Exit Plans: Ensure pricing supports accurate valuations.
Document Everything: Prepare master files, local files, and country-specific reports.
Monitor Post-Exit Compliance: Set up systems to track and adjust transfer pricing.

Why It Matters:

Tax authorities are stricter than ever, with penalties reaching up to 40% of understated tax.
High-profile cases like Coca-Cola and Ford show how poor transfer pricing can cost billions.
Proper preparation avoids delays, protects valuation, and ensures smoother exits.

Start early, document thoroughly, and collaborate across teams to avoid costly mistakes and maximize deal success.

Step 1: Review Current Transfer Pricing Policies

Take a close look at your current transfer pricing policies to identify any compliance issues or operational risks that could complicate transactions or lower your company’s valuation. This involves reviewing both the formal documentation and actual business practices to ensure they align with regulatory standards and economic realities. This step lays the groundwork for aligning your transfer pricing strategies with exit plans in the next stages.

Check Intercompany Transaction Agreements

Intercompany agreements (ICAs) are the backbone of your transfer pricing framework. These agreements spell out how related entities within your organization interact - whether it’s selling goods, providing services, or licensing intellectual property. Getting these agreements right is critical because poorly structured ICAs can lead to expensive tax audits and adjustments. For instance, Coca-Cola faced a $3.3 billion IRS tax adjustment due to a misclassified ICA. This underscores the importance of having clear, well-documented agreements that accurately reflect your business operations.

When reviewing ICAs, focus on these critical areas:

Parties and scope: Clearly identify all related entities and ensure the agreement covers all relevant activities.
Pricing mechanisms: Confirm that pricing methods align with the arm’s-length principle and can withstand regulatory scrutiny.
Risk allocation: Verify that the assigned risks match actual business operations and decision-making processes.
IP rights and usage: Clearly outline intellectual property ownership, licensing terms, and royalty arrangements.
Payment terms and compliance: Define payment schedules and ensure the documentation adheres to local tax laws.

Your ICAs must go beyond generic templates - they should be tailored to your business model and supported by economic analysis. Vague or overly broad language can be a liability during audits or due diligence. To maintain consistency and streamline audits or buyer reviews, consider centralizing ICA management.

Once your ICA details are reviewed, check for any inconsistencies between what’s documented and what’s actually happening in practice. These gaps can reveal potential risks that need to be addressed.

Find Transfer Pricing Risks

Spotting transfer pricing risks early in the M&A process can help you plan effectively and ensure smoother integration. Buyers often conduct thorough due diligence on transfer pricing, and any red flags they find could hurt your valuation or delay the deal.

To identify risks, compare your documented policies with actual practices. Some companies have policies on paper that don’t match how they operate in reality - a red flag for both tax authorities and potential buyers.

Key areas to examine include:

Documentation gaps: Ensure transfer pricing documentation is complete and that country-by-country reports are up-to-date for every jurisdiction where you operate.
Misalignment between agreements and practices: Check for discrepancies between intercompany agreements and how transactions are actually carried out.
IP location and returns: Verify that intellectual property is assigned to the correct jurisdiction and that returns align with the DEMPE (development, enhancement, maintenance, protection, and exploitation) functions performed.
Pricing methodology consistency: Ensure transfer pricing methods are applied consistently across similar transactions to avoid compliance issues and regulatory scrutiny.

Dive deeper by analyzing financial outcomes. Compare your transfer pricing policies with actual results to spot any patterns that suggest non-arm’s-length pricing. Watch for consistently high or low profit margins in specific jurisdictions, unusual price fluctuations, or outcomes that don’t align with the economic substance of your business.

Keep in mind that tax authorities are paying closer attention to transfer pricing, especially during M&A transactions. With increased deal activity and tighter regulatory focus, buyers are more cautious than ever about transfer pricing risks. For example, one company addressed these risks by securing a $280 million tax insurance program to cover potential liabilities.

Step 2: Run a Transfer Pricing Benchmark Study

A transfer pricing benchmark study is crucial for ensuring your pricing aligns with market standards and can withstand scrutiny during M&A exits. This process involves comparing your intercompany transactions to similar deals between independent parties, helping to confirm compliance with the arm's-length principle.

