Transfer Pricing vs. Financial Reporting (Accounting) Valuations: What Are the Key Differences?

Many tax authorities would generally not accept the results from an accounting valuation for a transfer pricing purpose without additional substantiation. For example, the OECD Transfer Pricing Guidelines state:

[Valuations] of intangibles contained in purchase price allocations performed for accounting purposes are not determinative for transfer pricing purposes and should be utilized in a transfer pricing analysis with caution and careful consideration of the underlying assumptions. [1]

When taxpayers use a valuation in the context of an intercompany transaction, they should ensure that the valuation analysis is in agreement with the “arm’s length principle” and the transfer pricing rules of the jurisdictions involved.

When Is a Transfer Pricing Valuation Needed?

Transfer pricing valuations are often required when taxpayers engage in the intercompany transfer of intangible assets such as patents, technology know-how, trademarks or customer relationships, among others. A transfer pricing valuation may be needed too when a taxpayer engages in a business restructuring which relocates functions to a different entity or results in the transfer of profit potential or a “going concern.” While the formal definition of going concern may vary across jurisdictions, generally this situation involves the transfer of a group of interrelated assets, functions and/or future profit opportunities.

Tax authorities may also reference to the arm’s length principle for transfers of equity holdings (shares) among related parties if the shares are required to be transferred at fair market value.

Why May an Accounting Valuation Not Meet the Transfer Pricing Requirements?

One common reason why a transfer pricing valuation may not yield the same results as an accounting valuation are differences in the definition of what is being valued. A typical transfer pricing fact pattern involves a multinational group acquiring a third-party business and then transferring cross-border certain intangibles to an affiliate. The purchase price allocation study prepared for accounting purposes may apply a narrower view to what constitutes an “identified intangible” whereas tax authorities following transfer pricing principles may use a broader lens. Tax authorities may also argue that for transfer pricing valuations attention should also be paid to the allocation of the expected synergy benefits, the tax interpretation of the control premium, the valuation of routine functions that remain behind and the effects of taxes.

Another important difference that taxpayers may encounter in audits is the perspective from which the financial projections and assumptions were prepared. Financial reporting valuations often adopt the one-sided perspective of a representative market or industry participant. Synergies, discount rates and other valuation inputs are set at levels consistent with what the average industry participant may be able to realize. In contrast, tax authorities are rather interested in how the attributes of the specific seller and buyer engaging in the transaction inform the valuation outcome. The Dutch Transfer Pricing Decree emphasizes this point:

[Valuations] should be done from the perspective of all parties involved in the transaction to arrive at an arm's-length price. The arm's-length price will lie between the value of the intangible asset from the perspective of the seller and the value from the perspective of the buyer (unless the value from the perspective of the seller is higher than the value from the perspective of the buyer). Thus, the value resulting from the application of a valuation method is not the same as the arm's-length price for the transaction.[2]

In our experience, similar arguments are often raised by other tax administrations too.

How Can Taxpayers Comply with the Transfer Pricing Requirements on Valuations?

A clear first step is not to assume that a valuation prepared originally for a different reason can be used for transfer pricing purposes. Taxpayers should also define properly the transaction to ensure the right “perimeter” is set around what is being valued. While situations that involve the transfer of a single, well-defined asset, such as an individual patent or trademark, are more straightforward, transfers involving multiple assets and/or functions require more detailed factual analysis to establish if the valuation should focus on these components individually or value them as a “business.” 

Next, when preparing financial projections, it is important to account for differences in how the buyer and seller may exploit the valued asset. For example, the buyer may have lower operating costs which implies the asset could be worth more under the buyer’s ownership. Lastly, taxpayers should strive for consistency between the valuation and the transfer pricing policies implemented after the transaction. Suppose that the valuation for transfer pricing purposes relies on 5% royalty income as an assumption. If the company’s transfer pricing policy would allow the buyer of the valued asset to license it at a 7% royalty rate in the future, additional substantiation for this discrepancy would be expected.

These examples are just a few among many relevant considerations when preparing transfer pricing valuations. If you would like to know more, please reach out to KPMG’s tax valuation specialists. Our team understands the nuances involved in preparing robust valuations for tax purposes and has extensive experience working with the Dutch Tax Authorities to resolve valuation-related disputes. 

[1] OECD (2022), OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022, OECD Publishing, Paris, https://doi.org/10.1787/0e655865-en. See Par 6.155.

[2] Decree of 14 June 2022 no. 2022-0000139020, Staatscourant 2022, no. 16685.