Transfer Pricing Considerations for Private Equity Funds
Private equity funds have to analyze their transfer pricing from multiple angles. There are the fund level considerations consisting of related fund services and transactions as well as fund financing; there are also portfolio company considerations consisting of transactions, operation expansions, asset transfers and reorganizations of the companies which the fund is invested in.
Fund Level Considerations
Transfer pricing considerations often arise when many funds are managed by the same fund managers. Funds under common management and their investments are considered related parties. Private equity funds with multinational operations often provide services including investment management, sourcing, and general back office services by a related party fund or portfolio company. These services and transactions need to be evaluated to the arm’s length standard review under Treasury Reg. 1.482-9.
The financing of private equity transactions can also involve transfer pricing issues. When private equity transactions are made through a number of separate funds with common control, the loans are subject to the arm’s length standard. This is a relatively new concept in some tax jurisdictions, such as in the United Kingdom, where in 2005 legislation was widened specifically to catch more private equity transactions.1
In the case of Sun Capital Partners III v New England Teamsters & Trucking Industry,2 the court found that two private equity funds were engaged in a trade or business and that they were under “common control” with a portfolio company. While this was not a tax case, it suggests that many third-party commenters believe that portfolio companies and funds with common ownership of a company are considered related parties for tax purposes.
Portfolio Company Considerations
Private equity portfolio companies face the same transfer pricing rules and regulations as any organization. However, when a PE fund invests in a portfolio company, they often reorganize the company, transfer assets or expand operations. Assessing the risk in these endeavors is particularly important prior to the acquisition or disposition of a company.
Additionally, some large portfolio companies are now subject to country-by-country reporting under the OECD’s Base Erosion Profit Shifting Act (“BEPS”) Action 13. BEPS was enacted to eliminate tax planning strategies that exploit gaps and mismatches in tax rules in order to maximize profits. A multinational portfolio company faces the same reporting standards even if it is fully owned by a fund based in one country.
Deemed Repatriation is a major consideration for all corporations with a global footprint but increasingly applicable to private equity portfolio companies. Under the Tax Cuts and Jobs Act (“TCJA”), any U.S. shareholder with 10% or more of a foreign corporation must include income for its proportionate share of the foreign corporation’s undistributed earnings if the foreign corporation is a controlled foreign corporation or one shareholder is a U.S. corporation. This will create substantial taxable income both at the fund level and for sponsors investing in the fund. Investors with 10% or more ownership in a foreign portfolio company may be subject to additional income for the tax year of 2017. This is especially relevant as many funds have owners in several different countries.