Alternative Investments

Navigating Transfer Pricing in the World of Alternative Investments—Part 2

As complex as transfer pricing issues can be at the management company level, some thorny and unique transfer pricing challenges are also observed at the fund level.

Transfer Pricing at the Fund Level

There are a multitude of cross-border and intra-country transfer pricing considerations when it comes to funds and their investment activities. And transfer pricing policies can also impact a number of areas beyond direct corporate tax liabilities.

One common transfer pricing issue that arises is intercompany financing. This can happen when a private equity firm acquires a target company and, as part of the transaction structuring, intercompany debt is introduced into the target group structure. There are also often “blocker corporations” set up as part of investment fund structures investing in U.S. real property, through which certain classes of investors—typically non-U.S.—can participate in the investment funds in a tax efficient manner. These blocker companies are often financed through a mixture of equity and shareholder loans from the investors. In such cases there is a need to determine the arm’s-length interest rate for the intercompany debt.

In addition, while some countries evaluate the magnitude of intercompany (and other) debt through thin cap rules, in the U.S., the U.K. and other countries, there is a need to specifically evaluate the “debt capacity” of the borrowing entity. This can include assessing the ability of the borrower to service interest and principal payment obligations, to help support characterization of the intercompany financing as debt and not equity from an economic perspective.

Benchmarking interest rates and establishing debt capacity for corporate loans can in some cases be a relatively straightforward process—starting with an evaluation of the credit risk of the borrower. However, this is not necessarily the case in the alternative investments sector, where intercompany loans are often used to finance assets whose credit risk is not easily understood or analyzed. For example, if the shareholder loan is used to capitalize a corporation that invests in real property, one may not be able to reliably analyze the credit risk of the shareholder loan without understanding some specifics of the underlying property. Similarly, what is the most reliable approach to analyzing a shareholder loan for a credit fund where the underlying investments are loans of varying quality and risk?

Also interesting are the transfer pricing issues raised when there are financial guarantees or loan facilities provided by the fund or other entities in the structure. Or when tax and transfer pricing professionals provide guidance on structuring the intercompany financing and terms:

  • Can interest be accrued?
  • What happens if the fund outlives the term of the intercompany loan?
  • What if not all the monies are needed at the outset of the loan?
  • Should multiple borrowers be set up, with one for each underlying investment?
  • Is there an economic value to any guarantees provided?

It is very important for transfer pricing practitioners to be working hand-in-hand with tax advisors and business representatives to understand the importance of tax issues such as withholding taxes and deemed dividends—and their impact on structuring and pricing intercompany financing transactions.

In a private equity context, transfer pricing can also play a critical role post-acquisition of a portfolio company in evaluating and supporting tax efficient structures, such as centralized ownership of intangible property. If a private equity fund is looking to restructure a portfolio company, these changes may often require the revision of transfer pricing policies at the acquired company.

Other interesting issues arise when transfer pricing principles are used to address separate tax matters. For example, the allocation of management fees between a fund and real estate investment trust (REIT) to avoid onerous preferential dividend taxes in the U.S. Or the pricing of transactions between non-taxable entities and their taxable affiliates or subsidiaries. It may also be important to help isolate income in a U.S. service provider to ensure that foreign investors are not engaged in a U.S. trade or business, which may put them within reach of the U.S. tax net.

Recent Developments in the Transfer Pricing Environment

Transfer pricing enforcement and best practices have evolved significantly over the past few years, including for the asset management industry. With the Base Erosion and Profit Shifting (BEPS) project, revisions to the Organization for Economic Cooperation and Development (OECD) transfer pricing guidelines, and an increase in transfer pricing controversy worldwide, transfer pricing practitioners have probably seen greater change in the last five years than the prior few decades.

Cutting across all these changes are three themes—aligning conduct with contractual arrangements, adjusting transfer pricing policies as businesses evolve, and transparency with respect to tax and transfer pricing policies and results. These themes are especially relevant to the alternative investments sector, at both the management company and fund levels.

