TRANSFER PRICING CASE STUDIES
WORKSHOP
SAN JOSE
31 MARCH - 4 APRIL 2014
3-d. Functional Analysis – Canadian Approach
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Risk Assess the File
• Knowledge of the Company, Industry and Business Structure:
• Organisational charts; Annual Reports; “contemporaneous
documentation”; Internet search for articles; filings with Securities
Commissions.
• Obtain contracts, agreements, etc. – look for internal CUPs,
understand how the transactions are structured.
• Obtain segmented financial statements:
-
analyse gross profit and operating profit of Domestic Company and foreign
associated enterprise(s)
-
identify “system profit”
• Clearly identify the transactions and the applicable treaty.
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Factors Determining
Comparability
• 5 major factors:
i.
Characteristics of property or services
ii.
Functional analysis – Functions, Assets, Risks
iii. Contractual terms
iv. Economic circumstances
v.
Business strategies
• Arm’s length principal - compare conditions in controlled
transaction with conditions in uncontrolled transactions.
• Determine if any “reasonably accurate adjustments” are
necessary.
• All TPMs are based on a certain degree of comparability.
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Functional Analysis
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•
•
•
•
•
Why …
What …
When …
Where …
How …
Who …
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Functional Analysis - Why?
• Critical audit step – verify that what is reported to the tax
administration reflects what is actually being done.
• So that we can determine:
• tested party
• most appropriate methodology
• most appropriate comparables
• Goal is to determine: who should get what for the
functions performed; which parties are responsible for
value-added activity?
• Identify key profit drivers.
• Need to support file for Appeals / Competent Authority /
Court
5
Functional Analysis – Who
• Go to the taxpayer’s premises to:
– interview the taxpayer’s key personnel
– do a tour of the premises
– obtain thorough understanding of the domestic operations
• Interview the people who are actually performing the
functions.
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Functional Analysis - What?
What is functional analysis?
= Functions performed; Assets used by all parties
involved in the transaction; Risks assumed.
• Functions: Production; Marketing; Distribution;
Management; Administrative; Technology
• Assets: Tangibles; Intangibles; Working Capital
• Risks: Technological; Market; Credit; Foreign
Exchange; Litigation; Inventory; Capital
Investment
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Functional Analysis - When?
• On every single file!
• It should be done for all related party
transactions and/or product lines.
• Done BEFORE making ANY determinations as to
who is the tested party, what methodology will
apply, or who the comparables will be.
• Do not get into discussions of comparables with
the taxpayer or their representatives until you
have completed the functional analysis.
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Functional Analysis - Where?
• It is easy for a taxpayer to state what functions
are performed in the other country, we need to
verify the accuracy of their statements.
• Visit the domestic operations, and go to the
foreign jurisdiction (when possible).
• Transfer pricing audits are not a desk job!
• Level of detail will vary, case-by-case, and
depending on the issue.
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Functional Analysis - How?
Before the Functional Analysis Interviews:
• Understand the company and major functions so
you interview the right people and ask the right
questions.
• Do not interview only the Director/VP levels;
interview the people actually doing the job.
• Use the Organisational Charts to identify people to
interview.
• Ask questions geared to that company and the
specific industry and markets they operate in.
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Functional Analysis – How?
During the Functional Analysis Interviews:
• Take detailed notes.
• Team approach - two auditors on every interview
– one to ask questions, one to take notes.
• If taxpayer requests questions in advance, we
explain that we will be asking questions that will
help us get an understanding of their operations.
It is basically, “What do you do?” “How do you do
it?” Further questions then flow from their
answers.
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Functional Analysis – How?
After the Functional Analysis Interviews:
• Write up notes as soon as possible.
• Must be factual, not opinions.
• What to do if the taxpayer is delaying/not fully
co-operating?
• Taxpayer must provide documentary support for
any facts they disagree with.
• Do not debate methodologies or comparables
before completing functional analysis
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Functional Analysis – How?
After the Functional Interviews:
• Determine how to classify the entity; do not
worry about “labels”.
• Relate the functional analysis to profit drivers.
• Using the functional analysis:
• Determine tested party – least complex entity and/or
most reliable information.
• Determine the TPM
• Find comparable transactions - similar levels of asset
intensity, bearing similar risks
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Conclusion
The end goal is to determine if the terms and
conditions in the controlled transaction are what
we would see in a comparable uncontrolled
transaction.
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Questions and/or
comments?