Transfer Pricing Insurance: a Game-Changer?
The attention for transfer pricing seems ever-increasing. Many tax authorities have embraced the topic as their favourite ‘go to’ in tax audits. The intensity and likelihood of having transfer pricing discussions is further fuelled by a substantial increase in transparency and a more fluid regulatory context, as many corner stone terms and concepts are subject to different interpretations.
By: SAMMY SHIHAB and RAYMOND DE LOOZE
Introduction
The attention for transfer pricing seems ever-increasing. Many tax authorities have embraced the topic as their favourite ‘go to’ in tax audits. The intensity and likelihood of having transfer pricing discussions is further fuelled by a substantial increase in transparency and a more fluid regulatory context, as many corner stone terms and concepts are subject to different interpretations.
Options on the table
A transfer pricing insurance puts a fundamentally new option on the table, in addition to the more ‘classical’ alternatives.
The first and most common option is to simply take a position on the transfer pricing policies, prepare proper documentation and defend it when challenged by authorities. Arbitration or a MAP may be used to ultimately secure the position or to have a corresponding adjustment.
If a taxpayer wishes to further reduce its transfer pricing risk profile, he may decide to solicit an APA. Unilateral or bilateral. Provided the company acts in line with the agreed conditions and representations, this should effectively limit transfer pricing exposures.
And now there is the possibility to get an insurance on transfer pricing risks. A transfer pricing insurance policy can relate to both sides of the transaction. In such cases, it is effectively the equivalent of a bilateral APA, as it eliminates the risk on the entire transaction from the taxpayer’s perspective.
So how do these options compare and why can transfer pricing insurance likely have a significant effect on transfer pricing risk management?
We have listed five key elements below.
Better price in M&A deals
Transfer pricing can lead to material risks and can thus be an important element in M&A transactions. This means that the buyer may seek a substantial price reduction to compensate for the risk. A transfer pricing insurance can prevent that. The seller may therefore consider getting transfer pricing insurance to avoid having to give a discount. A buyer may opt for insurance to eliminate the risk. Effectively, parties can make the insurance and its premium part of the deal dynamics and negotiations.
Fast results
Getting transfer pricing insurance can be relatively fast, specifically as compared to (bilateral) APA processes that can take up to multiple years to complete. If they ever lead to a signed version.
A typical transfer pricing insurance process includes a preliminary assessment to see whether there is a decent likelihood of the risk being ‘insurable’ at all. If so, the analysis will move to the next level of detail to assess what (maximum) exposure should be covered and what the terms and conditions of the insurance would be. Including the pricing conditions. All key points will obviously be covered in the insurance policy, including the (factual) representations to be made.
Using our balanced risk assessment methodology, it would typically take no more than a couple of weeks to get through the entire process. Specifically for financial transactions. Insurance for the transfer pricing of goods and services or wider business models may take a bit longer, depending on their complexity and the scope of the coverage.
Sharing information
An often-perceived disadvantage of an APA is that you have to give full transparency to authorities at a point in time where the outcome of the process is uncertain. That may particularly be the case in bilateral APA processes, where negotiation dynamics can be unpredictable. That means that if no agreement is reached, authorities will already have collected all potentially relevant information. And they can be expected it to use it to their advantage.
With a transfer pricing insurance, having solid insight in the situation and its key facts and circumstances is obviously important as well. If you want a fire insurance for your home, the insurer wants to make sure you do not store gasoline in your garage. It is just you don’t have to share all detailed insights with tax authorities, yet.
Avoid controversy cost
So what happens if the insured risk gets challenged by authorities? Well: the insurer will then take ownership of the process and take things forward. Defend the position, or let it go and settle the claim. This makes sense, since it is effectively the insurer’s risk.
The good news for the taxpayer is that the insurer will also bear the cost of defending its position. The insurer will seek to optimize the balance between the exposure at stake, the likelihood of success and the cost for getting through the controversy process.
The taxpayer will have to support the insurer with providing background, insights and information, as appropriate. In practice, there are typically various technical discussions. This is important, since for the taxpayer the insured risk may have effects on other pending discussions or tax risks as well. Those taxpayer interests obviously need to be monitored as well.
Avoid tax reserves
Insurance means translating an uncertain risk (= the transfer pricing exposure) into a certain cost (= the insurance premium). This may help reducing your tax expenses and uncertain tax positions on the balance sheet. On either side of the transaction.
Accordingly, if tax insurance is obtained for a transfer pricing position for which a tax accrual was already included on the balance sheet, your balance sheet performance ratios could be positively impacted.
So what do you think: will transfer pricing insurance be a game-changer?