Editing Transfer pricing (section)

==Comparability==

Most rules provide standards for when unrelated party prices, transactions, profitability or other items are considered sufficiently comparable in testing related party items.<ref>OECD Guidelines 1.15, ''et seq''., 26 CFR 1.482-1(d).</ref>  Such standards typically require that data used in comparisons be reliable and that the means used to compare produce a reliable result. The U.S. and OECD rules require that reliable adjustments must be made for all differences (if any) between related party items and purported comparables that could materially affect the condition being examined.<ref>OECD Guidelines 1.15, 26 CFR 1.482-1(d)(2).</ref>  Where such reliable adjustments cannot be made, the reliability of the comparison is in doubt. Comparability of tested prices with uncontrolled prices is generally considered enhanced by use of multiple data. Transactions not undertaken in the ordinary course of business generally are not considered to be comparable to those taken in the ordinary course of business. Among the factors that must be considered in determining comparability are:<ref>OECD Guidelines 2022 1.33-1.36; 26 CFR 1.482-1(d).</ref>
*the contractual terms of the transaction, either formalized in written contract or not;
*the functions performed by each of the parties to the transaction taking into account assets used and risks assumed (so-called Functions, Assets, and Risks Analysis or FAR Analysis);
*the characteristics of property transferred or services provided, as difference in quality or the extent of service may affect price;
*the economic circumstances of the parties and of the market in which the parties operate, e.g. the geographic location, the extent of competition, and consumer purchasing power may result in different pricing even for the same goods and services; and
*the business strategies pursued by the parties, e.g. start-ups and mature businesses may have different pricing strategy, whether to focus on customer acquisition or profitability.

===Nature of property or services===

Comparability is best achieved where identical items are compared.  However, in some cases it is possible to make reliable adjustments for differences in the particular items, such as differences in features or quality.<ref>OECD Guidelines 1.19, 2.7, [http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:6.0.1.1.1.0.8.183&idno=26 26 CFR 1.482-3(b)(2)(ii)(A)], [http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:6.0.1.1.1.0.8.191&idno=26 26 CFR 1.482-9(c)(2)(ii)(A)].</ref>  For example, gold prices might be adjusted based on the weight of the actual gold (one ounce of 10 carat gold would be half the price of one ounce of 20 carat gold).

===Functions and risks===

Buyers and sellers may perform different functions related to the exchange and undertake different risks.  For example, a seller of a machine may or may not provide a warranty.  The price a buyer would pay will be affected by this difference.  Among the functions and risks that may impact prices are:<ref>OECD Guidelines 1.20-1.27, 26 CFR 1.482-1(d)(3)(i) and (iii).</ref>
*Product development
*Manufacturing and assembly
*Marketing and advertising
*Transportation and warehousing
*Credit risk
*Product obsolescence risk
*Market and entrepreneurial risks
*Collection risk
*Financial and currency risks
*Company- or industry-specific items

===Terms of sale===

Manner and terms of sale may have a material impact on price.<ref>OECD Guidelines 1.28, 1.29, 26 CFR 1.482-1(d)(3)(ii).</ref>  For example, buyers will pay more if they can defer payment and buy in smaller quantities. Terms that may impact price include payment timing, warranty, volume discounts, duration of rights to use of the product, form of consideration, etc.

===Market level, economic conditions and geography===

Goods, services, or property may be provided to different levels of buyers or users:  producer to wholesaler, wholesaler to wholesaler, wholesaler to retailer, or for ultimate consumption.  Market conditions, and thus prices, vary greatly at these levels.  In addition, prices may vary greatly between different economies or geographies.  For example, a head of cauliflower at a retail market will command a vastly different price in unelectrified rural India than in Tokyo.  Buyers or sellers may have different market shares that allow them to achieve volume discounts or exert sufficient pressure on the other party to lower prices.  Where prices are to be compared, the putative comparables must be at the same market level, within the same or similar economic and geographic environments, and under the same or similar conditions.<ref>OECD Guidelines 1.30, 26 CFR 1.482-1(d)(3)(iv).</ref>

===Testing of prices===
Tax authorities generally examine prices actually charged between related parties to determine whether adjustments are appropriate. Such examination is by comparison (testing) of such prices to comparable prices charged among unrelated parties.  Such testing may occur only on examination of tax returns by the tax authority, or taxpayers may be required to conduct such testing themselves in advance of filing tax returns.  Such testing requires a determination of how the testing must be conducted, referred to as a transfer pricing method.<ref>OECD Guidelines 2.5, 26 CFR 1.482-.</ref>

====Best method rule====
Some systems give preference to a specific method of testing prices.  OECD and U.S. systems, however, provide that the method used to test the appropriateness of related party prices should be that method that produces the most reliable measure of arm's length results.<ref>OECD Guidelines 1.68-1.70, 26 CFR 1.482-1(c), [http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:6.0.1.1.1.0.8.189&idno=26 26 CFR 1.482-8].</ref>  This is often known as a "best method" rule.  Factors to be considered include comparability of tested and independent items, reliability of available data and assumptions under the method, and validation of the results of the method by other methods.

