Transfer pricing study or benchmarking study is very important in case of any international or specified domestic transaction between associated enterprises because it is used to identify the nature of the transaction between associated enterprise and whether same are at arm’s length while preparing documentation. Also, it sets up a benchmark for a transaction between related parties and determines the arm’s length range while determining an estimation of arm’s length price.
The main purpose of doing transfer pricing study is to determine what conditions or external environment are prevailing in the market for similar transactions conducted by a third party or unrelated party. Benchmarking study help to fixed up a markup range for arm’s length price i.e what should be lower and higher range of price of such transactions in open market in case such transactions was not done between associated enterprise but between unrelated third parties.
On basis of transfer pricing study, a comprehensive TP study report is prepared. On basis of said transfer pricing study report, tax authorities normally will compute whether arm’s length price determined by a taxpayer for a particular transaction is between aforesaid markup range or arm’s length range and in case of doubt, will be made necessary additions by determining his own arm’s length price.
Generally, TP study should be conducted on annual basis, however, in case of not much change in market conditions and profitability of the company, TP study may be conducted every 2 years.
Steps involved in Transfer Pricing Study
Normally, the following steps are involved in drafting suitable transfer pricing study report; however, the list is just illustrative and not comprehensive.
- First of all, we need to decide for how many years, benchmarking study is required.
- Making an analysis of the circumstances of the taxpayer.
- Understanding the international or specified domestic transaction and making functional and economic analysis in order to make choice of parties to be tested, what comparability factors to be taken into account and most appropriate method of computation of arm’s length need to be determined.
- Making a review of internal comparable if available.
- Making an analysis of reliable sources from where external comparable may be taken.
- Selection of most appropriate transfer pricing method by negating other methods and also making choice of financial indicators for selecting such methods.
- Making necessary adjustment incomparable, wherever required and
- Determining the final arm’s length price for the said transaction.
Importance of Transfer Pricing study
- First of all, it is a legal requirement in India to prepare and maintain proper documentation of transfer pricing transaction and TP study is part of such documentation file. Incomplete documentation file without TP study will lead to transfer pricing adjustment and penalties etc.
- On basis of transfer pricing audit report, the taxpayer can defend its position before tax authorities because it contains a detailed explanation about nature of a transaction, company profile and methods used to determine arm’s length price.
- Most importantly, it gives an overview of the financial and profitability situation of the company to the management and enables them to make informed decisions about business in the future.
Which databases are used in making transfer pricing study?
There are lots of domestic and international database for conducting TP study. In India, most frequently used are PROWESS and CAPITAL LINE. Some of the internationally used databases are:
- Amadeus – contains a database of all member states of the European Union;
- ORBIS contains a database of all global companies including Amadeus
- ROYALTY STAT
- THOMSON REUTERS
- LOAN CONNECTORS etc