A corporate restructuring—such as transferring functions, assets, or risks from one group entity to another, converting a full-risk distributor into a limited-risk distributor, or centralizing certain functions or intangibles in a single jurisdiction—may be based on legitimate business reasons.
From a Transfer Pricing perspective, the critical issue is not merely whether the restructuring has a business rationale, but rather determining precisely what changed between the parties, what economic value may have been transferred, and whether the agreed-upon terms are consistent with the arm’s-length principle.
The first step: define the restructuring precisely
The OECD Guidelines require an analysis of the transactions that make up the restructuring and a comparison of the parties’ situations before and after the change.
This involves reviewing the functions performed, the assets used, the risks assumed, the contractual rights, and the economic circumstances of each entity involved.
The business rationale for the restructuring, the expected benefits, and the options realistically available to each party must also be analyzed.
A transaction may be beneficial to the group as a whole and yet require further analysis to determine whether an independent company would have accepted the same terms, given its own economic position and the alternatives available to it.
What is being transferred, and how should the consideration be analyzed?
One of the most sensitive aspects of a restructuring is determining whether any item of economic value was transferred.
This may include tangible or intangible assets, contractual rights, an ongoing business activity, functions that are now performed by another entity, or certain economic positions associated with the business.
The analysis must determine whether, under comparable circumstances, independent parties would have agreed to compensation for such a transfer and, if so, what the arm’s-length value would have been.
However, a reduction in an entity’s expected profit does not automatically give rise to a right to compensation. It is necessary to identify whether there was actually a transfer of an element of value or a modification of rights that, between independent companies, would have given rise to compensation.
Termination or renegotiation of agreements: compensation is not automatic
Restructurings may also involve the early termination or substantial renegotiation of existing contracts or business relationships.
In such cases, it must be determined whether an independent company, under comparable circumstances, would have demanded compensation or indemnification.
Depending on various factors—including the contractual terms, the rights of the parties, the expected duration of the relationship, economic circumstances, and realistically available options—the answer will vary.
Therefore, it should not be assumed that every termination or renegotiation automatically gives rise to a right to compensation.
The most expensive mistake: not distinguishing between the “before” and the “after”
One of the main documentation risks arises when the post-restructuring Transfer Pricing analysis is limited to describing the new structure without adequately explaining the transition.
The documentation should make it possible to identify:
- which functions, assets, and risks existed before the restructuring;
- which ones remained and which ones were transferred;
- which entity began to perform the new functions or assume the new risks;
- whether assets, rights, or other elements of economic value were transferred;
- how, where applicable, the arm’s-length compensation was determined; and
- how the remuneration of the entities was determined after the restructuring.
This comparison is particularly relevant, for example, when a full-risk distributor becomes a limited-risk distributor. In that scenario, it is not enough to simply apply a new margin policy going forward: it is also necessary to analyze which functions, risks, assets, or rights the entity previously held and whether any of them were effectively transferred as a result of the restructuring.
The transition is also part of the transfer pricing analysis
Restructuring should not be analyzed exclusively based on the resulting structure.
The transition from the previous model to the new model may involve transactions that require separate valuation: transfers of assets, intangibles, contractual rights, operating activities, or substantial changes in economic relationships between related entities.
Therefore, the defense of a restructuring is stronger when there is consistency between the business rationale, the contracts, the parties’ conduct, the valuation of the transferred assets, and the subsequent remuneration of each entity.
At TPC Group, we assist multinational groups in planning and documenting corporate restructurings, evaluating the precise definition of the transaction, the options available to each party, and the arm’s-length compensation that may apply based on the economic characteristics of the restructuring.
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