Transfer Pricing Analysis: Business Strategy Factor
The “five factors” (characteristics of property or services; functional analysis; contractual terms; economic circumstances; and business strategies) are the standard reference in performing comparability analyses for determining transfer prices. Transfer price is the price of intra-group cross-border transactions between divisions of a company. For example, if a subsidiary company in the UAE sells goods or renders services to its holding company or a sister company in Bahrain, the price charged is referred to as the transfer price.
Companies need to ensure that the transfer prices are at arm’s length, which means they must charge their own divisions—or associated parties–as they would charge an unrelated company in the open market. A comparability analysis using the five comparability factors is critical in determining the transfer prices that are at arm’s length range. In this blog, we will walk you through the business strategy factor. Let us dive in:
What do ‘business strategies’ entail?
Business strategies may include aspects of a business such as innovation and new product development, degree of diversification, risk aversion, assessment of political changes, the input of existing and planned labour laws, duration of arrangements, and other factors bearing upon the daily conduct of the enterprise.
Consideration for market penetration schemes
Business strategies should also consider market penetration schemes. A business group trying to penetrate a market or to increase its market share may temporarily charge a price for its product that is lower than the price charged for otherwise comparable products in the same market. Taxpayers trying to enter a new market or expand their market share may also temporarily incur higher costs (e.g. due to start-up costs or increased marketing efforts) and hence achieve lower profit levels than other taxpayers operating in the same market.
When evaluating whether a taxpayer was following a business strategy that temporarily decreased profits in return for higher long-run profits, several factors should be considered. Tax administrations should examine the conduct of the parties to determine if it is consistent with the purported business strategy. Unusually intensive marketing and advertising efforts would often accompany a market penetration or market share expansion strategy.
Additional Considerations for Business Strategies
Another factor to consider is whether the nature of the relationship between the parties to the controlled transaction would be consistent with the taxpayer bearing the costs of the business strategy. An additional consideration is whether there is a plausible expectation that following the business strategy will produce a return sufficient to justify its costs within a period of time that would be acceptable in an arm’s length arrangement.
It is recognised that a business strategy such as market penetration may fail, and the failure does not of itself allow the strategy to be ignored for transfer pricing purposes. However, if such an expected outcome was implausible at the time of the transaction, or if the business strategy is unsuccessful but nonetheless is continued beyond what an independent enterprise would accept, the arm’s length nature of the business strategy may be doubtful and may warrant a transfer pricing adjustment.
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