Transfer pricing

International legal framework:

Art. 9 of the OECD Convention: associated enterprise:

1. Where:

2. a) an enterprise of a Contracting State participates directly or indirectly

in the management, control or capital of an enterprise of the other Contracting State,

3. or b) the same persons participate directly or indirectly in the

management, control or capital of an enterprise of a Contracting State and an enterprise

of the other Contracting State, and in either case conditions are made or imposed

between the two enterprises in their commercial or financial relations which differ from

those which would be made between independent enterprises, then any profits which

would, but for those conditions, have accrued to one of the enterprises, but, by reason

of those conditions, have not so accrued, may be included in the profits of that

enterprise and taxed accordingly. 2. Where a Contracting State includes in the profits of

an enterprise of that State — and taxes accordingly — profits on which an enterprise of

the other Contracting State has been charged to tax in that other State and the profits

so included are profits which would have accrued to the enterprise of the first-mentioned

State if the conditions made between the two enterprises had been those which would

have been made between independent enterprises, then that other State shall make an

appropriate adjustment to the amount of the tax charged therein on those profits. In

determining such adjustment, due regard shall be had to the other provisions of this

Convention and the competent authorities of the Contracting States shall if necessary

consult each other.

Primary adjustment:

Example: there is an italian company and dutch company: same groups. Dutch company

sells spare parts to ITA, ita pay 100 to have this. But italian tax authorities says that ita has

to pay 80 and this is a primary adjustment: so is the adjustment done by italian autorithies.

Corrisponding adjustments:

is the taxpayer claims for a corresponding adjustment in NL ti aviud the double

taxation. If there is an adjustment on the cost, there is also an adjustment revenant.

Methods: 1. Traditional Methods (transaction based): CUP, RPM CPM.

2. Transactional methods (profict – based): TNMM, PSM.

There is the CUP method compares:

1. The price charged for proporty or services transferred in a controller

transaction.

We have an internal comparable (one company comapre the assets of one good sold to

one company in group to the same good that is sold to another company out of the group,

and the second transaction is higher than the first. It is internal because there is the same

company) and external comparable (You compare the first transaction to one company in

the group to another transaction by the same company that are out of the groups, and the

second transaction is higher).

Strenghts:

CUP is a direct method a sit directly identifies prices charged in comparable transactions

(differently from the other traditional methods or prom the profit.

Weaknesses:

In practice it is generally difficult to locate strict comparable transactions, expecially in

relation to product comparability.

Reliable information on external Cups are generally rare to find in practice.

Typically use of CUP:

in generali s used in case of commodities (gas, petrols, metals: everything which is

easy to comapre).

There is the CPM method: the Cost plus method (CPM).

- The cost plus method begins with the cost incurred by the supplier of a product or

service provided to an associated enterprise.

- An appropriate Mark-up is then added to those costs in order to arrive to an

appropriate profit in light of the functions performer and the market conditions.

- Financial ratio used: gross profit/cost of good sold (COGS).

The comparison is not to price by to Gross margin.

Strenghts:

Cost plus is a traditional transactional method.

Weaknesses:

Difficulties related to the determination of costs:

Reliable information on comparale gross margins earned by indipendent parties are not

easy to find.

Accounting inconsistencies relevant to comparable transactions may affect the analysis.

Typical use of CPM:

It is typically applied when the associated enterprise under analysis is a manufacturing

company or a service provider.

Sales of products manufactured by one enterprise, performing limited functions assuming

limited risk.

There is also the RPM method: resale price method: tax autorithies starts from the

price of the market and fixed a margin of reseller: 0,5%. If distribution function is the

same, the margin is the same.

Main features:

- Starting points = resale price.

It’s the price at which a product that has been purchased from an associated enterprise is

resold to an indipendent enterprise.

- This price is reduced by an appropriate Gross Margin (resale price Margin):

amount out of which the reseller would seek to cover its selling and other operating

expenses and, in the light of the functions performer, make an appropriate profit.

- The Arm’s Lenght Price for the original transfer of property between the associated

enterprises is then given by the difference between the resale Price and the Gross

Margin.

- Financial Ratio = Gross margin.

Strenghths:

Resale price is a traditional method, and the none of the preferred OECD methods, when

transactional profit methods can be applied in an equally reliable manner. It’s based on

market prices, such as resale prices, determined by the demand.

Weaknesses:

Accounting inconsistences.

Typical use of RPM:

It is typically applied (manca).

The transactional Net Margin Method instead (TNMM):

- esamines the Net Profit Margin relative to appropriate bases for a particuar

transaction.

- Depending on the profit level indicators used, a transactional net margin method

operates in a manner similar to the cost plus and the resale price methods.

- TNMM compares the NET profit margin earned by an enterprise in a controller

transaction with the net profit margins realized by independent parties in comaprable

transactions.

- The TNMM is a more Indirect method than cost plus or resale price that are based

on gross margins and even more indirect than CUP that base on comparison of prices.

The profit Split Methods (PSM):

The transactional profit split method seeks to eliminate the effect on proficts of special

conditions made or imposed in a controller transaction by determining the division of

profits that indipendement enterprises would have expected to realize from engaging

in the transaction or transactions.

It addressed transactions which are so interrelated that they cannot be evaluate

onseparate basis or transaction in which both of the parties use valuable intangibles.

Two main approcches: Contribution analysis and residual analysis.

Strenghts:

The profits doesn’t grely on closely comparable transactions and it can be used in cases

when no such transactions between independent enterprise can be definied.

Weaknesses:

It’s difficult to apply because each group is different.

Application of the ALP: comparabilit analysis:

It’s the core of transfer price exercise.

There some steps that have to be followed: Understanding economically significant

charateristics of industry, business and controller transactions.

Examination of comparability factors of controller transaction.

Selecting the tested party.

Identifyng potentially comparable transactions (internal and external).

Comarability adjustments where appropriate.

Selection of most appropriate transfer pricing method.

Dettermination o fan arm’s lenght price or profit.

Documentation of the comparability analysis and monitoring.

Comparability factors:

Examination of comparability factors relevant to the controller transaction:

1. Contractual terms of the transaction.

2. Functions performer by each of the parties to the transaction.

3. Characteristics of property transferred or services provided.