Category: TPG2022 Chapter III: Comparability Analysis

TPG2022 Chapter III paragraph 3.83

Small to medium sized enterprises are entering into the area of transfer pricing and the number of cross-border transactions is ever increasing. Although the arm’s length principle applies equally to small and medium sized enterprises and transactions, pragmatic solutions may be appropriate in order to make it possible to find a reasonable response to each transfer pricing case ... Continue to full case

TPG2022 Chapter III paragraph 3.82

It is a good practice for taxpayers to set up a process to establish, monitor and review their transfer prices, taking into account the size of the transactions, their complexity, level of risk involved, and whether they are performed in a stable or changing environment. Such a practical approach would conform to a pragmatic risk assessment strategy or prudent business management principle. In practice, this means that it may be reasonable for a taxpayer to devote relatively less effort to finding information on comparables supporting less significant or less material controlled transactions. For simple transactions that are carried out in a stable environment and the characteristics of which remain the same or similar, a detailed comparability (including functional) analysis may not be needed every year ... Continue to full case

TPG2022 Chapter III paragraph 3.81

When undertaking a comparability analysis, there is no requirement for an exhaustive search of all possible relevant sources of information. Taxpayers and tax administrations should exercise judgment to determine whether particular comparables are reliable ... Continue to full case

TPG2022 Chapter III paragraph 3.80

One question that arises when putting the need for comparability analyses into perspective is the extent of the burden and costs that should be borne by a taxpayer to identify possible comparables and obtain detailed information thereon. It is recognised that the cost of information can be a real concern, especially for small to medium sized operations, but also for those MNEs that deal with a very large number of controlled transactions in many countries. Paragraph 4.28 and Chapter V contain explicit recognition of the need for a reasonable application of the requirement to document comparability ... Continue to full case

TPG2022 Chapter III paragraph 3.79

The use of multiple year data does not necessarily imply the use of multiple year averages. Multiple year data and averages can however be used in some circumstances to improve reliability of the range. See paragraphs 3.57-3.62 for a discussion of statistical tools ... Continue to full case

TPG2022 Chapter III paragraph 3.78

Multiple year data can also improve the process of selecting third party comparables e.g. by identifying results that may indicate a significant variance from the underlying comparability characteristics of the controlled transaction being reviewed, in some cases leading to the rejection of the comparable, or to detect anomalies in third party information ... Continue to full case

TPG2022 Chapter III paragraph 3.77

Multiple year data will also be useful in providing information about the relevant business and product life cycles of the comparables. Differences in business or product life cycles may have a material effect on transfer pricing conditions that needs to be assessed in determining comparability. The data from earlier years may show whether the independent enterprise engaged in a comparable transaction was affected by comparable economic conditions in a comparable manner, or whether different conditions in an earlier year materially affected its price or profit so that it should not be used as a comparable ... Continue to full case

TPG2022 Chapter III paragraph 3.76

In order to obtain a complete understanding of the facts and circumstances surrounding the controlled transaction, it generally might be useful to examine data from both the year under examination and prior years. The analysis of such information might disclose facts that may have influenced (or should have influenced) the determination of the transfer price. For example, the use of data from past years will show whether a taxpayer’s reported loss on a transaction is part of a history of losses on similar transactions, the result of particular economic conditions in a prior year that increased costs in the subsequent year, or a reflection of the fact that a product is at the end of its life cycle. Such an analysis may be particularly useful where a transactional profit method is applied. See paragraph 1.151 on the usefulness of multiple year data in examining loss ... Continue to full case

TPG2022 Chapter III paragraph 3.75

In practice, examining multiple year data is often useful in a comparability analysis, but it is not a systematic requirement. Multiple year data should be used where they add value to the transfer pricing analysis. It would not be appropriate to set prescriptive guidance as to the number of years to be covered by multiple year analyses ... Continue to full case

TPG2022 Chapter III paragraph 3.74

Data from years following the year of the transaction may also be relevant to the analysis of transfer prices, but care must be taken to avoid the use of hindsight. For example, data from later years may be useful in comparing product life cycles of controlled and uncontrolled transactions for the purpose of determining whether the uncontrolled transaction is an appropriate comparable to use in applying a particular method. The conduct of the parties in years following the transaction will also be relevant in accurately delineating the actual transaction ... Continue to full case