During M&A exits, buyers will closely examine your transfer pricing practices during due diligence. If your pricing deviates from market norms, it could raise concerns, potentially affecting your valuation or delaying the deal.

Collect Comparable Data

The backbone of any benchmark study is solid financial data that accurately represents your business activities. Start by identifying the transactions under review - whether they involve product sales, service fees, or intellectual property licensing within your group.

Pinpoint the "tested party", which is typically the entity with simpler functions, as this makes benchmarking more reliable. Once identified, develop a strategy to locate external companies with similar operations, risks, and assets. Focus on businesses operating under comparable industry conditions and business models.

Choosing the right database is key. For example, Orbis provides extensive global data and is particularly helpful for analyzing financial transactions like interest rates. Such industry-specific databases are invaluable for finding accurate comparables.

When searching for comparable companies, keep in mind the preferences of local tax authorities. Some jurisdictions prioritize domestic comparables, while others accept regional data. If local options are limited, you may need to broaden your search, but be sure to document why a wider geographic scope was necessary.

High-quality comparables are crucial for credibility. Look for companies with reliable financial reporting, similar business cycles, and comparable operational complexity. Avoid businesses dealing with major restructuring, bankruptcy, or other unusual circumstances that could distort their financial results.

Once you've gathered strong comparables, use them to validate your pricing decisions.

Confirm Arm's-Length Pricing

With comparable data in hand, the next step is to ensure your pricing aligns with market norms. This involves statistical analysis and making adjustments where necessary to achieve accurate comparisons.

"This valuation principle is commonly applied to commercial and financial transactions between related companies. It says that transactions should be valued as if they had been carried out between unrelated parties, each acting in his own best interest." - OECD

Methods like the Comparable Uncontrolled Price (CUP) or Comparable Profits Method (CPM) can help calculate the arm's-length range. The CUP method is the most straightforward when reliable comparable data is available, as it directly compares your transaction prices with those of independent entities in similar situations. However, finding exact CUP comparables can be challenging, which is why many companies turn to profit-based methods.

Profit-based methods, such as CPM, analyze overall profit levels rather than specific terms or prices. The CPM approach has gained traction, as seen in the Coca-Cola Co. v. Commissioner of Internal Revenue case. In this instance, the IRS replaced Coca-Cola's long-standing "10-50-50" method with CPM, and the Tax Court upheld the decision, demonstrating how tax authorities can challenge even well-established transfer pricing strategies.

Thorough documentation is essential throughout this process. Record your criteria for selecting comparables, data sources, adjustments made, and the reasoning behind your analysis. This documentation is critical if tax authorities question your transfer pricing or if buyers request detailed explanations during due diligence.

When analyzing results, consider whether to use the interquartile range (25th to 75th percentile) or the full range of comparable data. The interquartile range is often preferred because it filters out extreme values that may not reflect typical market conditions. However, some tax authorities accept any result within the full range.

To maintain compliance as market conditions evolve, update your benchmark studies regularly. Many companies opt for annual updates, while others use a "roll forward" approach, refreshing key financial metrics without reselecting comparable companies. The frequency of updates should align with your industry’s volatility and the importance of the transactions being reviewed.

Step 3: Match Transfer Pricing with Exit Plans

Bringing your transfer pricing strategy in line with your M&A exit plan is essential to avoid delays and ensure your business is valued appropriately. This step requires a close look at how pricing policies influence valuation, as well as collaboration across legal, tax, and finance teams.

"It is increasingly important that sufficient focus and time is anticipated and ultimately given to TP in the M&A context." - Jon Vine and Greg Smith, Deloitte

Leaving transfer pricing considerations until the final stages of a deal often uncovers avoidable issues. By connecting pricing policies to your exit strategy early, you can address these challenges proactively, building on earlier policy reviews.

Check Effects on Business Valuation

Transfer pricing plays a direct role in shaping your company’s financial performance - and by extension, its valuation during an exit. If pricing isn’t aligned with market conditions, it can skew valuation, lead to buyer skepticism, and even delay deals.

