I vividly remember a conversation I had with a client during my professional services days. We had drafted a Polish transfer pricing report and had used German comparables to benchmark the German entity that was providing management services to a Polish affiliate.
The client was adamant that Poland would not accept these comparables, because, at the time, the tax authority mandated the use of local comparables. At first, I thought he was suggesting that we should use local competitors of the Polish distribution entity, and I began to educate him on why competitors do not always make good comparables. Then I explained that we should use service providers similar to the German entity to benchmark the services more directly being rendered, rather than the foreign recipient. But he quickly stopped me, explaining that his intention was to use management service providers as comps, but replace the German companies with Polish ones. At this, I nearly fell out of my chair. Why would we ever use comparables that are not in the same jurisdiction as the tested party, if the tax authority mandates local comps?
I have since heard similar ideas from other clients, who have said that certain tax authorities expect that their own country’s companies be used as comps in an analysis, regardless of the tested party’s jurisdiction So, are they right?
Basically, in addition to functional comparability, there are other comparability factors—economic conditions being one—that come into play in a TNMM transfer pricing analysis. Germany and Poland, for example, have unique macroeconomic conditions that could impact the profitability of companies operating within their borders, despite the fact that they are both EU countries. So, using Polish companies to benchmark a German provider of management services introduces comparability issues unnecessarily. companies in Poland may make different margins than those in Germany, even if they do the same exact thing
But then what is the feasible alternative?” If we were running a business and not providing services intercompany, we would probably use a local Polish provider to provide management services to our Polish entity. This approach distills down to common sense, without introducing differences in macroeconomic conditions.
Whichever approach you take, it is worth noting that the Polish Ministry of Finance has never come out and stated that Polish comparables should be used in cases where the counterparty is the tested party—and I don’t know of any tax authority that has. Perhaps one day, tax authorities will take a stand, giving guidance to taxpayers and transfer pricing professionals. In the meantime, it’s important to justify whichever approach you take, as opposed to just assuming that tax authorities will accept it.
Resources you may be interested in:
Blog: “Comparing Transfer Pricing Comparables”
White paper: “Transfer Pricing in Germany: The Rising Risk”
White paper: “The Essential Guide to Intragroup Service Transactions”
White paper: “What You Need to Know About Transfer Pricing Comparable Searches”