====Comparable uncontrolled price (CUP) method====
The comparable uncontrolled price (CUP) method is a transactional method that determines the arm's-length price using the prices charged in comparable transactions between unrelated parties.<ref>OECD Guidelines 2.13.</ref> In principle, the OECD<ref>OECD Guidelines 2.3, 2.14.</ref> and most countries that follow the OECD guidelines<ref>See, for example, [http://www.cra-arc.gc.ca/E/pub/tp/ic87-2r/ic87-2r-e.html Canada Revenue Agency (CRA) Information Circular 87-2R] at [http://www.cra-arc.gc.ca/E/pub/tp/ic87-2r/ic87-2r-e.html#P196_20259 paragraphs 52-53], and [http://law.ato.gov.au/atolaw/view.htm?Docid=TXR/TR9720/NAT/ATO/00001 Australian Taxation Office (ATO) Taxation Ruling 97/20] at [http://law.ato.gov.au/atolaw/view.htm?Docid=TXR/TR9720/NAT/ATO/00001#P3.15 paragraph 3.15].</ref> consider the CUP method to be the most direct method, provided that any differences between the controlled and uncontrolled transactions have no material effect on price or their effects can be estimated and corresponding price adjustments can be made. Adjustments may be appropriate where the controlled and uncontrolled transactions differ only in volume or terms; for example, an interest adjustment could be applied where the only difference is time for payment (e.g., 30 days vs. 60 days). For undifferentiated products such as commodities, price data for arm's-length transactions ("external comparables") between two or more other unrelated parties may be available. For other transactions, it may be possible to use comparable transactions ("internal comparables") between the controlled party and unrelated parties.

The criteria for reliably applying the CUP method are often impossible to satisfy for licenses and other transactions involving unique intangible property,<ref>OECD (2015). [http://www.oecd.org/tax/aligning-transfer-pricing-outcomes-with-value-creation-actions-8-10-2015-final-reports-9789264241244-en.htm Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 - 2015 Final Reports] ("OECD actions 8-10") at para. 6.146.</ref> requiring use of valuation methods based on profit projections.<ref>OECD actions 8-10 at para. 6.153.</ref>

====Other transactional methods====
Among other methods relying on actual transactions (generally between one tested party and third parties) and not indices, aggregates, or market surveys are:
*[[Cost-plus]] (C+) method:  goods or services provided to unrelated parties are consistently priced at actual cost plus a fixed markup.  Testing is by comparison of the markup percentages.<ref>OECD Guidelines 2.32-48, 26 CFR 1.482-3(d), 26 CFR 1.482-9(e).</ref>
*Resale price method (RPM):  goods are regularly offered by a seller or purchased by a retailer to/from unrelated parties at a standard "list" price less a fixed discount.  Testing is by comparison of the discount percentages.<ref>OECD Guidelines 2.14-2.31, 26 CFR 1.482-3(c), 26 CFR 1.482-9(d).</ref>
*Gross margin method:  similar to resale price method, recognised in a few systems.

====Profit-based methods====
Some methods of testing prices do not rely on actual transactions.  Use of these methods may be necessary due to the lack of reliable data for transactional methods.  In some cases, non-transactional methods may be more reliable than transactional methods because market and economic adjustments to transactions may not be reliable.  These methods may include:
*Comparable profits method (CPM):  profit levels of similarly situated companies in similar industries may be compared to an appropriate tested party.<ref>26 CFR 1.482-5.</ref>  See U.S. rules below.
*[[Transactional net margin method]] (TNMM):  while called a transactional method, the testing is based on profitability of similar businesses.  See OECD guidelines below.<ref>OECD Guidelines 3.26-3.33.</ref>
*Profit split method:  total enterprise profits are split in a formulary manner based on econometric analyses.<ref>OECD Guidelines 3.5-3.25, [http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:6.0.1.1.1.0.8.187&idno=26 26 CFR 1.482-6].</ref>

CPM and TNMM have a practical advantage in ease of implementation.  Both methods rely on microeconomic analysis of data rather than specific transactions. These methods are discussed further with respect to the U.S. and OECD systems.

Two methods are often provided for splitting profits:<ref>OECD Guidelines 3.5.</ref>  comparable profit split<ref>26 CFR 1.482-6(c)(2).</ref> and residual profit split.<ref>26 CFR 1.482-6(c)(3).</ref>  The former requires that profit split be derived from the combined operating profit of uncontrolled taxpayers whose transactions and activities are comparable to the transactions and activities being tested.  The residual profit split method requires a two step process:  first profits are allocated to routine operations, then the residual profit is allocated based on nonroutine contributions of the parties.  The residual allocation may be based on external market benchmarks or estimation based on capitalised costs.