Take the Ford Canada case as an example. Ford Motor Company’s privatization offer of $185 per share for Ford Canada faced pushback from minority shareholders, who argued that Ford’s transfer pricing policies had unfairly reduced the subsidiary’s value. The court found that Ford Canada had operated at a loss for 19 years due to inflated prices on vehicles purchased from Ford US. As a result, the court awarded shareholders $207 per share, plus up to $52.36 per share in historical damages - an increase of up to 40% over the initial offer.

To avoid similar disputes, review your transfer pricing results early - well before the year’s end. This gives you time to make adjustments and show potential buyers that your pricing aligns with real market conditions. Consider factors like changes in your company’s operations or shifts in tax regulations that might affect pricing.

Using tax modeling tools can also be a game-changer. These tools simulate different scenarios, helping you predict tax liabilities under various deal structures. By doing this, you can find approaches that maximize your after-tax proceeds while staying compliant.

When transfer pricing accurately reflects arm’s-length returns, it provides clarity on your business’s key value drivers. Buyers can better distinguish which parts of your company generate real economic value versus those benefiting from internal pricing arrangements.

Work with Legal and Financial Teams

Once you’ve assessed how transfer pricing impacts valuation, it’s time to collaborate with your legal and financial teams to implement any necessary changes. Ensuring compliance during an M&A exit requires seamless coordination across these departments.

Your legal team will handle the structural side of intercompany agreements, making sure contracts are enforceable and well-drafted. Meanwhile, the tax team focuses on meeting compliance standards and finding optimization opportunities. The finance team provides the data and analysis needed to back up pricing decisions.

Strong collaboration between your tax and legal teams is especially critical. Together, they can create intercompany agreements that not only stand up to buyer scrutiny but also reflect fair and reasonable pricing.

Entity management systems can simplify this process by keeping all essential information - like legal entity details, stakeholder data, and transaction records - organized and accessible. This ensures you’re prepared when buyers request documentation during due diligence.

Cross-functional teamwork helps avoid costly mistakes. For example, you’ll need to evaluate potential adjustments to transfer pricing, including retroactive changes, customs and duties implications, and how projected changes in business operations might affect pricing.

Special attention should be given to intangible assets. Any functions related to the development, enhancement, maintenance, protection, or exploitation (DEMPE) of these assets may require updates to transfer pricing arrangements to reflect the transaction’s impact.

Phoenix Strategy Group offers advisory services to help companies navigate these challenges. Their expertise ensures transfer pricing considerations are seamlessly integrated into your broader exit strategy, paving the way for a smoother transaction process.

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Step 4: Create Transfer Pricing Documentation

Thorough documentation is your best defense during tax audits and buyer due diligence. Without detailed records, your compliance stance could crumble under scrutiny. This is especially crucial in M&A exits, where buyers meticulously review transfer pricing compliance. Gaps in documentation can derail deals, lower valuations, or lead to lingering liabilities long after the transaction is finalized.

Gather Financial Reports and Supporting Data

Start by collecting key financial documents like financial statements, intercompany agreements, and benchmarking studies that back up your pricing decisions. Your documentation needs to go beyond basic profit and loss statements. Include transaction-level data, cost allocations, and performance metrics that clearly justify how you applied your transfer pricing policies.

Next, create a detailed map of how functions and risks are distributed across your entities. A solid functional analysis should outline entity roles, asset ownership, and risk allocation to support your profit distributions. This analysis is essential to show that your pricing policies align with the economic realities of your business.

If you're preparing for tax audits, consider building a transaction matrix that tracks all intercompany transactions. Include records of extraordinary business events that could have influenced pricing decisions. Maintaining these records proactively shows that you’re ready to explain unusual circumstances if needed.

Focus on contemporaneous documentation - records created when transactions occurred, rather than after the fact. Tax authorities give more weight to documents generated as part of regular business processes. Once your internal documentation is complete, ensure it aligns with specific regulatory standards in each country where you operate.

