Business Restructuring and its Transfer Pricing Implications


Multinational Enterprises (MNEs) often engage in cross border business restructurings or supply chain adjustments to enhance operational efficiencies, achieve improved synergies, and maintain competitiveness. These changes might involve relocating functions, assets, or risks (FAR) among the entities within the group.

One question that arises is whether relocating the FAR requires paying an exit charge to the affected jurisdiction from a transfer pricing perspective. This publication aims to address this issue. Happy Reading!!!

Business Restructuring – Meaning

Business restructuring involves an internal reallocation of functions, assets and risks within a multinational enterprise. It may involve cross-border transfers of valuable intangibles. It may also involve termination of existing arrangement or substantial re-negotiation of existing arrangements.

A simple reduction in prices based on market conditions or adjusting an existing pricing strategy to match arm’s length pricing, without involving any of the mentioned elements, should not be considered as business restructuring.

Examples of Business Restructuring

  • Conversion of a full-fledged distributor into a LRD.
  • Conversion of a full-fledged manufacturer into a contract manufacturer
  • Transfer of IP rights to a central entity within the group
  • Business restructuring may also involve termination or substantial renegotiation of existing arrangements, reallocation of risks/intangibles, specialisation or de-specialisation of operations i.e. manufacturing sites/ processes, R&D activities, sales activities etc..
  • Transfer of valuable intangibles
  • Termination or substantial renegotiation of existing arrangements
  • Conversion of full-fledged manufacturers into contractors or toll manufacturer
  • Conversion of full-fledged distributor into LRD or commissionaires
  • Outsourcing of manufacturing to AE in a low cost location
  • Centralization of intangibles assets and of risks (Eg. to so called “IP Company”) or that of regional management
  • Revision of business model rationalization/ specialization/ despecialization of operations (R&D, manufacturing, sales/ services) including downsizing and closing operations
  • The UN practical manual on TP for developing countries defines Business restructuring as the cross-border redeployment of functions, assets and risks by an MNE.

OECD Guidance on Business restructuring

A business restructuring typically leads to a reallocation of profits among the members of the MNE group, either immediately or in the future and a question arises whether the entity whose profit is adversely impacted should receive a compensation in the form of an exit charge.

In this regard, the arm s length principle does not require compensation for a mere decrease in the expectation of an entitys future profits or for a mere transfer of FAR.

The question of an exit charge arises only,

  1. When there is a reallocation of functions and profits
  2. When there is a transfer of something of value either rights or other asset
  3. When the termination or substantial renegotiation would require to be compensated between independent enterprises in comparable circumstances.

Whether there is a transfer of valuable/distinctive rights and/or assets?

Transfer of something of value may entail either transfer of tangibles, intangibles such as trade or marketing intangibles or in some cases, even contractual rights with customers or transfer of a going concern. Typically, situations which entail only a transfer of such intangibles if already compensated at arm s length may not warrant a separate exit charge for a business restructuring.

Whether the termination / substantial renegotiation of existing contract needs to be compensated?

As regards whether an exit charge arises to compensate for loss of future profit on account of termination or substantial renegotiation of existing contracts, the following cumulative principles apply:

  • Whether there is a written or formal arrangement for indemnification in case of termination or renegotiation?
  • Whether the terms of the arrangement and the existence or non-existence of an indemnification (as well as the terms of such a clause where it exists) are arm s length?
  • Whether indemnification is provided for by commercial legislation or case law?
  • Whether another party dealing at arm’s length would have been willing to indemnify the one that suffers from the termination or re-negotiation of the agreement?

What options are realistically available to parties?

The OECD considers that the options available at the individual level may be relevant in applying the arm s length principle to a business restructuring. However, it states that it is not necessary to document all hypothetical options realistically available but if there is a realistically available option that is clearly more attractive it should be considered.

The concept of options realistically available seems to build on the economic theory of opportunity cost and rational decision making. Both parties engaging in a business restructuring should assess their respective realistically available options. This would imply that both would need to value the realistically available options and then engage in a transaction only if they are both not worse off compared to their respective next best alternative.

UN TP Manual on Business restructuring

The UN Practical Manual on Transfer Pricing is in line with the OECD Transfer Pricing Guidelines. The application of Article 9 of the United Nations Model Double Taxation Convention to business restructurings requires that the arm’s length consideration for a supply, acquisition or transfer of property is that which might reasonably be expected to be made under an agreement between independent parties dealing at arm’s length. As a result, a business restructuring generally involves the determination of whether at arm’s length a payment would be warranted for the transfer of something of value, or for the termination or substantial renegotiation of commercial arrangements between associated enterprises, and if so what the amount of such arm’s length consideration would be.

International Judicial Rulings

There are very few international judicial precedents on the issue of business restructurings. However, countries like Germany and Australia have issued detailed guidance on the issue.

French Ruling

Nestle Finance France, a French subsidiary of the Nestle Group was carrying out routine intragroup central corporate treasury function. The function was later relocated to the Swiss Group entity. Whether or not this relocation required an arm’s length compensation was the dispute before the court. The court held that the activity performed exclusively for the AE includes a valuable customer list. Therefore, the relocation of intra-group central corporate treasury function was regarded by the court as a transfer requiring an arm s length remuneration. The above ruling highlights the uncertainty being faced by taxpayers worldwide in view of the restrictive stand that seems to have been considered in this ruling on business restructuring.

