1. Centre for Tax Policy and Administration Organisation for Economic Co-operation and Development Workshop on Transfer Pricing and Exchange of Information Quito, Ecuador 24 – 27 August 2010 Wolfgang Büttner OECD TNMM and the Use of Databases Case Study

2. © OECD TNMM Database Search  In order to ensure a sufficient degree of objectivity, it is important that the process followed in the comparability analysis be transparent, systematic and repeatable  Comparables searches in databases are typically used as part of a TNMM analysis to determine the level of remuneration (operating profit) for the least complex party involved in the intra-group transaction (“tested party”)  Deductive approach (typically: database search)  Methodology  Strengths and weaknesses

3. 3 Screening Process Potential comparables = Database screening Companies meeting primary screening = Quantitative screening Companies meeting secondary screening = Qualitative screening Companies meeting tertiary screening = final set of comparables = Adjustments Final Set of Comparables (adjusted)

4. 4 Database Screening  Geographic scope  Activity (“NACE”, “SIC” or other code)  Independence (criteria)  Reporting and disclosure standards (accounting/IFRS issues)  Loss-making comparables  Use of multiple-year data & business cycles  Other database screenings: keywords, active/inactive companies, year of incorporation, data sufficiency, …

5. General Rules in Screening  Functional analysis of the tested party  Appropriate screening criteria based on the functional analysis  Broad information source (not only database)  Both quantitative analysis and qualitative analysis  Keep records of used screening criteria, reason for adopting those criteria, and data excluded in screening process

6. 6  Quantitative screening  Screening financial information of the comparables including whether they report sufficient turnover data and operating profit data  Can also be used in a more sophisticated manner by applying various financial ratios (referred to as diagnostic ratios) to reject companies that do not fulfil certain criteria  Assumption = diagnostic ratio constitutes a reflection of the company’s functional and risk profile Database Screening

7. 7  Qualitative screening  To reject companies that are not viewed as being comparable based on qualitative information available : – Review of business descriptions – Qualitative database review : info of the companies in other commercial databases – Internet-search : primary information (internet site of the company) + secondary information (= third party info) Database Screening

8. Typical Example of a Screening Flow 1. Selection of Company Population deemed comparable (“potential comparables”)  Selection of database which covers country tested party located  Selection of corporation population from the database based on business code  Addition to the corporation population using public information other than database (if necessary)

9. Typical Example of a Screening Flow 2. Quantitative analysis  Exclude companies of different size – determination based on scale of business in terms of sales, expenses, assets, etc.  Exclude companies with no financial data for certain periods  Exclude companies with operating losses more than certain periods

10. 3. Qualitative analysis  Exclude companies engaging certain volume of controlled transactions – determination based on annual report, independence indicator in ORBIS  Exclude companies with material intangible properties – determination based on existence of intangible properties or level of R & D costs  Exclude companies with low comparability, i.e. different business category, different level of transaction, and special circumstance (start up situations etc.) – determination based on website, annual report, etc. Typical Example of a Screening Flow

11. TNMM Case Study

12. Transaction Chart Sale of Product A Related Party Customers Parent Co P R&D Manufacturing Distribution of parts ‘a’, ‘b’, ‘c’ … Supply of Part ‘a’ Subsidiary S Manufacturing Distribution of final Product A Country YCountry Z Country X controlled transactions

13. Summary of Controlled Transactions Audit Period 2007-2009 P (Parent company)  performs R&D  manufactures and sells, among others, part ‘a’ to subsidiary S  Part ‘a’ is manufactured using original technologies resulting from P’s R&D activities S (Subsidiary)  purchases part ‘a’ from P and other parts and raw materials from independent suppliers  manufactures final product A (complex assembly/production lines) and  sells product A to related parties (does not perform any marketing or advertising)

14. Relevant Questions 1) Tested party? 2) Most appropriate TP method? 3) Arm’s length transfer prices for the controlled transactions?

15. Tested Party Sale of Product A Related Party Customers Parent Co P Supply of Part ‘a’ Subsidiary S Manufacturing Distribution of Product A Country YCountry Z Country X Transfer Price? Tested Party

16. Most Appropriate Transfer Pricing Method  CUP?  No: part “a” and final product A are unique  Cost Plus (for manufacturing functions)?  No: manufacturing costs are affected by association (purchases from related party = no uncontrolled purchases)  Resale Price (for distribution function)?  No: sales price for Product A is affected by association (sales to related parties = no uncontrolled sales)

17. Most Appropriate Transfer Pricing Method  TNMM (PLI = ratio of operating (net) profit to an appropriate base)?  Which PLI?  Berry Ratio! Berry ratio = GP/OPEX = 1 + OP/OPEX  Why Berry Ratio? Value of the functions performed in the controlled transaction(s) – is proportional to OPEX (cf. para. 2.101 TPG) – is not materially affected by the value of the product(s) manufactured/distributed (cf. para. 2.101 TPG) Tested party performs intermediary activities (cf. para. 2.102 TPG)  Caution: Berry Ratio is sensitive to classification of costs!

18.  Database: ORBIS  Business category to be considered (US-SIC code) 3531Construction Machinery 3532Mining Machinery 3534Elevators & Moving Stairways 3535 Conveyors & Conveying Equipment 3536Hoists, Cranes, & Monorails  PLI: Berry Ratio Manufacturers Database Search for Comparables

19. Screening Criteria Result 1Select corporations in the above business categories in country Y20,000 2Select corporations with Independence Indicator in ORBIS A or B, and Listed Corporations ( ※ ) ※ A ： No shareholder with more than 25% direct or total ownership B ： No shareholding recorded with more than 50% direct, indirect or total ownership 150 3 Select corporations with financial data (FY 2007 ～ 2009) 130 4 Select corporations with average sales ﹩ 50 million or more ( ※ ) 70 5Select corporations with no operating losses for more than 2 years65 Database Search of Comparables for S

20. Screening CriteriaResult 6 Exclude P Corporation ( △ 1) 64 7Exclude corporations with 3% or more R&D ratio on average sales ( △ 16) 40 8Exclude of corporations engaging in controlled transactions, based on the note of annual report ( △ 20) 20 9Based on overview in ORBIS, annual report, Website etc 1. Exclude corporations engaging in (additional) different business 2. Exclude corporations with material intangible properties 3. Exclude corporations whit production sites other than country Y etc. ( △ 9) 11 Database Search of Comparables for S (2)

21. Result of Database Search 21