With major shifts in the global economy – such as the Trump 2.0 tariff war in the US, the UK’s Finance Act 2025 impacting inheritance tax for non-domiciles, and the rising trend of ‘reverse flipping’ in the startup ecosystem driven by India’s attractive public markets – multinational corporations (MNCs) are entering a new era of cross-border business evolution.
Aiming to counter continuously changing business dynamics and increasing competitive pressure, MNCs have been optimising operations across geographies, improving operational synergies, and enhancing financial performance through strategies such as restructuring of ownership or operations, hiving off non-performing assets, transitioning between cost-plus and ‘entrepreneur’ structures, flipping and reverse flipping of holding structures, and M&A (hereinafter broadly referred to as ‘business restructuring’).
Any business restructuring decision involves the evaluation of diverse business factors; however, taxation plays a critical role in determining the optimal restructuring strategy. In the case of cross-border restructuring, taxes may be levied under the domestic tax laws of the relevant jurisdictions –particularly in transactions involving the transfer of tangible or intangible assets.
Currently, business restructuring transactions are being closely monitored and thoroughly scrutinised by tax authorities across jurisdictions (especially in the US and India) to assess whether the restructuring entails any erosion of the tax base or shifting of substance/valuable assets (particularly intangible assets) from one jurisdiction to another.
Business restructuring in the context of transfer pricing
Tax, transfer pricing, and valuations all come into the spotlight when a restructuring exercise is undertaken by MNCs. While operational business restructuring is decided in boardrooms, tax, transfer pricing, and valuation aspects must be evaluated and factored in prior to executing the restructuring.
According to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022), there is no legal or universally accepted definition of business restructuring. However, as per Chapter IX: Transfer Pricing Aspects of Business Restructurings, business restructuring refers to “the cross-border reorganisation of the commercial or financial relations between associated enterprises, including the termination or substantial renegotiation of existing arrangements”.
Typically, from a transfer pricing perspective, operational restructuring within an MNC involves the redeployment of functions, assets, or risks (FAR) among group entities, which may have the following implications:
Conversion of a fully fledged distributor into a limited-risk distributor, or vice versa;
Conversion of a fully fledged manufacturer into a contract manufacturer, or vice versa;
Conversion of an ‘entrepreneurial service provider’ into a captive or limited-risk service provider;
Transfer of valuable intangibles (business contracts, customer lists, brand, etc.);
Termination or substantial renegotiation of existing arrangements; or
Concentration of functions and/or intangible assets in a regional or central entity.
Exit charge – one-time arm’s-length compensation
As can be inferred from the above, restructurings may result in base erosion or reallocation of profit potential (through changes in FAR, transfer of intangibles, etc.) across borders among related parties of an MNC. The impact on profits arising from such restructuring – shifting from one country to another – may be immediate or spread over several years following the restructuring.
The key question is whether such a reallocation of profit potential from one country to another is consistent with the arm’s-length principle. In other words, are the conditions made or imposed in a business restructuring arrangement different from those that would have applied had the transaction occurred between independent enterprises or unrelated third parties?
Any intragroup business restructuring transaction may require arm’s-length compensation or remuneration – either for the restructuring itself and/or for the impact on future years following the restructuring.
This one-time payment of arm’s-length compensation resulting from a restructuring is commonly referred to as an ‘exit charge’. Essentially, an exit charge is compensation paid for the reallocation of profits from one country to another or for the removal of assets from an entity whose business activity is being simplified or scaled down. In other words, an exit charge is applicable if the restructuring leads to a reduction in the profitability of an enterprise in a particular country – whether immediately or in the future – due to the restructuring exercise.
Tax authorities are particularly concerned with restructuring activities that shift the tax base away from their jurisdictions through the transfer of profit drivers to other countries.
Key considerations for determining arm’s-length compensation
In many cases, the exit charge or arm’s-length compensation for a business restructuring is determined based on the perceived value of the transferred assets – especially intellectual property (IP) and business functions. Tax authorities may require MNCs to account for the fair market value of these assets at the time of exit and to discharge tax on any gains realised from the transfer. Additionally, authorities are increasingly applying the substance-over-form principle to assess whether the restructuring has a genuine commercial rationale or is primarily tax-driven. The OECD’s BEPS Action Plan (actions 8–10) emphasises aligning profits with value creation and economic substance.
