International tax issues for newly multinational corporations: a due-diligence perspective.

• Author: Weber, Mindy Tyson

A taxpayer that ventures into international business by acquiring a multinational target may encounter a number of tax issues that could result in significant unanticipated tax liabilities. Both sellers and buyers should perform a thorough and thoughtful due-diligence review to identify all potential tax (and other) exposures to arrive at a final purchase price that reflects the parties' best assessment of the value of the business.

Proper due diligence will allow the buyer to request any warranted purchase price reductions (or an increase of tax escrow). Additionally, thorough due diligence will allow the buyer to demand the best possible valuation of an acquisition target. While these issues vary from case to case, four areas of tax exposure often arise in acquisitions of multinational businesses with U.S. operations. This item discusses these areas--transfer pricing, limitations on interest deductions, permanent establishment, and U.S. withholding taxes.

Transfer Pricing

Improper or inadequate documentation of intercompany pricing practices likely is the most significant tax exposure for companies performing due diligence on acquiring a multinational business. In transactions with their non-U.S. subsidiaries or partners, U.S. companies may have intercompany commission payments, loans, interest, royalties, or dividends flowing from one entity to another. U.S. transfer-pricing regulations generally require that these related-party transactions occur at a price that unrelated parties would charge each other when dealing at arm's length and that is supported by contemporaneous documentation (Regs. Sec. 1.6662-6(d)(2)(iii)).

The contemporaneous-documentation requirement can be satisfied only if an annual transfer-pricing report has been prepared when an annual tax return is filed (Regs. Sec. 1.6662-6(d)(2)(iii)(A)). If a taxpayer does not have contemporaneous documentation of an arm's-length price reasonably determined under an allowable method and the IRS makes an adjustment, an additional 20% penalty tax can be applied if either (1) the price for any property or service is 200% or more, or 50% or less, of the amount determined to be the correct price, or (2) the transfer-pricing adjustment exceeds the lesser of $5 million or 10% of gross receipts (Sec. 6662(e)).

In many cases, multinational companies have substantial intercompany transactions with transfer prices that do not reflect appropriate arm's-length rates or lack contemporaneous...