Transfer Pricing

Transfer Pricing

Transfer Pricing, Verrechnungspreise, DBA, Steuern, cross border tax, international structure, shared services, law, compliance, CPA, Steuer

Erich Lohr Erich Lohr Premium

Benchmark studies necessary?

Hello together,

within our group we have installed the cost plus method as regular transfer pricing method for all manufacturing and service providing entities that do only intercompany transactions. For calculating the markup we have made a internal survey of all functions and risks for the entities in our global value chain. Based on this survey we have clustered the intercompany manufacturer and service provider very roughly in "high-middle-low" functional entities. "High" means the entity gets a higher mark up (up to 6%), "low" means corresponding a low markup (3%).

We actually use no benchmark studies for proofing our markups as arm´s length conform, as we rely on our experience and stay in a range from 3-6%. For us, benchmark studies as a possible way of proofing the arm´s length principle, but no legal obligation. Until now we had no big issues in the fiscal audits in countries where we have intercompany manufacturer, with the exeption USA, where we headed for an APA.

Now I want to clarify our point of view about the legal situation regaring benchmark studies. Does anyone know in what specific countries the local fiscal authorities have the set benchmark studies as legal / statutory obligation for the transfer pricing calculation and evidence of the arm´s length principle? Or is there any survey existing, for example from the OECD?

Thank you and kind regards

Erich Lohr

Henning Straeter Henning Straeter Moderator

Dear Mr Lohr

If you have detailled questions, please do not hesitate to contact me.
Best regards,
Henning Straeter

Luis Carrillo Luis Carrillo

Hi Erich,

I believe IBFD has a comprehensive database (IBFD Transfer Pricing Database) that summarizes country-by-country rules, methods and documentation requirements. I suggest you subscribe to it. It's the most comprehensive survey of TP requirements I have seen in the market so far.

Ernst & Young also has an excellent (free) transfer pricing survey, but it does not touch on benchmarking specifically.

Broadly speaking, and not knowing the specific facts and circumstances of your situation, I can say the following:

In general, from the perspective of countries that prescribe to the OECD Guidelines for transfer pricing purposes, you must justify the arm's length nature of your intra-group pricing. To do so, the OECD Guidelines suggest 5 principal methods, but they also allow for the use of "unspecified methods" to the extent such unspecified methods result in a more reliable measure of arm's length.

You do not have to run a benchmark analysis, but you do have to have evidence (comparables) that your cost-plus mark-ups occur in arm's length situations. Comparables can be a transaction you have with a third party (where the products traded, the geographies, the volumes and terms and conditions are comparable to your intra-group transaction) or independent companies that engage in comparable transactions with other independent third parties.

I would classify your "business experience" as an "unspecified method", but most tax authorities that follow the OECD could challenge your use of "business experience" and enforce a transfer pricing adjustment (if they find comparables that support a different transfer pricing policy).

If the mark-up on costs you're using is the ratio of net operating profits (sales - cost of goods sold - overhead and administrative expenses) divided by total operating costs (cost of goods sold + overhead and administrative expenses), the 3% - 6% range you use might be defendable from a Transactional Net Margin Method point of view.

If the mark-up on costs you're using is simply the ratio of gross profits (sales - cost of goods sold) divided by direct manufacturing costs (cost of goods sold), then the range of 3% - 6% may be difficult to justify from a Cost Plus Method point of view (unless you have situations where your manufacturing entities manufacture and sell similar products to third parties at a mark-up of 3% to 6%).

Clearly, the best thing to do is to have a detailed conversation with a transfer pricing professional who can clearly advise you based on a thorough understanding of the facts. The above is nothing more than a generalized observation based on the little information you have shared.

Anyway, I hope you find this useful.

Erich Lohr Erich Lohr Premium

Hi Luis,

thank you for your detailled answer, and sorry for my late reply.

I agree that our approach is more the unspecified method, until now we had - with exeption in US - no big issues with our transfer pricing. Actually we have a group fiscal audit in Germany, and there are several audits also running at our foreign entity. So we will see the reaction and first opinion of the fiscal authorities pretty soon.....

Thanks again and kind regards


Karol Stojek Karol Stojek

Hi Erich,

I know a German company (production) that had multiple distribution companies all around Europe. The company had benchmarking studies (prepared with the use of Amadeus database). They set the markup just in the middle of the median of the markups resulting from the benchmarking study (the spread was - as far as I remember - 5-6 percent points).

When the tax authority came, they said that it's perfect, that they had a benchmarking study, but the spread is high and in their opinion, the markup should be higher. Then it came to negotiations that lasted for more than 2 weeks. The final conclusion was: the German company will pay 400 T EUR, will not adjust the CIT in other countries, will change the policy for the future.

To sum it up: benchmark was important. Negotiation skills were crucial.

I'll keep my fingers crossed that everything will go smoothly.



Marco van Erp Marco van Erp

Dear Mr Lohr,

Search for third party data is the cornerstone of transfer pricing. However, this can be burdensome and costly for tax payers.

In the Netherlands, Dutch tax authorities generally expect a ‘proportional effort’ on benchmarking. For a minor and incidental transaction, it could be argued that it makes no sense to perform a database search.

To determine which effort is proportional, it is especially helpful to evaluate the following elements:
1 the starting point for determining pricing, e.g. (annual) cost base (when applying a cost plus model);
2 the duration of the intercompany transaction (e.g. is it structural or not?);
3 financial interests of the countries involved (e.g. is it a cross border transaction affecting a proper tax return filing in various countries?);
4 level of tax planning, e.g.
- applying mark-ups which could be close to the borders of the arm’s length pricing range;
- transactions in which a tax haven is involved.

By multiplying (a) annual cost base (e.g. EUR 1 million) x (b) the duration (e.g. 6 years), it is possible to obtain swift insights in the potential financial impact of an adjustment of the mark-up by the tax authorities. If the tax rate is 25% and tax authorities would adjust the mark-up for 6 years, tax costs in relation to such transfer pricing adjustment would amount to:
- EUR 15,000 (mark-up adjustment of 1%; such an adjustment is hardly beneficial for tax authorities);
- EUR 30,000 (mark-up adjustment of 2%);
- EUR 45,000 (mark-up adjustment of 3%);
- Et cetera

This information could be a useful starting point, when evaluating whether the costs of a benchmark study sufficiently offset the potential tax costs of a transfer pricing adjustment. Of course, this is very simple tool to evaluate whether it might be proportional to perform a benchmark study. In addition, your level of comfort and other costs may have an impact on a decision to perform a benchmark study (e.g. costs of managing tax audits, managing tax assessments, managing double taxation (if present), interest and penalties).

The above briefly addresses elements to consider in relation to benchmarking (from a Dutch transfer pricing perspective). Of course, setting a proper mark-up is important, when applying a cost plus model (Cost Plus Method or a cost plus model supported by the Transactional Net Margin Method). At the same time, it may also be beneficial to pay attention to the arm's length nature of the cost base.

I hope this information is useful for you.

Kind regards,