Valuation Perspectives From Around the World: Increased analysis within financial reporting comes with increased levels of analysis required for tax reporting.

AuthorPatel, P.J.

The valuation of entities and assets is under greater scrutiny by tax authorities. Although valuation standards for tax purposes have generally lagged behind those for book purposes, new global standards require increased data, analysis, and support. This article will briefly review the developing and changing landscape and provide some practical considerations for implementation.

Higher Standards for Tax

Before recent conceptual developments and guidelines, the movement of assets and entities among different tax jurisdictions employed a relatively simple concept: value the asset or entity as it exists. Although simple in execution, this process lacked transparency, provided tax jurisdictions with minimal information, and isolated the asset or entity under review. As a result, a multinational enterprise (MNE) could be scrutinized or audited on a standalone basis, but without contextualization of value across a larger MNE group.

However, tax authorities began to capitalize on the increased levels of analysis and scrutiny required for financial reporting. As a result, tax requests for quantitative and qualitative bridges, and support for differences in intragroup charges and royalty rates, became commonplace.

Valuation engagements have therefore moved toward understanding the differences between tax and book accounting and reconciling these values. This process often involves the top-down approach of valuing the MNE group (which owns the MNE) or the MNE (which owns the assets) and reconciling values, from group to entity to asset. However, challenges remain in the absence of reliable financial information or forecasts (such as with nonintegrated entities). In these scenarios, a wide range of value conclusions invites scrutiny.

Overall, increased analysis within financial reporting has (intentionally or not) increased the levels of analysis required for tax reporting. This is particularly clear now that the Organisation for Economic Co-operation and Development's (OECD's) base erosion and profit-shifting project (BEPS) is underway.

BEPS Project

The (in-process) BEPS project has introduced major changes to global taxation and transfer pricing, with requirements for more detail and information-sharing around economic and legal ownership and asset characteristics. As a result, practitioners and tax authorities have posed several new questions, such as:

* Is there a difference between an asset's economic and legal ownership?

* What parties developed the asset, and in what location(s)?

* What is the substance of a transferred asset, and are the economics consistent with the legal substance?

* Where and how does the asset fit within the value chain of the overall entity?

The OECD's BEPS project has had a significant impact on valuations for tax purposes, because its goal is to limit tax avoidance by MNEs and MNE groups by eliminating double taxation, stopping the facilitation of double non-taxation, and aligning profit and value creation with location. To facilitate this effort, most jurisdictions have taken the BEPS project's recommendation on increased disclosure, implementing country-by-country reporting requirements, with the ultimate intention of sharing the reporting among tax authorities. The BEPS project is still in process, since numerous challenges remain in the task of balancing the alignment of global taxation with the maintenance of national sovereignty.

BEPS invites additional scrutiny into and higher standards for the valuation of assets, intangibles, and other entities within transfer pricing studies, royalty assessments, and other analyses. In general, the methodologies covered under BEPS utilize in-depth qualitative and quantitative analyses to link valuation outcomes with supportable and documentable entity-wide value creation.

Transfer Pricing Considerations

Particularly within transfer pricing, numerous complexities in transactions between associated entities make it imperative to be able to reference a recent pricing study to justify charges. Establishing transfer prices--defined as the prices at which an enterprise transfers physical goods, intangible property, or services to associated enterprises--first requires determining the substance of intragroup relationships. This substance is ascertained through a functional analysis, supported by legal and valuation analyses. However, accurately determining market prices and market values can be quite difficult, especially in the...

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