Can the valuations used for financial reporting be used for transfer pricing and tax reporting?

Both the IRS and the OECD have pointed out that valuations of intangible assets (“IP”) for financial reporting and transfer pricing are not exactly the same, and taxpayers should not assume that financial statement auditors and tax authorities would accept one for the other.

Under US GAAP and IFRS Fair Value is the benchmark for the price that would be received to sell an asset or paid to transfer a liability between market participants at the measurement date.

For Transfer Pricing (tax reporting) purposes the Arm’s Length Standard is the benchmark to achieve the results that would have been realized between uncontrolled taxpayers.

Although similar, financial reporting and transfer pricing definitions of IP are different in several areas which often lead to different valuation results.

Aggregation Approach For Financial Reporting And Transfer Pricing

Financial reporting focuses on tangible and intangible assets acquired and liabilities assumed. Excess is recorded as goodwill. Fair value is measured in the aggregate, and then is assigned/allocated to Reporting Units which may span across different legal entities and geographical locations.

Transfer pricing looks at a bundle of intangible assets and focuses on the legal entity level.

Goodwill And Buyer Specific Synergies

Financial reporting tends to exclude buyer-specific synergies (such as completing the product line of the buyer for market shares). Such synergies would be reflected in the residual goodwill if paid for as part of the purchase price.

Transfer pricing analysis tends to include such synergies in the arm’s length price for the intangible assets separate from goodwill.

Treatment Of Future Technology

For financial reporting purposes existing technology or IPR&D is valued at the date of acquisition and the value of the right to create future business opportunity is treated as goodwill. On the other hand, for transfer pricing analysis, both the value of the technology currently and the value of the technology’s contribution to future development efforts are taken into consideration as intangible assets separate from goodwill.

Post-Tax vs. Pre-Tax Cash Flows

Financial reporting valuation is performed on a post-tax basis while transfer pricing/tax valuation is performed on a pre-tax basis

Motivating Factors

For financial reporting purposes low value for IP means low amortization expense in the future and therefore higher net book income. However, long-lived or indefinite- lived IP and goodwill are tested impairment.

For tax/transfer pricing purposes while taxpayers would prefer higher tax deductions through amortization of IP, tax authorities are concerned about protecting the domestic tax revenue base.

Key Take-Away – Valuation For Financial Reporting And Transfer Pricing Should Be Coordinated Together To Achieve The Following Benefits:

• Significant time savings are realized through joint interviews

• Cost savings result when same comparables are leveraged

• Utilizing same initial financial projections reduces company management’s time and provides for consistency in financial data for projection.

• Differences between financial reporting and transfer pricing valuations are properly and timely addressed. This will in turn:

♦ enhance the company’s ability to support its transfer pricing positions for tax provision reserves and tax audit purposes;

♦ provide assurance to financial statement auditors, company board members and investors.

 In accordance with Circular 230 Disclosure