For the purpose of arm’s-length analysis, it is essential to accurately delineate the business restructuring transaction and evaluate the following factors:
The business rationale and expected outcomes of the restructuring;
The functions performed, assets employed, and risks assumed by the entities within the MNE group before and after the restructuring;
Identification of tangible assets (e.g., equipment) and intangible assets (e.g., patents, marketing intangibles, customer lists, business contracts) being transferred as part of the restructuring;
Whether an independent third party would be willing to enter into a similar restructuring arrangement with or without compensation;
Whether a valuation exercise has been undertaken to assess the value of transferred functions, risks, and assets; and
Whether the restructuring is driven by group synergies – such as cost savings, economies of scale, or operational efficiencies – and whether such synergies would be compensated between unrelated parties.
Case study
Let us consider an example. An Indian company (I.Co) in the service industry is acquired by an independent company from the US (US Co). Prior to the acquisition, I.Co operated as a fully fledged service provider – managing its own third-party customer contracts, independently performing key decision-making and management roles, and heavily leveraging its own brand and technology.
Following the strategic investment, US Co decided to restructure I.Co’s business model –transitioning it from a fully fledged service provider to a captive service provider, in order to leverage location-based advantages in India. This restructuring gives rise to implications under Indian tax law, transfer pricing regulations, valuation norms, and India’s foreign exchange laws, necessitating a comprehensive evaluation.
In this context, a critical assessment of the FAR profile of I.Co is required – pre-acquisition versus post-acquisition. The analysis reveals that pre-acquisition, I.Co operated independently in the open market, performing significant strategic functions; owning and employing non-routine intangible assets such as brand, technology, and customer contracts; and assuming higher levels of business risk. As a result, I.Co earned higher profitability as an independent entrepreneur, with past profitability ranging between 40% and 50%.
However, post-acquisition, US Co decided to transfer I.Co’s customer contracts to itself and convert I.Co into a captive service provider, supporting the operations of US Co. Consequently, I.Co’s profit potential was reduced to a capped return of 15%, resulting in the transfer of future revenue and profitability base from I.Co (India) to US Co (US).
Based on Indian income tax law and internationally recognised principles of business restructuring (as discussed earlier, including those laid out by the OECD), this substantial change in I.Co’s FAR profile and resulting decline in profitability clearly amounts to a business restructuring.
A valuation exercise by an independent registered valuer plays a key role in this context. I.Co’s business, pre-acquisition – as an independent entrepreneur with strong profitability and growth potential – is valued at $15 million using an appropriate valuation methodology. Post-acquisition, I.Co – now functioning as a captive service provider with restricted profitability and lower growth – is valued at $10 million.
The difference in valuation of $5 million ($15 million minus $10 million) essentially represents the value of transferred strategic functions, intangible property (such as customer contracts and technology), and critical risks from I.Co in India to US Co.
Accordingly, I.Co would be liable for a one-time compensation (exit charge) on account of such transfer. This compensation would be treated as a one-time receipt, subject to taxation in India as an ‘exit tax’.
Documentation best practices
Contemporaneous documentation – including valuation reports, board resolutions, internal communications, and feasibility reports – should be maintained to substantiate the business rationale for the restructuring.
Compliance/disclosure
The transfer pricing treatment and related compliance/disclosure requirements for business restructuring arrangements may vary across jurisdictions. In India, a business restructuring or reorganisation transaction between associated enterprises is specifically included within the definition of an ‘international transaction’, regardless of whether it impacts profit, income, assets, or liabilities. Therefore, disclosure of such transactions is mandatorily required in Form No. 3CEB, and robust transfer pricing documentation must be maintained to substantiate the arm’s-length compensation (i.e., exit charge).
Furthermore, details regarding transactions involving business restructuring, acquisitions, or divestments within the group are also required to be disclosed in the master file.
Tax implications: the Indian tax perspective
The primary question from a tax standpoint is whether such exit charge or compensation should be taxed as business income or as capital gains in the hands of the recipient. This characterisation will have implications from various perspectives, including:
The applicable tax rate;
The timing of the taxable event;
The jurisdiction entitled to tax the income;
The potential for double taxation; and
The availability of foreign tax credits.
The characterisation of income arising from business restructuring and exit charges depends on the nature and underlying intent of the transaction and accounting treatment. Generally, an intragroup business restructuring transaction that results in a payment of arm’s-length compensation – either for the restructuring itself or to make good an opportunity loss expected in future years – requires detailed evaluation.
Where such receipts are intrinsically linked to the core operational framework – such as compensation for termination of contracts, loss of business, or relocation of commercial activity – they are typically regarded as business income, being revenue in nature.