====Tested party and profit level indicator====
Where testing of prices occurs on other than a purely transactional basis, such as CPM or TNMM, it may be necessary to determine which of the two related parties should be tested.<ref>OECD Guidelines 3.43, 26 CFR 1.482-5(b)(2).</ref>  Testing is to be done of that party testing of which will produce the most reliable results.  Generally, this means that the tested party is that party with the most easily compared functions and risks.  Comparing the tested party's results to those of comparable parties may require adjustments to results of the tested party or the comparables for such items as levels of inventory or receivables.

Testing requires determination of what indication of profitability should be used.<ref>OECD Guidelines 3.41, 26 CFR 1.482-5(b)(4).</ref>  This may be net profit on the transaction, return on assets employed, or some other measure.  Reliability is generally improved for TNMM and CPM by using a range of results and multiple year data.<ref>OECD Guidelines 3.43, 3.44, 26 CFR 1.482-1(e)(2).</ref>
this is based on circumstances of the relevant countries.

===Intangible property issues===
Valuable intangible property tends to be unique.  Often there are no comparable items.  The value added by use of intangibles may be represented in prices of goods or services, or by payment of fees (royalties) for use of the intangible property.  Licensing of intangibles thus presents difficulties in identifying comparable items for testing.<ref>OECD Chapter VI, 26 CFR 1.482-4.</ref>  However, where the same property is licensed to independent parties, such license may provide comparable transactional prices.  The profit split method specifically attempts to take value of intangibles into account.

===Services===
Enterprises may engage related or unrelated parties to provide services they need.  Where the required services are available within a multinational group, there may be significant advantages to the enterprise as a whole for components of the group to perform those services.  Two issues exist with respect to charges between related parties for services:  whether services were actually performed which warrant payment,<ref name="PLR8806002">For the U.S., see, ''e.g.'', [http://cases.justia.com/us-court-of-appeals/F2/410/1233/154707/ ''Young and Rubicam'', 410 F.2d 1233 (Ct.Cl., 1969)], PLR 8806002.</ref> and the price charged for such services.<ref>OECD Guidelines 7.5, 26 CFR 1.482-9.</ref>  Tax authorities in most major countries have, either formally or in practice, incorporated these queries into their examination of related party services transactions.

There may be tax advantages obtained for the group if one member charges another member for services, even where the member bearing the charge derives no benefit.  To combat this, the rules of most systems allow the tax authorities to challenge whether the services allegedly performed actually benefit the member charged.  The inquiry may focus on whether services were indeed performed as well as who benefited from the services.<ref name="PLR8806002" /><ref>OECD Guidelines 7.5-7.18</ref>  For this purpose, some rules differentiate stewardship services from other services.  Stewardship services are generally those that an investor would incur for its own benefit in managing its investments.  Charges to the investee for such services are generally inappropriate.  Where services were not performed or where the related party bearing the charge derived no direct benefit, tax authorities may disallow the charge altogether.

Where the services were performed and provided benefit for the related party bearing a charge for such services, tax rules also permit adjustment to the price charged.<ref>OECD Guidelines 7.19 ''et seq''., 26 CFR 1.482-9.</ref>  Rules for testing prices of services may differ somewhat from rules for testing prices charged for goods due to the inherent differences between provision of services and sale of goods.  The OECD Guidelines provide that the provisions relating to goods should be applied with minor modifications and additional considerations.  In the U.S., a different set of price testing methods is provided for services.  In both cases, standards of comparability and other matters apply to both goods and services.

It is common for enterprises to perform services for themselves (or for their components) that support their primary business.  Examples include accounting, legal, and computer services for those enterprises not engaged in the business of providing such services.<ref>Such services may be referred to those not integral to the functioning of the primary business.</ref>  Transfer pricing rules recognize that it may be inappropriate for a component of an enterprise performing such services for another component to earn a profit on such services.  Testing of prices charged in such case may be referred to a cost of services or services cost method.<ref>OECD Guidelines 7.33, 26 CFR 1.482-9(b).</ref>  Application of this method may be limited under the rules of certain countries, and is required in some countries e.g. Canada.{{Citation needed|date=July 2010}}

Where services performed are of a nature performed by the enterprise (or the performing or receiving component) as a key aspect of its business, OECD and U.S. rules provide that some level of profit is appropriate to the service performing component.<ref>OECD Guidelines 7.29 ''et seq''., 26 CFR 1.482-9(b)(2).</ref>  Canada's rules do not permit such profit.{{Citation needed|date=July 2010}}  Testing of prices in such cases generally follows one of the methods described above for goods.  The cost-plus method, in particular, may be favored by tax authorities and taxpayers due to ease of administration.