Meet Country-Specific Documentation Rules

While the OECD offers general guidelines for transfer pricing documentation, each country has its own unique requirements. The OECD’s Base Erosion and Profit Shifting (BEPS) Action 13 framework suggests a three-tiered approach: a master file, a local file, and country-by-country reporting. However, how these guidelines are implemented varies widely across jurisdictions.

Master File: This high-level document provides an overview of your global organizational structure, financial data, and transfer pricing policies. It’s designed to give tax authorities a broad understanding of your business and its interconnections.
Local File: This focuses on specific intercompany transactions within individual jurisdictions. It includes detailed financial records and explains how your transfer pricing strategies were applied locally.
Country-by-Country Report: This report offers a snapshot of your global income allocation, taxes paid, and economic activity in each jurisdiction.

Regulations are evolving, with enforcement becoming stricter. For example, in 2024, the IRS ramped up its transfer pricing audits, issuing 180 voluntary compliance letters to foreign-owned distributors by mid-November. Penalties for violations can be steep - ranging from 20% to 40% of understated tax. India also enforces stringent rules, with penalties of 2% of the transaction value for documentation failures and up to 300% of the tax sought to be concealed. These examples highlight the financial risks of non-compliance.

To avoid triggering audits or undermining your credibility, tailor your master file, local file, and country-by-country reports to meet the specific requirements of each jurisdiction. Inconsistencies across these documents can raise red flags with tax authorities.

Regularly review and update your documentation to reflect changes in tax laws and your business operations. What worked last year may not suffice as regulations shift in response to international tax initiatives.

For companies navigating these challenges, Phoenix Strategy Group offers advisory services to help meet complex documentation requirements, ensuring compliance across all jurisdictions and preparing for smooth M&A exits.

Step 5: Track Post-Exit Transfer Pricing Compliance

Even after an exit, transfer pricing responsibilities don't just vanish. A well-structured Operational Transfer Pricing (OTP) process ensures your policies align with your financial statements, especially as tax authorities ramp up their scrutiny.

Failing to monitor these processes can lead to costly quarterly or year-end adjustments. These adjustments not only highlight weak internal controls but can also trigger audits and hefty penalties - ranging from 20% to 40% of understated tax. To avoid these risks, maintaining detailed documentation and consistent monitoring is essential for ongoing compliance.

Set Up Monitoring Systems

Start by mapping out your current processes, pinpointing gaps, and defining your desired OTP framework. This isn’t a one-and-done task - it requires regular updates as regulations shift and your business evolves.

Conduct an inventory of intercompany transactions, focusing on those that could heavily influence your tax position or catch the attention of regulators. A good monitoring system should track these transactions in real time - not just at year-end when adjustments may come too late.

Automation plays a key role here. Automating OTP processes reduces manual errors, strengthens audit trails, and saves time. Companies that embrace automation often see lower operating costs, fewer penalties, and more bandwidth for strategic tax planning.

It’s also critical to evaluate year-to-date results well before the year ends. This proactive step allows you to make timely adjustments, understand what’s driving your results, and fix issues early. If adjustments are necessary, ensure they comply with jurisdictional rules and collaborate with your accounting and tax teams to record changes accurately and on time. Additionally, keep your FP&A team in the loop to update projections for the next fiscal year, and coordinate with legal teams to revise intercompany agreements as needed.

Once your monitoring systems are automated and adjustments are made, focus on preparing for potential tax audits by strengthening your dispute management strategy.

Handle Post-Exit Tax Audits

Tax authorities now expect more than standard documentation - they want detailed, context-rich files. To stay ahead of potential audits, include transfer pricing risk management as part of your ongoing tax planning rather than waiting for an audit notice to act.

Prepare comprehensive documentation that includes legal opinions, economic analyses, and supporting materials. This should demonstrate that your transfer pricing methods were reasonable and well-applied. Clear evidence of your analysis - covering functions, risks, intangibles, and value drivers - can save time for both your company and tax examiners.

Ensure your legal agreements align with day-to-day operations. Any inconsistencies can raise red flags during audits and weaken your transfer pricing position.

Develop a risk management framework to identify, assess, and escalate transfer pricing risks systematically. Regularly monitor dispute trends in key markets and review your tax risks to stay ahead. For significant intercompany transactions, consider adopting an Advance Pricing Agreement (APA) strategy to provide clarity and reduce audit risks.