TPG2022 Chapter III paragraph 3.73

The reasoning that is found at paragraphs 6.181-6.185, which provide guidance on the arm’s length pricing of transactions involving intangibles for which valuation is highly uncertain at the time of the transactions, applies by analogy to other types of transactions with valuation uncertainties. The main question is to determine whether the valuation was sufficiently uncertain at the outset that the parties at arm’s length would have required a price adjustment mechanism, or whether the change in value was so fundamental a development that it would have led to a renegotiation of the transaction. Where this is the case, the tax administration would be justified in determining the arm’s length price for the transaction on the basis of the adjustment clause or re-negotiation that would be provided at arm’s length in a comparable uncontrolled transaction. In other circumstances, where there is no reason to consider that ... Continue to full case

TPG2022 Chapter III paragraph 3.72

The question arises whether and if so how to take account in the transfer pricing analysis of future events that were unpredictable at the time of the testing of a controlled transaction, in particular where valuation at that time was highly uncertain. The question should be resolved, both by taxpayers and tax administrations, by reference to what independent enterprises would have done in comparable circumstances to take account of the valuation uncertainty in the pricing of the transaction ... Continue to full case

TPG2022 Chapter III paragraph 3.71

Both the arm’s length price-setting and the arm’s length outcome-testing approaches, as well as combinations of these two approaches, are found among OECD member countries. The issue of double taxation may arise where a controlled transaction takes place between two associated enterprises where different approaches have been applied and lead to different outcomes, for instance because of a discrepancy between market expectations taken into account in the arm’s length price-setting approach and actual outcomes observed in the arm’s length outcome-testing approach. See paragraphs 4.38 and 4.39. Competent authorities are encouraged to use their best efforts to resolve any double taxation issues that may arise from different country approaches to year-end adjustments and that may be submitted to them under a mutual agreement procedure (Article 25 of the OECD Model Tax Convention) ... Continue to full case

TPG2022 Chapter III paragraph 3.70

In other instances, taxpayers might test the actual outcome of their controlled transactions to demonstrate that the conditions of these transactions were consistent with the arm’s length principle, i.e. on an ex post basis (hereinafter “the arm’s length outcome-testing” approach). Such test typically takes place as part of the process for establishing the tax return at year-end ... Continue to full case

TPG2022 Chapter III paragraph 3.69

In some cases, taxpayers establish transfer pricing documentation to demonstrate that they have made reasonable efforts to comply with the arm’s length principle at the time their intra-group transactions were undertaken, i.e. on an ex ante basis (hereinafter “the arm’s length price-setting” approach), based on information that was reasonably available to them at that point. Such information includes not only information on comparable transactions from previous years, but also information on economic and market changes that may have occurred between those previous years and the year of the controlled transaction. In effect, independent parties in comparable circumstances would not base their pricing decision on historical data alone ... Continue to full case

TPG2022 Chapter III paragraph 3.68

In principle, information relating to the conditions of comparable uncontrolled transactions undertaken or carried out during the same period of time as the controlled transaction (“contemporaneous uncontrolled transactions”) is expected to be the most reliable information to use in a comparability analysis, because it reflects how independent parties have behaved in an economic environment that is the same as the economic environment of the taxpayer’s controlled transaction. Availability of information on contemporaneous uncontrolled transactions may however be limited in practice, depending on the timing of collection ... Continue to full case

TPG2022 Chapter III paragraph 3.67

There are timing issues in comparability with respect to the time of origin, collection and production of information on comparability factors and comparable uncontrolled transactions that are used in a comparability analysis. See paragraphs 5.27 and 5.36 of Chapter V for indications with respect to timing issues in the context of transfer pricing documentation requirements ... Continue to full case

TPG2022 Chapter III paragraph 3.66

A similar investigation should be undertaken for potential comparables returning abnormally large profits relative to other potential comparables ... Continue to full case

TPG2022 Chapter III paragraph 3.65

Generally speaking, a loss-making uncontrolled transaction should trigger further investigation in order to establish whether or not it can be a comparable. Circumstances in which loss-making transactions/ enterprises should be excluded from the list of comparables include cases where losses do not reflect normal business conditions, and where the losses incurred by third parties reflect a level of risks that is not comparable to the one assumed by the taxpayer in its controlled transactions. Loss-making comparables that satisfy the comparability analysis should not however be rejected on the sole basis that they suffer losses ... Continue to full case

TPG2022 Chapter III paragraph 3.64

An independent enterprise would not continue loss-generating activities unless it had reasonable expectations of future profits. See paragraphs 1.149-1.151. Simple or low risk functions in particular are not expected to generate losses for a long period of time. This does not mean however that loss-making transactions can never be comparable. In general, all relevant information should be used and there should not be any overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result ... Continue to full case