Special Purpose Acquisition Companies (SPACs) have undergone a renaissance over the past couple years, and in particular during 2021.1 SPAC IPO activity has seen explosive growth, as the number of SPAC IPOs during 2020 was nearly four times the 2019 total, and the first quarter of 2021 alone has already eclipsed the record high 2020 totals. Specifically, as of the beginning of 2021, there were over 400 SPACs actively seeking acquisition targets and an additional 247 SPACs have filed for IPO in the first quarter of 2021. It remains to be seen how well the SPAC market helps identify targets and execute acquisitions as only 26 de-SPAC transactions have been completed in the first quarter of 2021.
As SPACs continue to look for targets (notwithstanding the valuation issues that have recently been put forward by the SEC), it is likely that many target companies will have multinational operations and, as such, will be subject to transfer pricing rules. It is also likely that some de-SPAC transactions may involve U.S. domestic companies acquiring companies with international operations, creating new transfer pricing issues for those acquiring entities. Similarly, in the case of a SPAC transaction involving a spin out, understanding how the spin company will transact between related parties, and how that may differ from the company from which it will be spun, is critical. There may also be transactions, such as temporary services agreements, between the spin company and the remaining company that need to be priced considering the arm’s length standard. Spin companies should also be aware of the transfer pricing issues associated with any anticipated intercompany financing or leverage pushdowns that may be contemplated.
Needless to say, as SPACs take advantage of investment opportunities in jurisdictions beyond the U.S., there will be an obvious increase in the transfer pricing (TP) challenges and risks associated with international operating models. This expansion, together with the overall attention on TP aspects of international business, more generally, will raise TP risk management issues for the group. In this article, we discuss some pre- and post-acquisition transfer pricing issues to keep in mind.
For any acquisition, financial due diligence is necessary for a prudent investor to understand and evaluate the risks associated with the target. Tax is generally a critical component of financial due diligence; however, transfer pricing, despite falling under the tax umbrella, is often overlooked or the due diligence review is limited. Given the fact that transfer pricing has become a key focus of taxing authorities, it merits more than just a cursory review. Frankly, transfer pricing risks in the context of acquisitions are often hidden from plain sight and need to be carefully identified and addressed in the diligence process to avoid tax surprises post acquisition. Likewise, there may be hidden opportunities for the newly combined entity to take advantage of that the diligence process can uncover.
At a minimum, transfer pricing diligence should address the following:
- Identify intercompany transactions of the target and assess the related transfer pricing policies:
- Certain controlled transactions may be more readily identifiable, while others may not be as apparent and may require a deeper dive into the target’s operations, including, for example, financial guarantees and intangible-related transactions.
- Request any existing transfer pricing documentation prepared for the target. If none exists, it may be necessary to evaluate the arm’s length nature of the material intercompany transactions to assess the magnitude of risk.
- Understand audit history and any audit-related transfer pricing inquiries (or controversy)
- Asking about the transfer pricing audit/controversy history of the target helps indicate which jurisdictions and transactions pose higher risks
- Identify value-driving intangibles and understand intangible ownership structure
- Take time to understand the legal and economic owner(s) of the valuable intangibles that can have substantial contributions to value. Transfer pricing due diligence should also consider whether the substance of the intercompany transaction is consistent with the form explicitly put in place by the company.
Evaluating and taking inventory of the transfer pricing risks allows the investors to: (1) have more transparency into the risks of their investments, and therefore to make more informed decisions about investing; and (2) negotiate a purchase price that reflects the inherent risks. In certain cases, investors will walk away from a deal because the diligence process uncovered transfer pricing risks that were too large to handle in negotiations. All that said, aside from the risk management perspective, transfer pricing due diligence often identifies planning opportunities that can add value to the investment (e.g., optimizing transfer pricing policies or modifying the organizational structure to lower the effective tax rate).
Another area where transfer pricing comes into play is in the de-SPACing process. While sponsors seeking domestic targets, typically, set up a domestic SPAC and sponsors seeking foreign targets set up a foreign SPAC, there may arise situations where a foreign SPAC identifies a domestic target (and vice versa). In these instances, the SPAC would, typically, attempt to expatriate to the jurisdiction of the foreign target prior to business combination, requiring a valuation for tax purposes. Any such tax valuation would need to consider the current and anticipated transfer pricing policies and may need to model in the transfer pricing impact of any plans to reorganize or restructure the target post-acquisition. Regardless, there will likely be a need to align transfer pricing policies from either the acquirer or target perspective (and sometimes both) and an acquisition can be an ideal time to make changes to the location of economic ownership of IP.
In short, many issues related to transfer pricing that are relevant for SPACs are similar to those present in any acquisition involving a multinational target company. However, given the speed with which SPAC acquisitions need to take place, the ability to quickly perform transfer pricing due diligence will be key to successful mergers.
1.Data referenced in this first paragraph is available in the Duff & Phelps Market Report: Special Purpose Acquisition Companies. Spring 2021.