Remember, over 75 countries now enforce formal transfer pricing documentation requirements, and these rules are constantly evolving. What worked last year may not meet today’s standards. Regularly review your documentation to ensure it reflects current regulations and your business’s reality.

For businesses navigating these intricate post-exit compliance hurdles, Phoenix Strategy Group provides advisory services to help maintain solid transfer pricing frameworks. Their expertise ensures you’re prepared for tax authority reviews across multiple jurisdictions, reinforcing your overall strategy for successful exit outcomes.

Conclusion: Key Points for Transfer Pricing in M&A Exits

Navigating transfer pricing in M&A exits demands careful planning and seamless collaboration to sidestep costly mistakes. As Chad Martin from Eide Bailly aptly states:

"Bad transfer pricing causes trouble for a long time."

To recap, the five-step approach discussed earlier serves as a practical guide for staying compliant while maximizing the value of an exit. Starting early is critical. Sellers who proactively address transfer pricing issues can avoid purchase price reductions, while buyers who understand the target's transfer pricing framework can streamline post-merger integration and save valuable resources.

Strong documentation and consistent oversight are the backbone of transfer pricing compliance. It’s essential to update transfer pricing documentation every 1–3 years to account for business changes and shifting regulations.

Collaboration across legal, tax, accounting, and finance teams is equally essential. Conducting transfer pricing due diligence helps prevent tax audits, ensures accurate valuation of intangible assets, and reduces reputational risks.

Intellectual property considerations further complicate the landscape. High-profile cases like those involving Coca-Cola and GlaxoSmithKline show how disputes over transfer pricing can lead to billion-dollar settlements. Even smaller-scale disputes, such as IBM’s, demonstrate the potential for significant financial impact.

Post-exit compliance is just as important. Tax authorities require detailed, context-specific documentation to validate transfer pricing methods. For companies with substantial intercompany transactions, Advance Pricing Agreements (APAs) can provide clarity and reduce the likelihood of audits.

FAQs

What risks can arise if transfer pricing isn’t aligned with an M&A exit strategy?

Not aligning transfer pricing with your M&A exit strategy can lead to major challenges for your business. These challenges include unexpected tax bills, compliance headaches, and heightened scrutiny from tax authorities - potentially resulting in penalties or financial adjustments. If transfer pricing doesn’t adhere to arm's length principles, the financial results of the transaction could take a hit.

On top of that, weak transfer pricing documentation can create complications during post-merger integration. Misaligned asset valuations or profit allocations might spark disputes, trigger delays, or even lead to financial setbacks. For cross-border M&A deals, failing to comply with stricter international regulations can further disrupt operations and derail strategic goals.

Getting transfer pricing right is essential to sidestep these risks and ensure a smooth, compliant M&A exit process.

How can companies ensure their transfer pricing documentation complies with different countries' regulations?

To navigate transfer pricing regulations effectively across different countries, businesses need a well-organized and forward-thinking strategy. Begin by familiarizing yourself with the specific rules and documentation requirements in every country where your company operates. This often means creating detailed local files that explain the pricing methods you’ve chosen, the economic reasoning behind those methods, and the financial data of the entities involved.

It’s equally important to keep this documentation up to date, especially as regulations change. Staying current with international frameworks, like those from the OECD, can help maintain consistency and minimize the risk of disputes with tax authorities. Additionally, investing in regular training for your compliance teams and performing periodic audits can enhance your transfer pricing processes, ensuring they align with both local laws and global expectations.

Why is transfer pricing important in valuing a company during an M&A exit?

Transfer pricing plays a key role in determining a company’s value during mergers or acquisitions. It ensures that profits are tied to the actual economic activities of the business, offering a transparent view of its financial condition and operational efficiency. This clarity is essential for accurately projecting future cash flows, a critical factor in valuing the company.

Well-structured transfer pricing policies not only highlight genuine value creation but also minimize risks tied to tax compliance. By tackling these aspects, transfer pricing can improve deal outcomes while protecting against financial and regulatory hurdles.