One way to determine the right (at arm's length) price for a transaction (or series of transactions) between related parties, is to determine the economically viable profit allocation on the basis of the characteristics of the transactions, the functions performed, risks assumed and assets used (functional analysis).

Within the functional analysis also the contractual terms, the economic circumstances surrounding the transactions and applicable business strategies of the enterprise must be considered, but more as context than key parameter.

The functions performed

The basis for any functional analysis, is the proper identification and qualification of functions performed by each part of the group, and attached to that the actual value drivers within the business of the group.

it is in particular relevant that  the value of each function within the total business chain is determined whereby both the subjective perspective of the tax payer as the hard economical data are relevant.

The functions that may be identified can include all normal functions that you would expect to find within any comparable operating business, and can depending on the nature of the business for instance include, manufacturing, assembling, research and development, aftersales, procurement, distribution, marketing, advertising, sales, transportation, etc.

The allocation of risks

The proper pricing of a transaction will in most cases be influenced by the allocation of risks between parties. Generally speaking; a higher risk will justify a higher return on investment, although there are evident exceptions to this rule. For instance, an outdated business strategy shall by its nature bear a higher risk than a contemporary strategy, but this is not a guarantee for a higher return. In fact, a lower return would be more likely to occur.

This does however not invalidate the economical principle that low risk activities generally earn a low return, and high risks, a higher return.

Relevant risks to consider may be country risk, market risks, product liability risk, credit risk, technology risk, risk of loss, financial risks, etc.

Agreements are a good first indicator for the risk assumption, but not in all cases the contractual arrangements properly reflect the actual relationship between parties, in particular if it concerns transactions between related parties. Next to the contractual allocation of risks, atttention will have to paid to actual capacity to absorb risks.

Assets used 

The investment in assets can be an important indicator for the return on investment and profitability. This applies to tangible assets, like machinery or plants, but sure also to intangible assets, like brands, trademarks and patents.

What we can do for you:

We are gladly prepared to assist you with setting up a functional analysis and to assist with clarifying transfer pricing issues, and handling the associated documentation and filing requirements.

If you wish to receive more information, please feel free to contact us via e-mail or call us at our office in Amsterdam +31 (0)20 5709440 or Rotterdam +31 (0)10 2010466.  

We will make time for you!

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