===Cost sharing===
Multi-component enterprises may find significant business advantage to sharing the costs of developing or acquiring certain assets, particularly intangible assets.  Detailed U.S. rules provide that members of a group may enter into a cost sharing agreement  (CSA) with respect to costs and benefits from the development of intangible assets.<ref>OECD Chapter VIII, [http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:6.0.1.1.1.0.8.188&idno=26 26 CFR 1.482-7T].</ref>  OECD Guidelines provide more generalized suggestions to tax authorities for enforcement related to cost contribution agreements (CCAs) with respect to acquisition of various types of assets.<ref>OECD Guidelines 8.3.</ref>  Both sets of rules generally provide that costs should be allocated among members based on respective anticipated benefits.  Inter-member charges should then be made so that each member bears only its share of such allocated costs.  Since the allocations must inherently be made based on expectations of future events, the mechanism for allocation must provide for prospective adjustments where prior projections of events have proved incorrect.  However, both sets of rules generally prohibit applying hindsight in making allocations.<ref>Note that few countries besides the U.S. have formally adopted cost sharing rules, as of 2009.  The OECD Guidelines do not specifically require such rules, so adoption of the Guidelines may not constitute approval of cost sharing under the laws of some countries.</ref>

A key requirement to limit adjustments related to costs of developing intangible assets is that there must be a written agreement in place among the members.<ref>U.S. rules permit, in some cases, actions of members consistent with the principles of a CSA to be considered to constitute a CSA.</ref>  Tax rules may impose additional contractual, documentation, accounting, and reporting requirements on participants of a CSA or CCA, which vary by country.

Generally, under a CSA or CCA, each participating member must be entitled to use of some portion rights developed pursuant to the agreement without further payments.  Thus, a CCA participant should be entitled to use a process developed under the CCA without payment of royalties.  Ownership of the rights need not be transferred to the participants.  The division of rights is generally to be based on some observable measure, such as by geography.<ref>OECD Guidelines 8.9, 26 CFR 1.482-7T(b)(4).</ref>

Participants in CSAs and CCAs may contribute pre-existing assets or rights for use in the development of assets.  Such contribution may be referred to as a platform contribution.  Such contribution is generally considered a deemed payment by the contributing member, and is itself subject to transfer pricing rules or special CSA rules.<ref>OECD Guidelines 8.16, 8.17, 26 CFR 1.482-7T(c).</ref>

A key consideration in a CSA or CCA is what costs development or acquisition costs should be subject to the agreement.  This may be specified under the agreement, but is also subject to adjustment by tax authorities.<ref>OECD Guidelines 8.13-8.18, 1.482-7T(c).</ref>

In determining reasonably anticipated benefits, participants are forced to make projections of future events.  Such projections are inherently uncertain.  Further, there may exist uncertainty as to how such benefits should be measured.  One manner of determining such anticipated benefits is to project respective sales or gross margins of participants, measured in a common currency, or sales in units.<ref>OECD Guidelines 8.8, 8.9, 26 CFR 1.482-7T(e).</ref>

Both sets of rules recognize that participants may enter or leave a CSA or CCA.  Upon such events, the rules require that members make buy-in or buy-out payments.  Such payments may be required to represent the market value of the existing state of development, or may be computed under cost recovery or market capitalization models.<ref>OECD Guidelines 8.31-8.39, 26 CFR 1.482-7T(g).</ref>

===Penalties and documentation===
Some jurisdictions impose significant penalties relating to transfer pricing adjustments by tax authorities.  These penalties may have thresholds for the basic imposition of penalty, and the penalty may be increased at other thresholds.  For example, U.S. rules impose a 20% penalty where the adjustment exceeds US$5 million, increased to 40% of the additional tax where the adjustment exceeds US$20 million.<ref>[https://www.law.cornell.edu/uscode/text/26/6662-26 USC 6662].  A second threshold based on the relative magnitude of the adjustment may also applyl.</ref>

The rules of many countries require taxpayers to document that prices charged are within the prices permitted under the transfer pricing rules.  Where such documentation is not timely prepared, penalties may be imposed, as above.  Documentation may be required to be in place prior to filing a tax return in order to avoid these penalties.<ref>[http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:13.0.1.1.1.0.16.256&idno=26 26 CFR 1.6662-6].</ref>  Documentation by a taxpayer need not be relied upon by the tax authority in any jurisdiction permitting adjustment of prices.  Some systems allow the tax authority to disregard information not timely provided by taxpayers, including such advance documentation.  India requires that documentation not only be in place prior to filing a return, but also that the documentation be certified by the chartered accountant preparing a company return.