To determine an arm’s-length remuneration for an entities’ activities, generally, a benchmark needs to be performed. A benchmark is a search for companies that perform similar activities as the company for which an arm’s-length remuneration needs to be determined, usually referred to as the “tested party”. This page provides for an overview of the relevant steps that are taken when a benchmark is performed and it provides for general information about the benchmarking process.
The comparability analysis is a comparison of a controlled transaction with an uncontrolled transaction (or transactions). Controlled and uncontrolled transactions are comparable if none of the differences between the transactions could materially affect the factor being examined in the methodology (e.g. price or margin), or if reasonably accurate adjustments can be made to eliminate the material effects of any such differences.
The OECD Transfer Pricing Guidelines provides for five comparability factors, which are shown below:
- Characteristics of goods and services
- Functional analysis
- Contractual terms
- Economic circumstances
- Business strategies
In order to be able to compare companies, commercial databases (such as Amadeus, Bloomberg, etc.) are used that contain enormous amounts of information about a large amount of companies. In an effort to categorize all these companies, industry codes have been created. The European Union, for example, has developed so-called “NACE” codes (Nomenclature Générale des Activités Economiques Dans Les Communautés Européennes Rev. 2.0) where every company is labeled with a certain NACE code that corresponds with the activity of that company. When performing a benchmark, the first step is to determine the NACE code(s) of the tested party in order to find comparable companies. Since many companies perform multiple different activities (i.e. a sales office might also perform after-sales support, marketing support, etc.) usually more NACE codes can be linked with the tested party. The more NACE codes can be linked with an entity the more possible comparable companies can be found.
The benchmarking process is generally the same and the OECD has provided a description of a typical process of a comparability analysis. This process is described below:
Steps and Description
- Step 1: Determination of years to be covered
- Step 2: Broad-based analysis of the taxpayer’s circumstances
- Step 3: Understanding the controlled transaction(s) under examination, based in particular on a functional analysis, in order to choose the tested party (where needed), the most appropriate transfer pricing method to the circumstances of the case, the financial indicator that will be tested (in the case of a transactional profit method), and to identify the significant comparability factors that should be taken into account
- Step 4: Review of existing internal comparables (if any)
- Step 5: Determination of available sources of information on external comparables where such external comparables are needed taking into account their relative reliability
- Step 6: Selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator (e.g. determination of the relevant net profit indicator in case of a transactional net margin method)
- Step 7: Identification of potential comparables: determining the key characteristics to be met by any uncontrolled transaction in order to be regarded as potentially comparable, based on the relevant factors identified in Step 3 and in accordance with the comparability factors as provided by the OECD (and which are mentioned above)
- Step 8: Determination of and making comparability adjustments where appropriate
- Step 9: Interpretation and use of data collected; determination of the arm’s length remuneration
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