The Functional Analysis in Transfer PricingBy Robert Robillard - 4 June 2014
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Paragraph 1.42 of the OECD Transfer Pricing Guidelines explains:
“In transactions between two independent enterprises, compensation usually will reflect the functions that each enterprise performs (taking into account assets used and risks assumed). Therefore, in determining whether controlled and uncontrolled transactions or entities are comparable, a functional analysis is necessary. This functional analysis seeks to identify and compare the economically significant activities and responsibilities undertaken, assets used and risks assumed by the parties to the transactions. […].”
Paragraph 1.43 of the OECD Transfer Pricing Guidelines suggests:
“The functions that taxpayers and tax administrations might need to identify and compare include, e.g. design, manufacturing, assembling, research and development, servicing, purchasing, distribution, marketing, advertising, transportation, financing and management. The principal functions performed by the party under examination should be identified. […].”
In Canada, paragraph 32 of IC 87-2R International Transfer Pricing recognizes this approach.
In the United States, item (d)(3)(i) of §1.482-1 Allocation of income and deductions among taxpayers suggests:
“(i) Functional analysis. Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the functions performed, and associated resources employed, by the taxpayers in each transaction. This comparison is based on a functional analysis that identifies and compares the economically significant activities undertaken, or to be undertaken, by the taxpayers in both controlled and uncontrolled transactions. A functional analysis should also include consideration of the resources that are employed, or to be employed, in conjunction with the activities undertaken, including consideration of the type of assets used, such as plant and equipment, or the use of valuable intangibles. A functional analysis is not a pricing method and does not itself determine the arm’s length result for the controlled transaction under review. Functions that may need to be accounted for in determining the comparability of two transactions include—
(A) Research and development;
(B) Product design and engineering;
(C) Manufacturing, production and process engineering;
(D) Product fabrication, extraction, and assembly;
(E) Purchasing and materials management;
(F) Marketing and distribution functions, including inventory management, warranty administration, and advertising activities;
(G) Transportation and warehousing; and
(H) Managerial, legal, accounting and finance, credit and collection, training, and personnel management services.”
The functional analysis is a key component of any proper transfer pricing documentation. It should be updated yearly or as needed to insure compliance with the Income Tax Act and the Internal Revenue Code.
Robert Robillard, CPA, CGA, MBA, M.Sc. Econ.
Transfer Pricing Chief Economist, RBRT Inc.
514-742-8086; robert.robillard “at” rbrt.ca
RBRT Inc. is all about transfer pricing. We specialize in transfer pricing. Our services include transfer pricing documentation, transfer pricing dispute resolution, advanced pricing agreement (APA), value chain management and TP planning, transfer pricing training. The information in this blog post is general information only. Data and information come from sources believed to be reliable but complete accuracy cannot be guaranteed. RBRT Inc. and the author are not responsible or liable for any error, omission or inaccuracy in such information. Readers should seek independent tax advice and tax counsel from RBRT Inc. as required.
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