Transfer Pricing Compliance – Comparability Analysis
Transfer pricing guidance emphasises the application of arm’s length principle when pricing transactions between connected companies. The terms and conditions agreed between connected companies are compared with those that would have been agreed by independent unrelated enterprises. Comparability analysis, therefore, compares the controlled transactions between connected companies with comparable transactions between unrelated companies.
Comparability analysis requires accurate delineation of actual controlled transaction to determine the economically relevant characteristics of the transaction in addition to identifying roles and responsibilities of each party involved in the controlled transaction. Comparability is an essential condition for assessing whether an inter-company transaction is at arm’s length and plays a pivotal role in selecting the appropriate transfer pricing method.
Comparability analysis is undertaken by considering the contractual terms, economic circumstances, functions performed, asset used, and the business strategies undertaken by the parties to the transaction. Potential comparables are identified by reviewing uncontrolled transactions that operate in similar industries, employ same level of resources, and are faced with similar level of risk.
HMRC recently issued guidance on the quality issues encountered with documentation received for comparability analysis. As per the guidance HMRC have notices quality issues regarding the following
- How the final comparables set was arrived at
- How specific UK specific comparability factors are met
- What work has been done to establish them as the most reliable
HMRC expectation is that the comparability analysis is performed for each controlled transaction in detail and the price and conditions of the controlled transactions are accurately delineated and are correctly compared with uncontrolled transactions between independent enterprises. A well-documented process is needed to identify external comparables with a clear audit trail of search criteria employed and showing clear steps how comparables were reviewed, accepted, and rejected.
Compliance risks are created in the areas of
- comparables search design
- comparability and reliability of comparables.
Compliance risk would be created where the design of comparables searches does not include reasonable searches for internal comparables or the criteria used to design search parameters are not based on the economically significant activities. Problems also arise where the search criteria do not cover all the functions and services to be priced and the accept or reject criteria is automatically applied without a manual review to remove less reliable potential comparables.
Comparability and reliability of comparables are undermined where broad range of comparables are used which are unlikely to be equally reliable or comparable, comparables applied to a specific transaction are applied to another transaction without proper consideration, a single comparable search is relied on to cover multiple functions or there are no checks for material differences in profit and loss line items of the UK entity and the comparables.
How can we help?
Our in-house international tax team would be well placed to assist you with your transfer pricing compliance documentation to ensure it meets HMRC’s requirements. Please get in touch with us for further details.
