An audit of transfer pricing documentation may result in an overestimation of income/loss, which may translate into tax settlements of the audited entity. For this reason, it is important to determine the terms of the transaction corresponding to the market and to verify them in the form of a comparative analysis. Importantly, market conditions must be met throughout the transaction.
What is comparative analysis?
Comparative analysis (benchmark) is used in transfer pricing documentation. The analysis is based on a benchmark, which is the basis for verifying that a transaction between related parties was determined on an arm’s length basis. It compares the subject’s transaction with similar transactions carried out by independent companies in the market. It relies on data from independent commercial databases containing financial information and terms of transactions of other companies. This makes it possible to demonstrate that the transfer prices used comply with the arm’s length principle.
When should it be updated?
Many transactions are entered into for a period spanning several years or indefinitely. Thus, market conditions can change significantly over the course of a single transaction. Therefore, in order to maintain the relevancy of the transaction, it is necessary to regularly update the benchmark.
According to the regulations, the benchmarking analysis should be updated at least once every three years, unless there has been a change in the economic environment to a degree that significantly affects the prepared analysis, which justifies an update in the year in which the change occurs. In doing so, it is emphasized that an analysis from a three-year perspective, as a rule, captures market trends and avoids distortions resulting from one-year fluctuations.
An earlier update is advisable instead in the following situations:
- There has been a significant change in economic circumstances, e.g. sudden emergence of new technologies, changes in the economic sector, global crises, which may drastically affect the profitability of the industry and thus the market terms of the transaction.
- The related party’s business strategy has changed through, for example, restructuring, changing the business model, expanding into new markets.
- A negative opinion from a tax authority has been received – if the tax authorities challenge transfer pricing, updating the benchmark may be crucial to defend against negative consequences.
What does a current comparative analysis provide?
An up-to-date comparative analysis provides evidence that the transaction terms used are in accordance with the arm’s length principle. This minimizes the risk of them being challenged by the tax authorities and thus protects against potential sanctions. In addition, a regularly updated benchmark enhances the quality and credibility of local documentation, and allows for ongoing monitoring and identification of potential transfer pricing risks before they become an issue.
An up-to-date benchmark is therefore not only an obligation for some taxpayers, but above all a tool that allows self-verification of the compliance of transactions entered into. It is a safeguard from a tax and transaction perspective. That is why its update is so important.