The arm’s length principle requires related companies to apply transfer prices that are comparable to prices between unrelated companies that conduct business under comparable economic conditions, in particular regarding their added value, their assets, functions, and risks as well as economic, political, and social circumstances. To be able to estimate what unrelated parties would agree on, the search aims at identifying independent comparable companies in the database. Searching various databases (international or domestic), identifying comparable companies and their profit margins are the main goals of a benchmarking analysis.
The main criteria when creating the list of potentially comparable companies from the database in the bechmarking analysis of companies are:
- Independence: potentially comparable companies must not have any related parties
- Available financial statements in last 3 years
- Activity: searching only active companies which still perform regular business activities
- Geography: Rulebook on transfer pricing demands searching for comparable companies in the domestic market first. Only in case there are not sufficient comparable companies, in order to ensure a sufficient level of comparability for the calculation of prices that meets “arm length principle”, the geographic market can be expanded
- Excluding companies with negative financial results in three consecutive years
- Year of incorporation: The criterion “year of incorporation screening” prevents the arm’s length range from being affected by companies that are in a start-up phase and therefore have non-comparable economic conditions during the considered period
- Industry Screening: using NACE Rev. 2 codes
- Revenues and number of employees: In order to ensure better comparability and eliminating the impact of specific factors that may affect the business, we select potentially comparable companies on the basis of the amount of revenues and number of employees
After the list of potentially comparable companies is created, the next step of benchmarking analysis is qualitative analysis. The resulting set of potentially comparable companies in the database is analysed from the perspective of:
- a description of activities provided in the base
- content on the websites of companies and other publicly available information on the internet
- additional assurances that the company identified no related parties and the comparability regarding the use of net working capital and fixed assets (through ratio analysis of financial statements)
- comparison of balance sheet items and ratio numbers
The last step of benchmarking analysis, after the final set of comparable companies is identified, is to determine the interquartile range of prices (margins) for comparable transactions (companies).
If you have any questions, feel free to contact one of the WTS tax experts.