Conversely, where the receipts pertain to the transfer of capital assets – such as the sale of shares, business undertakings, or relinquishment of enduring rights – they may be characterised as capital gains.
The classification depends on a careful assessment of the factual matrix, contractual provisions, and relevant judicial precedents, in order to determine whether the income constitutes:
Compensation for the loss of a profit-generating structure (capital receipt); or
Compensation for the loss of anticipated profits (revenue receipt).
Deemed dividend implications: the US tax perspective
In addition to potential exit charges, the US may impose taxes on deemed distributions of income in cross-border structures. When a change in transfer pricing policies results in a reallocation of profits from a US subsidiary to its foreign parent entity (such as an Indian company), without corresponding economic justification or adequate compensation, the Internal Revenue Service may recharacterise such adjustments as constructive dividends under US tax law (pursuant to Internal Revenue Code sections 301 and 316).
These deemed dividends are generally treated as US-source income and may be subject to US withholding tax at the default rate of 30%, unless a reduced rate applies under an applicable tax treaty – such as the India–US tax treaty, which may lower the rate to 15%, depending on the specific conditions met. Accordingly, modifications to intercompany pricing arrangements that effectively shift value or income to a foreign affiliate could trigger US withholding tax exposure, even in the absence of an actual dividend declaration.
Nominal or no exit charge
It may be argued that an exit charge is not justified solely due to a reduction in profits earned by an enterprise. There must be evidence demonstrating that the enterprise has transferred functions or assets (including valuable contracts), and that, between unrelated parties, a payment would have been made for such a transfer.
If the restructuring leads to a reduction in profits due to reasons such as streamlining processes or workforce reductions – without any transfer of functions or assets – it may be reasonable to conclude that no compensation is warranted, as independent parties would likely not pay under similar circumstances.
In some cases, the exit charge may be minimal because the projected profitability impact of the restructuring is negligible. However, it is essential to obtain a valuation report to substantiate the charge. More importantly, the actual post-restructuring profitability should reflect the same position.
Valuation considerations
An exit charge in transfer pricing requires the valuation of transferred assets to determine arm’s-length compensation. Typically, the three most commonly accepted valuation approaches are:
The income approach;
The market approach; and
The cost approach.
The discounted cash flow method is widely used for business transfers and the valuation of primary intangible assets.
Key considerations include the reasonableness of projected cash flows over the discrete period and the selection of discount rates that are commensurate with the risks associated with those cash flows. In addition, benchmarking challenges unique to the subject business and the transferred intangible assets require careful attention.
For example, royalty rate benchmarking must be aligned with the specific nature of the intangible assets transferred and the industry in which the business operates. A robust valuation analysis and report not only ensures compliance but also helps to mitigate potential disputes. It is essential that the valuation aligns with internationally accepted methodologies, taking into account the nature of the business or assets being transferred.
Danish court judgment on exit charges
A Danish court ruling involving the conversion of a Danish company (D Co) from a distributor to a commission agent provides a useful precedent and is summarised below.
In this case, D Co was restructured from a sales company into a commission agent acting on behalf of a group company; following which, customer contracts were entered into by the group company instead. The Danish Tax Agency (Skattestyrelsen) argued that compensation (i.e., an exit charge) was warranted for the transfer of profit potential, intangible assets, know-how, and customer relationships to the new entity.
The National Tax Tribunal (NTT) held that D Co was indeed entitled to compensation for the transferred intangible assets. Referring to OECD guidelines, the NTT emphasised that an independent distributor would not relinquish such profit potential without adequate compensation. The ruling also highlighted the importance of maintaining accurate documentation and using appropriate valuation assumptions when determining such compensation.
KNAV comments
Business restructuring – particularly when it involves the transfer of intangible assets or changes in FAR across borders – can potentially trigger exit charges. Careful evaluation and thorough documentation are essential to avoid disputes.
To mitigate any penalties, it is important to maintain comprehensive documentation of the FAR analysis both before and after the restructuring. Any changes to intercompany agreements should clearly demonstrate the business rationale behind the restructuring and ensure that the transaction adheres to arm’s-length principles.
Defences against exit charges can be strengthened by demonstrating that there has been no transfer of assets or change in FAR, and by maintaining consistent pricing in intercompany transactions – whether with related parties or third parties.
As highlighted in the Danish NTT case, maintaining appropriate documentation, conducting accurate valuations of transferred assets, and understanding the impact on profit potential are critical to minimising the tax and transfer pricing litigation risks arising from business restructuring.