U.S. Coca-Cola Case
Recently, the Internal Revenue Service in the U.S. won a very large transfer pricing litigation involving The Coca-Cola Company’s overseas manufacturing affiliates, with a potential transfer pricing adjustment exceeding $9 billion just for the 2007-2009 audit period (see The Coca-Cola Co. v. Commissioner). The decision in favor of the IRS revolved around a few key elements, including: (1) contractual agreements that the U.S. Tax Court determined were not clear in establishing the rights and responsibilities between the parent company that was the legal owner of the brand intangibles and the manufacturing affiliates; (2) conduct that the Tax Court determined was misaligned with positions asserted by Coca-Cola; and (3) large profits in the manufacturing affiliates for undertaking what the Tax Court characterized as relatively routine functions with minimal risks.

The Coca-Cola litigation is not an isolated example; there are numerous transfer pricing audits worldwide examining whether the conduct of a multinational enterprise is consistent with its contractual arrangements. This may not be a straightforward exercise for an investment manager. The complicated structures of many alternative investment firms—with feeder funds and main funds, general partners, management companies, special purpose entities holding investments, etc.—as well as the multiple roles often played by the key decision makers, can make it challenging to ensure transfer pricing policies are aligned with actual conduct. Furthermore, the rapid growth of many industry players, including into new asset classes which may involve unique intercompany transactions, creates additional challenges for updating transfer pricing policies in a timely manner.

Moreover, it is important to point out that although Coca-Cola was following the terms of a prior IRS settlement concerning its transfer pricing policies, the IRS was successful in arguing that the company’s transfer pricing policies for 2007-2009 were not consistent with its business operations. Tax authorities expect transfer pricing policies to be updated as functions of the relevant parties evolve over time, i.e., transfer pricing policies should not be viewed as “evergreen.” If a taxpayer’s transfer pricing policies have not yet been meaningfully audited, it should not assume that they won’t be in the future.

Tax transparency starts with providing evidence to tax authorities to support and defend transfer pricing policies. It is no longer enough to create or commission a transfer pricing report annually; tax authorities are reaching further into a taxpayer’s files for additional support.

For example, the Indian tax inspectors are known to ask for email trails to support that intercompany services were indeed provided. The U.K. recently put forth a proposal for taxpayers to keep an evidence log of emails, interview notes, etc. alongside the transfer pricing report. Other tax authorities are scouting LinkedIn and other sources to understand value drivers and requesting compensation information to review whether employees’ remuneration matches the characterization of their functions and contributions.

Other manifestations of transparency involve the provision of raw data to tax authorities, primarily under the country-by-country (CbyC) reporting regime that was introduced under the BEPS project a few years ago. Larger multinationals are required to report information such as revenue (including intercompany revenue), assets, functions and taxes paid by country. This information is to be shared among tax authorities in all jurisdiction in which the taxpayer operates, and it may provide a distorted view of business metrics and their relationship to tax liabilities.

Managing and explaining all this information to a tax authority, or multiple authorities, can require significant resources, especially for alternative investment firms (particularly smaller ones) that typically feature unique structures and run with a lean infrastructure.

Finally, there are today increasing worries about the potential for public tax transparency, including making some CbyC data public, especially in the EU.


Alternative investment firms are a growing component of the asset management industry and overall economy, raising their profile with tax authorities. Tax authorities are devoting resources to better understand the complex structures of investment firms and the resulting transactions, at both the management company and fund levels, and increasingly coordinating among themselves. Consequently, business as usual when it comes to managing transfer pricing risks and opportunities is becoming a less viable option for alternative investment managers. Sophistication in the analysis and benchmarking of various intercompany relationships must keep up with this evolving environment.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Vinay Kapoor is a principal in the Economic Valuation Services practice of KPMG LLP, Sherif Assef is a principal in the Washington National Tax practice of KPMG LLP, Brett Fieldston is a principal in the International Tax practice of KPMG LLP, and Anthony Brown is a transfer pricing partner at KPMG Canada.

The information in this article is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at

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