Unlocking the Key Transfer Pricing Aspects in Asset Management

The asset management industry has experienced significant growth in recent years driven by the pursuit of higher returns, leading asset managers to explore investment opportunities beyond their borders. It is estimated that the Assets Under Management (AUM) of UK-based asset managers have more than tripled in the last decade and a half, while AUM of those based in mainland Europe have doubled. It is also estimated that there are over 1,000 asset managers in the UK and around 5,000 in Europe. Similar growth trends are also evident in the Americas and Asia.

The rapid expansion of the global asset management industry, coupled with increased employee mobility post-Covid, evolving tax and transfer pricing landscape at the policy level, and governments seeking to bolster their revenues, creates a cocktail of risks and opportunities from a transfer pricing perspective. This article highlights key transfer pricing considerations for asset managers, focusing on two main aspects: the Management side (how asset managers are structured); and the Funding side (how investments are funded and structured).

The Management Side

The Management side refers to the structure and functional profile of asset managers, including the roles and responsibilities of various teams located in different geographies and the interactions between them. It is extremely important to map these roles out, as they form the basis for the arm's length allocation of asset management/portfolio management fees between different entities within the asset management company. An allocation of fees that is not based on facts and circumstances can attract scrutiny from tax authorities. Key transfer pricing considerations on the Management side include:

1. Composition of the Investment Committee (IC): A detailed analysis of the IC's composition is essential, particularly where IC members (employees of various entities) are located in different jurisdictions and have different voting rights. Assessing the composition of the IC properly is critical for ensuring arm's length allocation of fees between entities.
2. Contributions of various teams: Depending on the size of the asset management company and its internal structure, the IC may play an extensive or limited role in the investment process. In addition, the functions performed, and the contributions made by various teams — such as research, deal making, marketing, distribution, capital raising, sub-advisory, etc — must be analysed to ensure that appropriate fees are allocated to the entities hosting these teams and activities.
3. Transfer Pricing Policy Design: Given the contribution of various teams in separate locations to the generation of fees, a sound transfer pricing policy is essential. This policy should provide a mechanism for the appropriate allocation of fees between entities, reducing the risk of tax audits in jurisdictions where the asset management company has legal entities (or permanent establishments). The design phase also offers an opportunity to develop a more tax-efficient policy for the company.
4. Policy Implementation: This aspect considers how well the transfer pricing policy has been implemented within the different entities of the asset management company. Proper implementation would be reflected in the quantum of profits being booked (based on the contributions made by these entities), thereby reducing the risk of tax audits.
5. Legal Agreements and Compliance Documentation: This includes drafting legal agreement(s) that govern arrangements between entities and ensuring that actual conduct aligns with the contract. It also involves preparing transfer pricing compliance documentation to meet legal requirements in specific jurisdictions. This documentation should be consistent with the policy and ensure that the facts presented are uniform across all jurisdictions.

The Fund Side

The Fund side focuses on the structure set up for investments, including how these investments are funded and managed. This will typically include the incorporation of a special purpose vehicle (SPV) through which funds will flow. Depending on the jurisdiction in which the investments are made, there may be certain regulatory aspects to consider regarding the activities performed by the General Partner (GP) and the Alternative Investment Fund Manager (AIFM). In addition, it is essential to consider the appropriate funding mix (i.e., debt versus equity), as this can affect interest deductibility and, in result, the return on investment (ROI). Identifying and appropriately pricing individual intra-group transactions is critical to ensure compliance with the arm's length principle. Key transfer pricing aspects to consider on the Fund side include:

1. Mapping all Intra-group Transactions: Once the asset has been identified and the structure for funding the investment has been set up —incorporating GP, AIFM, SPV and other entities as appropriate— all intra-group transactions need to be identified and mapped. This exercise is critical, as all intra-group transactions must be priced at arm's length to comply with local tax legislation.
2. Arm's Length Pricing for all Intra-group Transactions: This involves conducting economic analyses to determine the arm's length price for each identified intra-group transaction. For example, if the acquisition of the asset is financed through a mix of debt and equity, it is necessary to assess the right debt/equity ratio and ensure arm's length interest rates on the debt. Similarly, if certain management and administrative services are provided to the entity holding the asset, then an arm's length service fee must be determined. It is critical that all intra-group transactions are appropriately characterised and priced at arm's length to ensure compliance with local regulations.
3. Legal Agreements and Compliance Documentation: This involves drafting the legal agreement(s) that govern transactions between entities and preparing transfer pricing compliance documentation that provides the required details of the transaction and their arm's length pricing. Such documentation is required to meet compliance obligations in relevant jurisdictions, as failure to do so could result in penalties and tax audits.

As the asset management industry continues to evolve and tax authorities become more sophisticated in their approach, we can expect some tussle between the two. Adding fuel to the fire are increased transparency and compliance requirements. By using data analytics, machine learning and artificial intelligence, tax authorities can relatively easily identify transactions that warrant further investigation. Therefore, ensuring that your transfer pricing practices are in order is crucial to mitigating tax risks, providing certainty to investors and safeguarding reputation. This also provides an opportunity for asset managers to optimise their structure (both on the Management and Fund side) in a manner that can reduce their overall tax liability and generate higher returns.