When it comes to completing a company’s often extensive financial reporting requirements, it is easy to lose sight of the impact those valuations may have on the company’s tax positions. However, ensuring that the financial reporting valuations align with the tax positions of a company is crucial for maintaining a company’s fiscal health and compliance. Unfortunately, many valuations prepared for financial reporting purposes do not adequately consider how some of the underlying assumptions and valuation conclusions may contradict certain tax positions. Discrepancies between valuations for financial reporting and a company’s adopted tax positions pose significant risks. This article explores these risks and provides insights into how companies can navigate these challenges.
Understanding the Risks
The following includes specific scenarios where these conflicts may arise, and the valuation analysis unintentionally undermines the tax positions of a company:
- Intercompany Transfer Pricing: Transfer pricing regulations require that intercompany transactions be conducted at arm’s length. There are two areas where we encounter the most significant inconsistencies with financial reporting valuations and intercompany transfer pricing:
- A company has an intercompany transfer pricing agreement in place in which it treats an entity as a limited risk distributor, remunerated with a defined profit margin (e.g., cost-plus 5.0%). As part of a valuation of that same entity for financial reporting purposes, the appraiser ignores the transfer pricing and applies a market participant profit margin associated with the overall global company, which is much higher, and is disconnected from the reality of the actual operations, risks, and profitability of the subject entity. The local tax authorities can reference the financial reporting valuation, which indicates the taxable income for the entity should be higher than reported for tax purposes, thus unnecessarily creating an issue for the company.
- A valuation of intellectual property (IP) is conducted as part of a purchase price allocation for financial reporting purposes. As part of an internal transfer, the acquirer sells certain IP rights to a related non-U.S. entity. The company utilizes the financial reporting valuation to ascribe fair market value (FMV) to the IP rights that are part of the internal transfer. This can create any of the following issues:
- The valuation methodology applied for financial reporting purposes may be inconsistent with those accepted for tax purposes.
- The IP being transferred could include assets that were separately identified in the financial reporting purchase price allocation, such as customer relationships, goodwill, etc., that are treated for tax purposes as being part of the transferred IP asset. In this situation, utilizing the IP value from the financial reporting valuation would understate the FMV of the transferred IP assets, creating a tax issue for the company.
- If the structure of the internal transfer requires the IP valuation to be consistent with Internal Revenue Code Section 482 (IRC 482), utilizing a financial reporting valuation most likely will not be compliant with the specific tax requirements pursuant to IRC 482.
- A company borrows debt via an intercompany note payable with a related party. As part of the financing agreement, the terms of the note payable must be arm’s length and consistent with the terms a third party would secure in a similar situation. There are two common areas in which inconsistencies can arise:
- The entity is a borrower of an intercompany note payable with a related party and deducts the interest expense on its tax return in the local jurisdiction. The equity value of that entity is being determined for financial reporting purposes, and the appraiser unilaterally treats the intercompany debt as equity. The local tax authority can question why the interest expense has been deducted for tax purposes and take a position that the intercompany debt should be recategorized as equity, given the company’s own valuation views it as equity.
- The fair value of debt is estimated for financial reporting purposes, and the interest rate utilized in the valuation is materially different from the interest rate that the company is paying based on its own intercompany transfer pricing agreements. There should not be differences in the interest rates, given the intercompany transfer pricing agreement reflects an arm’s length interest rate. We have even encountered situations in which an interest rate assumed in a valuation for tax purposes, e.g., cancellation of debt, etc., contradicts the company’s own transfer pricing. It is imperative that any interest rates utilized in a valuation are consistent with the company’s intercompany transfer pricing agreements.
- Personal Goodwill: In certain situations, a transaction will be structured as an acquisition of both corporate and personal assets, namely personal goodwill. Given the sensitivity of this analysis, a specialist appraiser is typically engaged to estimate the FMV of the personal goodwill for tax purposes, consistent with the latest Internal Revenue Service (IRS) guidance. However, as part of the financial reporting requirements for the transaction, the company will need to follow purchase price accounting rules, potentially preparing valuations of certain corporate intangible assets. To the extent assumptions are not consistent, or the estimates of value are not in harmony between the two analyses, the financial reporting may inadvertently contradict tax positions, leading to IRS scrutiny. The most common place for this contradiction is in the company’s trade name value ascribed in the financial reporting analysis, as it could be inconsistent with the personal goodwill valuation. We have encountered situations in which the value of the trade name indicates that the value of the personal goodwill asset should be lower than the concluded value or potentially undermines the presence of personal goodwill altogether. These two analyses should be consistent to ensure the personal goodwill value is not compromised.
- FIRPTA and USRPHC: The Foreign Investment in Real Property Tax Act (FIRPTA) has specific implications for foreign investors in U.S. real estate. A company’s classification as a U.S. Real Property Holding Corporation (USRPHC) depends on the FMV of its U.S. Real Property Interests (USRPIs) compared to the FMV of its total assets. To comply with these rules, companies frequently engage an appraisal firm to prepare a comprehensive analysis and provide an opinion as to whether an entity represents a USRPHC. As part of this analysis, the appraiser will prepare valuations of all USRPIs as well as for the company as an operating entity. Certain financial reporting requirements, such as purchase price accounting and impairment testing analyses, will require certain assumptions concerning both individual assets and the operating company. When certain assumptions, such as discount rates, company-specific risk premiums, asset lives, replacement costs, and depreciation factors, differ between these analyses, the financial reporting work may unintentionally contradict the conclusion as to whether the company meets the definition of a USRPHC, with substantial tax consequences.
Mitigating the Risks
To mitigate these risks, companies should ensure close collaboration between their chosen appraisal firm and their finance and tax departments. Ensuring that the selected appraiser has experience with specific tax considerations and the interplay of assumptions with financial reporting workstreams to ensure that they identify and address potential conflicts is vital.
In conclusion, while the complexities of financial reporting and tax compliance are challenging, proactive management of valuations can prevent costly discrepancies and ensure alignment with regulatory requirements. Companies that prioritize aligning valuations and tax positions strengthen their position to withstand IRS and local tax authority scrutiny while maintaining robust financial health.
© Copyright 2026. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.
