How do you use benchmarking and comparability analysis in your master file for transfer pricing?

1 Benchmarking and comparability analysis

Benchmarking and comparability analysis are methods of finding comparable transactions or entities to determine the arm's length range of prices or profits for a given transaction or entity. Benchmarking and comparability analysis are essential for validating your transfer pricing policies and demonstrating that they are consistent with the economic reality of your business. They can also help you identify potential risks and opportunities for optimization.

2 Types of benchmarking and comparability analysis

There are two main types of benchmarking and comparability analysis: internal and external. Internal benchmarking and comparability analysis use data from transactions or entities within the same MNE group, while external benchmarking and comparability analysis use data from transactions or entities outside the MNE group. Internal benchmarking and comparability analysis are preferred, as they reflect the specific conditions and functions of the related parties. However, internal data may not always be available or sufficient, so external benchmarking and comparability analysis may be necessary.

3 Sources of data for benchmarking and comparability analysis

When conducting benchmarking and comparability analysis, the sources of data depend on the type of transaction or entity being analyzed, the reliability of information, and the requirements of tax authorities. Financial statements and annual reports of the MNE group or comparable companies, commercial databases with financial and operational data, industry reports and studies for market information and trends, contracts and agreements for comparable transactions, and publicly available information such as websites, press releases, or news articles are all common sources.

4 Steps for conducting benchmarking and comparability analysis

Conducting benchmarking and comparability analysis requires defining the tested party and the tested transaction or entity, selecting the most appropriate transfer pricing method and profit level indicator, identifying potential comparable transactions or entities, applying comparability adjustments, and determining the arm's length range. The tested party is usually the less complex or more routine one in the transaction or entity. The transfer pricing method should be chosen based on the nature and characteristics of the transaction or entity, as well as the availability and quality of data. Data for potential comparable transactions or entities can be sourced from internal or external sources. Comparability adjustments can be quantitative or qualitative, such as accounting adjustments to align accounting policies and standards, working capital adjustments to reflect differences in accounts receivable, accounts payable, and inventory levels, risk adjustments to account for differences in risk profiles and allocations, and market adjustments to reflect differences in market conditions. Lastly, an arm's length range can be determined using statistical methods like interquartile range, median, or mean to assess whether the transfer price or profit level of the tested party is within or outside the range.

5 How to document your benchmarking and comparability analysis

It is important to document your benchmarking and comparability analysis in your master file for transfer pricing, along with your functional analysis, transfer pricing policies, and economic activities. This documentation should provide sufficient information and evidence to support your transfer pricing positions and demonstrate compliance with the arm's length principle. The document should include a description of the tested party and transaction or entity, a description of the transfer pricing method and profit level indicator selected, a description of the data sources used and search criteria applied, a list of potential comparable transactions or entities identified and their financial and operational data, a description of the comparability adjustments applied, a calculation of the arm's length range, a comparison with the transfer price or profit level of the tested party, and a conclusion on whether the transfer price or profit level is within or outside the arm's length range. Adjustments should be made if necessary.