Global Unpredictability Calls for Transfer Pricing Risk Planning

Geopolitical turbulence is rattling mergers and acquisitions markets in the UK and internationally, as evidenced by a report from the Office of National Statistics highlighting a slump in UK M&A activity towards the end of 2024.

Dealmakers and their advisers have understandably become more risk averse amid economic, regulatory, and political uncertainty. They’re also facing unpredictability in that most notorious of life’s two certainties: tax.

Fortunately, good tax planning, allied with tax insurance, can minimize many categories of tax risk relevant to M&A deals. The evolution of the transactional risk insurance market means that more categories of tax risk can be insured, easing investor concerns and facilitating M&A transactions.

A key area that policies can cover is transfer pricing. One of the most complex and contentious areas of tax, it’s often a key factor when it comes to assessing and structuring proposed transactions between related entities.

The UK government’s corporate tax roadmap aims to provide certainty for investors, and it does promise to keep the rate at 25% for the lifetime of the current government. But while the headline corporation tax rate may be predictable, investors are concerned about potential changes to the UK’s transfer pricing rules, which could have serious tax implications for transactions.

In a multinational group, changes to the tax rules in other jurisdictions can greatly affect a deal’s viability as well, so the international consensus also matters.

The UK government’s corporate tax roadmap suggests that it remains committed to the two-pillar global tax plan from the Organization for Economic Cooperation and Development. However, the government has indicated that it will soon consult on potential rule changes that could include reducing existing thresholds for medium-sized businesses so that they fall within the existing transfer pricing rules.

The government also may look at new measures for sharing of intellectual property across group companies, which can be a key factor in international corporate tax structures. It also has flagged potential new reporting requirements for multinational enterprises involved in cross-border group transactions.

Transfer pricing regulations essentially require that intragroup transactions be conducted at arm’s length. In simple terms, they should mirror the sort of conditions that would apply between independent parties. These rules are designed to prevent artificial profit shifting and tax base erosion by ensuring that profits are taxed where economic activities and value creation take place.

Given the complexity of transfer pricing arrangements, it often had been difficult to secure transactional risk insurance relating to them. Such risk typically was excluded under many warranty and indemnity insurance policies. That means a separate specific tax insurance policy was the only feasible insurance solution if the M&A parties were concerned about an identified transfer pricing risk.

The willingness of insurers to cover transfer pricing risks more generally traditionally was limited. However, insurers became more willing to offer this cover for intercompany debt or shareholder loans—particularly as regards interest rate risk. Such cover has become the primary focus of tax insurance for transfer pricing, and underwriters are becoming more comfortable insuring these risks.

Tax insurance has broadened further still to include transfer pricing risks beyond intercompany debt. This expansion in cover reflects the increasingly complex nature of global business operations and the increased capabilities of insurance brokers and underwriters to address and mitigate these exposures.

Underwriters’ comfort levels with insuring such risks depend on available access to clear documentation, as well as robust planning and advice around the specific scenario.

Outside of intercompany debt coverage, tax insurance also is being used to cover transfer pricing risks including intellectual property allocations, intercompany services, and tangible goods transactions.

For both debt-related and non-debt-related risks, a robust transfer pricing benchmarking study is crucial. These studies provide the necessary evidence that prices or interest rates applied are at arm’s length, giving underwriters the ability to insure such risks. Each risk is individually assessed, depending on the specific facts of a particular matter.

Another factor that gives underwriters the ability to offer more comprehensive cover is when similar arrangements in previous tax years have been audited without challenge.

The insurability of such risks depends heavily on the jurisdiction involved; countries have different regulations and enforcement practices. This, of course, influences the risk assessment and scope of cover that underwriters can obtain. Therefore, when designing a tax structure, it’s wise to use jurisdictions whose policies provide greater certainty.

When used efficiently and effectively, tax insurance can provide a safety net for companies, allowing them to better manage the financial risks associated with M&A, overcome uncertainty, and facilitate deals which may not have happened otherwise. It can be a risk mitigation strategy for a group facing the sort of complex transfer pricing challenges that can arise during transactions.

As tax authorities in the UK and overseas increase their scrutiny of transfer pricing, dealmakers and their advisers should adopt more robust risk management strategies. When allied to careful and expert tax advice, tax insurance can offer a pragmatic risk management solution and help dealmakers get transactions over the line, even in a time of increased uncertainty.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

James Wilson is head of M&A and transactional risks for Factor Risk Management.

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