All methods that apply the arm’s length principle can be tied to the concept that independent enterprises consider the options realistically available to them and in comparing one option to another they consider any differences between the options that would significantly affect their value. For instance, before purchasing a product at a given price, independent enterprises normally would be expected to consider whether they could buy an equivalent product on otherwise comparable terms and conditions but at a lower price from another party. Therefore, as discussed in Chapter II, Part II, the comparable uncontrolled price method compares a controlled transaction to similar uncontrolled transactions to provide a direct estimate of the price the parties would have agreed to had they resorted directly to a market alternative to the controlled transaction. However, the method becomes a less reliable substitute for arm’s length transactions if not all the characteristics of these uncontrolled transactions that significantly affect the price charged between independent enterprises are comparable. Similarly, the resale price and cost plus methods compare the gross profit margin earned in the controlled transaction to gross profit margins earned in similar uncontrolled transactions. The comparison provides an estimate of the gross profit margin one of the parties could have earned had it performed the same functions for independent enterprises and therefore provides an estimate of the payment that party would have demanded, and the other party would have been willing to pay, at arm’s length for performing those functions. Other methods, as discussed in Chapter II, Part III, are based on comparisons of net profit indicators (such as profit margins) between independent and associated enterprises as a means to estimate the profits that one or each of the associated enterprises could have earned had they dealt solely with independent enterprises, and therefore the payment those enterprises would have demanded at arm’s length to compensate them for using their resources in the controlled transaction. Where there are differences between the situations being compared that could materially affect the comparison, comparability adjustments must be made, where possible, to improve the reliability of the comparison. Therefore, in no event can unadjusted industry average returns themselves establish arm’s length prices.
TPG2022 Chapter I paragraph 1.40
Category: D. Guidance for applying the arm’s length principle | Tag: Commercial and financial relation, Comparability analysis, Comparability factors, Delineation, Industry average, Options realistically available
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Next » Related Guidelines
- TPG2022 Chapter I paragraph 1.36The economically relevant characteristics or comparability factors that need to be identified in the commercial or financial relations between the associated enterprises in order to accurately delineate the actual transaction can be broadly categorised as follows: The contractual terms of the transaction (D.1.1)....
- TPG2022 Chapter I paragraph 1.34The typical process of identifying the commercial or financial relations between the associated enterprises and the conditions and economically relevant circumstances attaching to those relations requires a broad-based understanding of the industry sector in which the MNE group operates (e.g. mining, pharmaceutical, luxury...
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Related Case Law
- Peru vs. Borrower Branch, June 2021, Tax Court, Case No 05569-1-2021A foreign group had transferred funds to a branch in Peru and claimed that the transfer was a capital contribution – and not a loan. Following an audit the tax authorities issued an assessment, where the funds were considered a loan and withholding...
- Ukrain vs PrJSC “Poltava GZK”, June 2022, Supreme Court, Case No 440/1053/19Poltova GZK is a Ukrainian subsidiary of the Ferrexpo group – the world’s third largest exporter of iron ore pellets. In FY 2015 the iron ore mined in Ukraine by Poltava GZK was sold to other companies in the group – Ferrexpo Middle...
- Portugal vs “FURNITURE S.A.” No I, November 2021, CAAD, Case No 14/2021-TFurniture S.A is engaged in the production and sale of furniture and had established a US subsidiary to market and sell furniture overseas. The pricing of the controlled transactions with the US subsidiary had been based on a resale price method, which resulted...
- Romania vs “Milk and Dairy” A. SA, September 2020, Supreme Court, Case No 4702/2020In regards of transfer pricing A. SA had two activities – production of dairy products and distribution of milk – that had been subject to an audit by the tax authorities which resulted in an assessment of additional taxable income. The transfer pricing...