18 Lessons from the EU on Identifying Robust Comparables
The EU Joint Transfer Pricing Forum ("EU JTPF") has provided additional guidance on how taxpayers and tax administrations should apply transparency when conducting or controlling a comparable search. The EU JTPF was created in 2002 from an EU communication on eliminating transfer pricing from the EU, in which it was called the “Joint Forum on Transfer Pricing.” It was to be composed of member states and business representatives.
Companies have a wide variety of data sources at their disposal to develop comparable searches for transfer pricing purposes. Key recommendations by the EU JTPF are restating the importance to: (1) document the comparable search; (2) archive evidence; and (3) maintain supporting documents according to national rules. Here are 18 important observations to identify a robust number of comparables:
- Obtain and process internal comparables vs. searching external ones through commercial databases. It can be less costly – particularly for small transactions and small multinationals. Consider using internal comparables to support other methods where comparability can be improved upon, such as per unit prices with third parties or royalty rates charged to unrelated parties for similar rights.
- Taxpayers should document the economic analysis and set-up an approach to ensure search process objectivity when preparing and making search comparables. Tax administrators should take this approach when challenging or initiating a new search.
- Apply (1) quantitative criteria when searching external databases in order to process and filter potential comparables; (2) turnover thresholds based on the tested party’s facts and circumstances; and (3) a general independence test where no shareholder has more than a 50% ownership. Analyze, and possibly exclude, potential comparables with extreme results.
- Do not exclude publicly available accounts from listed companies as a source for comparable information because they may contain relevant information in the analysis.
- Compare the tested party’s selected diagnostic ratios of balance sheets and P&L account items, as they may prove valuable to the comparability analysis. You don’t have to define a minimum or maximum number of comparables in a range, and don’t exclude the possibility of only accepting one or two comparables.
- Don’t exclude the full range when it comprises results of similar or greater reliability for all comparability factors. If the range proves too broad, use statistical methods (e.g., interquartile range) to ensure benchmark reliability.
- Taxpayers and tax administrations may evaluate statistical tools (e.g., interquartile range) to determine enhanced range reliability. If so, consider every point in the narrowed range as being arm's length. Thus, do not adjust if the controlled transaction’s relevant conditions are within that range. If the transaction’s relevant conditions fall outside the range asserted, adjust to a point within the arm’s length range.
- Tax authorities and taxpayers should analyze all relevant facts and circumstances to decide which specific value within the range should be assessed. If the taxpayer or tax administration cannot justify another point in the range, consider the median as a reference point.
- Use multi-year data to better understand the controlled transaction and provide useful information on comparables.
- Consider the effect of business and product/intangible life cycles or anomalies in third-party information to determine the applicable period or if multi-year data is warranted.
- Be consistent when applying multi-year data, and make complete and accurate data available for the whole period.
- Do not exclude comparables because they report losses in a limited number of years on the analysis.
- Cover three years at a minimum for a multi-year analysis.
- Use information concurrent with the transaction, and consider the delay of third-party transaction information.
- Reference the relevant geographic market when conducting a pan-EU comparable search in accordance with OECD transfer pricing guidelines. This generally includes the territory in which the MNE operates, provided it is homogeneous.
- Taxpayers should document the underlying reasons for the region on which the comparable search is based when using foreign or pan-European data.
- Consider some practices further to define a geographic market when there is a lack of local independent comparables.
- Help define a relevant geographic market on a case-by-case basis using criteria that characterizes market specificities.
While comprehensive, this list may not be exhaustive depending on the circumstances. Working with a trusted advisor who understands your business and industry, as well as vetting potential internal comparables thoroughly, will result in a defensible and robust benchmarking strategy.