Organisation for Economic Co-operation and Development
Auditing Multinational Enterprises
7 - Cutting Edge Comparability
Analysis and Method
Centre for Tax Policy and Administration
Summary
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Cutting Edge Corporation (CE Corporation) manufactures and sells
advanced and specialised electronic equipment used in diagnostic
testing in hospitals.
The parent company, CE Corporation is resident in Country A,
where it has an R&D facility, a manufacturing facility and a
domestic sales division.
It has one subsidiary, CE (B) Ltd, resident in Country B, which
carries out a sales/distribution function.
You are carrying out an audit on the 2009 return of CE Corporation,
focusing on the transfer pricing of the sale of products from CE
Corporation to CE (B) Ltd.
CE Corp has not maintained any formal documentation of their
transfer pricing, but they do provide you with some financial data.
Financial data
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You ask for a breakdown of CE Corporation’s turnover
and you are told that is divided between:
- Sales within Country A - 225 units at an average price
of $133K
- Sales to CE (B) - 650 units at an average price of
$100K.
The company tells you that sales of CE-manufactured
goods within A and B carry the CE brand-name and
logo.
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Methods example
 The company tells you also that CE (B)
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purchases products from an independent
manufacturer (IndyMedical), also located in
Country A, and sells the products under the
independent manufacturer’s brand-name and
logo.
It purchases 125 units sourced from the
independent manufacturer at an average price
of $ 80K.
CE (B)’s selling prices
The company tells you that Company (B):
 Sells units sources from Cutting Edge Corporation for
an average of $132 K
 Sells units sourced from IndyMedical for an average of $
108K
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Financial information
You are provided with extracts from:
 2009 accounts of CE Corporation
 2009 accounts of CE (B) Ltd, which are provided to you by CE
Corporation
 2009 accounts of an independent manufacturer of diagnostic
equipment in Country A, which sells units to CE (B) Ltd. These
accounts are publicly available in Country A.
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What methods may be available here?
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CUP?
Cost-plus?
Resale minus?
TNMM?
Profit split?
Comparable uncontrolled price
Cutting Edge Corporation sells goods to CE (B)
for $ 100K.
Potential comparables for this transaction are:
 Sales by CE Corporation to domestic customers
- $133K each
 Sales by IndyMedical to CE (B) Ltd - $80K
each.
How reliable are these comparables likely to be?
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Comparable Uncontrolled Price
How reliable are the comparables?.
 Are the sales into the same level of the market? CE
Corporation’s sales in A appear to be to end customers.
The controlled transaction is to a sales/distribution
company.
 Do they involve the same product as the controlled
transaction? There appear to be marked differences
between the products manufactured by CE Corporation
and by IndyMedical
It is unlikely that there is sufficient product or functional
comparability to allow the comparable uncontrolled price
method to be reliably used in this case.
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Cost-plus
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The accounts of the independent manufacturer show a
66.7% mark-up on direct costs.
Does this provide a comparable that can apply to the
manufacturing costs of CE Corporation?
Functional analysis:
• CE(Corp) owns 2 intangibles – brand and trade (R & D
expenditure).
• Cost plus, which would involve testing CE Corporation, is
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unlikely to be suitable unless the independent has similar
intangibles of similar value
We do not know this
We also do not know the product mix in the sales of the
independent manufacturer – we need to identify the mark-up it
achieves on the sale of goods to CE(B) Ltd.
Resale price method
The gross margin earned by CE (B) Ltd on units purchased from the
independent manufacturer is a potential comparable.
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We know that, on units sourced from CE Corporation, CE (B) Ltd
earns a gross profit of 24% ((132-100)/132.)
We know that on units sourced from the independent
manufacturer, the gross margin is also 26% ((108-80)/108).
A comparability analysis is necessary to establish whether this a
sufficiently reliable comparable.
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Transactional Net Margin method
Is TNMM available?
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We know that Cutting Edge (B) earns a net margin of 10%
However we do not know how this is split between the net margin
earned on goods sourced from Cutting Edge Corporation and that
earned on goods sourced from Indy Medical
That is, we do not have transactional information
Also ..
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We know the net margin earned by Cutting Edge Corporation and
that earned by IndyMedical
But , again, we do not have the information available at a
transactional level .
So TNMM is unlikely to be reliable in this case.
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And…Profit split method
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A potential comparable would be the split of profit between the
independent manufacturer and CE (B) Ltd derived from the
manufacture and sale of the units produced by the independent
manufacturer and sold to CE (B) Ltd.
If we used a profit split method, this would be compared to the
split of profit between CE Corporation and CE (B) Ltd, from the
manufacture and sale of the units produced by CE Corporation.
However, we do not have the information to enable us to do
this on a transactional basis. We have only whole-company
information on net profit.
Also, profit split is most appropriate where both of the parties to the
transaction carry out non-benchmarkable functions. This would
need to be tested.
Conclusions
The tentative conclusion might be that the
resale price method is available in this case.
However, we would need to carry out a
comparability analysis to determine whether this
method, and the chosen comparable
transaction, are sufficiently reliable.
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Comparability Factors
A comparability analysis focuses on five factors:
 Nature of product
 Contractual terms
 Functional analysis (including assets used and risks
assumed)
 Economic conditions
 Business strategy
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Comparability analysis
You are asked to carry out a comparability analysis
between the following transactions:
 a) purchases of units by CE(B) from CE Corporation,
and
 b) purchases of units by CE(B) from IndyMedical.
(See template)
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Comparability analysis
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(see key doc)
 Analysis shows that there is poor product
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comparability between the goods sourced by
CE (B) from CE Corporation and IndyMedical
But there is good functional comparability
between the functions carried out by CE (B) in
respect of goods sourced from CE Corporation
and IndyMedical
Conclusions
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In this case, we would probably consider that there is
good functional comparability between:
the functions performed by CE(B) in respect of CE
Corporation sourced goods, and
The functions performed by CE (B) in respect of
IndyMedical sourced goods
.. and that the resale price method is likely to be
sufficiently reliable
and that no transfer pricing adjustment is necessary.