Meaning
Comparative analysis used to establish the fair market value of transactions between associated enterprises. This transfer pricing benchmark functions as the primary evidence to support that inter-company prices comply with the arm’s length principle. It involves a systematic search for independent companies with similar business activities and risk profiles.
The transfer pricing benchmark provides a range of financial results that are considered acceptable by the tax authorities. By using a transfer pricing benchmark, a company can justify the pricing of its goods and services and royalties. The state taxation administration requires the transfer pricing benchmark to be updated annually as part of the local file documentation.
Failure to provide a valid transfer pricing benchmark can lead to tax adjustments and penalties. The process for creating a transfer pricing benchmark is governed by international standards and local regulations. It is an essential component of the tax compliance strategy for multinational corporations.
Database Selection
Identifying the right source of information is the first step in creating a reliable transfer pricing benchmark. Analysts use specialized commercial databases that contain the financial data of millions of public and private companies. For a transfer pricing benchmark in the domestic market, local databases are often preferred because they reflect the specific economic conditions of the country.
The selection of the database must be justified based on the availability and the reliability of the data. The transfer pricing benchmark requires the use of multiple years of data to smooth out the impact of economic cycles. Typically, three to five years of financial results are used for the transfer pricing benchmark analysis.
The database search starts with a wide set of industry codes and is then narrowed down through manual screening. The criteria for the transfer pricing benchmark include the geographic location and the size and the independence of the companies. A well chosen database ensures that the transfer pricing benchmark is defensible during a tax audit.
Comparability Adjustment
Refinement of the data is necessary to ensure that the companies in the transfer pricing benchmark are truly comparable to the tested party. Accountants perform adjustments to the financial statements of the comparable firms to eliminate differences in working capital and accounting practices. These adjustments improve the accuracy of the transfer pricing benchmark by leveling the playing field.
For example, the transfer pricing benchmark might be adjusted for differences in inventory levels or accounts receivable. The goal of these adjustments in the transfer pricing benchmark is to isolate the profit margin that is directly attributable to the business functions. The transfer pricing benchmark also considers the impact of unique assets or intangible property.
If a comparable company has a very different risk profile, it may be excluded from the transfer pricing benchmark altogether. These comparability adjustments are often the subject of intense debate between the taxpayer and the tax bureau. Providing a clear explanation for every adjustment is vital for the credibility of the transfer pricing benchmark.
Compliance Burden
Maintaining a current transfer pricing benchmark places a meaningful administrative requirement on the domestic subsidiary. The company must perform a new benchmark search or update the existing data every year. This transfer pricing benchmark is a mandatory part of the annual transfer pricing documentation.
The tax bureau uses the transfer pricing benchmark to assess the risk of profit shifting in the group. If the company’s profit falls below the range established by the transfer pricing benchmark, it must provide a detailed explanation. The transfer pricing benchmark must be consistent with the global transfer pricing policy of the multinational group.
In cases of significant business changes, a completely new transfer pricing benchmark may be required. The cost of obtaining the database access and the expert analysis can be high for small companies. However, a robust transfer pricing benchmark is the best defense against a costly tax audit.
The transfer pricing benchmark remains the standard tool for managing international tax risks in a complex regulatory environment.
