At the core of every transfer pricing policy is the requirement to demonstrate that related-party transactions are consistent with market terms. Benchmarking is the process of identifying and applying comparable data to support this principle.
Done well, it can strengthen documentation and reduce the risk of tax authority enquiries. This issue explores the practicalities of benchmarking and how to use data effectively.
What Is Benchmarking in Transfer Pricing?
Benchmarking involves comparing the terms of related-party transactions to those that would be agreed between independent entities. The goal is to determine an arm's length range or price that reflects commercial reality.
The transfer pricing methods (with the exception of the profit split method) rely heavily on the use of benchmarking techniques:
- Comparable Uncontrolled Price (CUP): Comparing the price of goods or services to transactions between independent parties.
- Transactional Net Margin Method (TNMM): Assessing profitability margins in comparable companies or transactions.
- Cost Plus or Resale Minus: Applying a mark-up to costs or a reduction from resale prices to reflect a third-party perspective.
Where to Find Reliable Data
Reliable benchmarking depends on selecting appropriate comparables. Data sources include:
- Public financial databases
- Industry reports
- Government publications and trade statistics
- Internal uncontrolled transactions (if available)
When using external databases, it's important to ensure that data is up to date, consistent in format, and reflects similar functions, risks, and assets.
Common Issues and How to Address Them
- Geographical relevance: Comparables should reflect the economic conditions of the tested party's jurisdiction or region.
- Functional similarity: Entities selected must perform similar functions with comparable levels of risk.
- Screening criteria: Applying too many or too few filters can either exclude relevant comparables or include weak ones.
- Currency and timing adjustments: Converting data into the appropriate currency and time period is essential for a meaningful analysis.
Maintaining Robust Benchmarking
Benchmarking is not a one-time exercise. It should be updated periodically, typically every three years, and reviewed annually for consistency with financial performance. If significant changes occur within the business or the market, it may be necessary to refresh the benchmarking analysis sooner.
Additionally, the rationale for choosing specific comparables and excluding others should be clearly documented. Transparency in methodology improves the credibility of the analysis.
Benchmarking helps support transfer pricing positions with objective, structured data. By selecting relevant comparables and applying sound methodology, businesses can demonstrate that their pricing policies are aligned with market conditions. This not only strengthens compliance but also improves internal confidence in pricing decisions.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
