Zurich Adapts Transfer Pricing Practice for the Asset Management Industry

The Zurich Cantonal Tax Administration is adapting its practice regarding transfer pricing in the asset management industry. Going forward, distribution will be classified as an entrepreneurial function by default and must be compensated through a revenue split. Existing cost-plus rulings will either not be extended or will be withdrawn in some cases.

The purpose of transfer pricing is to ensure that the various functions performed within a group are appropriately compensated, taking into account the risks assumed and the assets employed. A distinction is typically made between routine and entrepreneurial functions. While routine functions are generally compensated on a cost-plus basis, resulting in a lower but stable profit, entrepreneurial functions retain the residual profit or loss. When several entrepreneurial functions are performed simultaneously, the profit (or revenues) is usually allocated to these functions using a key (profit split model).

Asset Management Industry

Asset management includes the management of collective investment schemes as well as management and advisory mandates for institutional clients such as pension funds, sovereign wealth funds, and insurance companies. In asset management, a distinction is typically made between the functions of administration, distribution, and management/advisory. Distribution covers all activities involving direct contact with clients, such as providing potential clients with information about the products offered, regularly publishing results, or fulfilling legal disclosure requirements.

Distribution Qualified as Entrepreneurial

Historically, distribution was often considered a purely routine function and was therefore compensated using a cost-based transfer pricing method. The Zurich Cantonal Tax Administration has issued rulings on this basis, but over time with an increasingly higher profit mark-up.

A few years ago, the Zurich Cantonal Tax Administration began classifying this function as entrepreneurial for private equity and hedge funds. This approach was also supported by the Zurich Tax Appeals Court (DB.2015.166, ST.2015.210, in German).

The Zurich Cantonal Tax Administration is now adapting its practice by classifying distribution as an entrepreneurial function by default. As a result, existing rulings based on cost-plus methods will no longer be extended and may be withdrawn in some cases. The expectation is that this function must be compensated through a revenue split due to its entrepreneurial nature. According to Deloitte’s experience, the split should amount to at least 40% to 50% of the management fees. The size of the split should be determined using the comparable uncontrolled price method (CUP).

Deloitte’s View

In our opinion, this change in practice by the Zurich Cantonal Tax Administration is not surprising. Distribution is already classified as entrepreneurial by various foreign tax administrations, reflecting the increasingly important role this function plays in the asset management industry. It is not only the performance of an investment scheme that is a success factor but also the distribution to the investor. Due to increasing transparency resulting from EU and other regulations (such as MiFID), more information is available about compensation for distribution. Such information can be found in commercial databases like Lipper and can serve as a basis for the comparable price method.

We expect that the practical adjustment made by the canton of Zurich will be adopted by other cantons. If distribution within a group is still compensated on the basis of a cost-based transfer pricing method, we recommend reviewing the transfer pricing model as soon as possible.

Authors

• Thomas Hug – Partner, National Tax Office
• Petrit Ismajli – Partner, Financial Services Tax
• Danielle Koyuncu – Director, Financial Services Tax
• Lara Koerzendoerfer – Manager, Financial Services Tax