Danish Ruling

The taxpayer, a Danish Company, was part of an international group (the Group) engaged in provision of software solutions and operated as a distributor of software products of the Group.

It was performing three categories of activities through its employees:

  • Distribution of Group’s license
  • Distribution of access to IT solution through its Software as a Service (SaaS) division
  • Implementation support for Group software solutions

Under the Distributor agreement between the taxpayer and the Group, the taxpayer paid royalty to the Parent for the right to use Group’s trademark and sell software licenses. The customer lists were considered to be the proprietary property of the Parent and shall be returned to it on termination of the distributor agreement.

During 2010, as part of Global re-organization, the Group converted its sales companies in various countries into commissionaires. Consequently, the taxpayer’s distributor agreement was terminated and replaced by commissionaire agreement.

The arrangement amongst the entities pre- and post-restructuring is depicted below:

A new entity (H4 Co/New entity) in another country was formed to handle Group’s operations in Europe, the Middle East and Africa (EMEA) region (which includes Denmark) and its function include devising overall strategy and policy for EMEA region in terms of sales, budgets etc.

No major change in the functions performed by taxpayer, however as a commission agent, it will act on behalf of New entity. The New entity will pay the royalty to the Parent instead of the taxpayer.

Contentions and Final Rulings:

Danish Tax Authorities

  • The Taxpayer has made extensive efforts to build customer
  • The Taxpayer transferred its intangibles in the form of customer relationship and know-how.
  • The profit margin of taxpayer would drop, whereas the New entity benefits without providing any compensation

Contentions of Assessee

  • It did not transfer any intangible to the new entity and does not warrant any
  • The skilled employees can be replaced in the New entity, thus workforce is not
  • The taxpayer did not have specialised technical
  • As per the Danish law, the ownership of accumulated goodwill belongs to a person who controls the

National Tax Tribunal – OECD Guidelines

  • An independent distributor with a high future profit potential will not be willing to give up its profit potential in favour of lower stable earnings without
  • The customer relationship and market know-how built by the taxpayer can be covered under the ambit of intangible asset
  • The New Entity entering into new contracts with same customers qualifies as “transfer of contract rights”.

The National Tax Tribunal (NTT) held that though per the Danish regulations, discretionary assessment conducted by SKAT (Danish Customs &Tax Administration) was unwarranted, per Section 2(1) of the Tax Assessment Act, SKAT was justified in re-determining arm’s length price.

Finally, NTT upheld SKAT’s stand that restructuring of the taxpayer has not taken place on an arm’s length basis.

Indian TP framework around business restructurings

Business restructuring was inserted as part of the explanation to the definition of international transaction as Explanation to Section 92B inserted by the Finance Act, 2012 with retrospective effect from 1 April 2002 as under:

a transaction of business restructuring or reorganisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date;

However, the term business restructuring or restructuring itself finds no definition in the Act leading to lack of clarity on what specific circumstances are sought to be covered under the Act. In this regard, we can consider the meaning of business restructuring & its examples from OECD Guidelines & ICAI Guidance note.

Clause 18 of the Form 3CEB requires disclosure of international transactions arising out/being part of any restructuring or reorganization entered into by the MNEs. It requires only the description of the transaction in terms of its nature, terms of arrangement, etc. and not the amount of such transactions.

Business restructuring achieved through a sale of Intellectual Property (IP) to be covered under the more specific reporting related to sale of intangible property or a more generic reporting as business restructuring is another point of discussion here.

The more specific reporting requirements and implications for sale of IP (i.e., capital gains, arm’s length valuation of IP, etc) would apply. However, the taxpayer would have to demonstrate that the relocation of IP encompasses the entire shift in the business operations and there are no other elements such as termination of other rights which need to be separately considered under business restructuring.

Documentation Requirements

Any business restructuring should be supported by the following illustrative documents on a contemporaneous basis:

  • Commercial rationale for restructuring:
    • Business
    • Expected benefits from the restructuring, including the role of synergies (highlighting misalignments, lack of efficiency, foregone business
    • Board minutes, emails, other documents to evidence that the decision has been taken in the benefit of the MNE.
  • Written contractual agreements are the starting point for delineating transactions comprising of business restructuring between MNEs involved
  • Description of the roles, responsibilities, and rights of the restructured entity under the pre restructuring arrangement and the manner and the extent to which those rights and obligations change due to
  • Substance of the payer by clearly demonstrating its capability in controlling the risk and also financial capacity of assuming the risk;
  • Benchmarking study to justify revised transfer pricing policy,

The above documents can be used as a first line of defence in both the jurisdiction of MNE and the payer especially considering the increased exchange of information between tax authorities. Further, contemporaneous documentation is not only helpful in mitigating litigation risk, but can also be used pro-actively, for example applying for an APA, etc.


Business restructurings are likely to attract increasing attention from tax authorities. Solid and contemporaneous documentation on the aspects outlined above will be critical for taxpayers to defend their positions. APAs (especially Bilateral APAs) should be considered to achieve alignment and upfront certainty between the taxpayer and the two jurisdictions involved in the situation.

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