TP Challenges in the Absence of Comparable Information Summary of key issues

Context Availability of comparable data is identified as a major (if not the major) challenge faced by the tax administrations and private sector Availability of data has long been a topic of concern in the field of transfer pricing, but “ring fenced” as developing country issue Recent events (BEPS focus, global focus on transfer pricing) have thrust this issue into the spotlight: – Tax and Development Forum; G20 mandated toolkit

The paper in a nutshell Importance of comparable information to implement ALP: theoretical underpinnings and practical requirements The status quo in EECA: a dearth of comparables in commercial databases Why do we lack information? Market structure; Regulation; Administrative limitations/non-compliance; Collection strategy How do practitioners deal with lack of information? heavy reliance on data from other geographic markets What kind of guidance is available on using/adjusting “foreign comparables”? –> Little How much trust can we have in approaches promoted/used in practice to adjust information? -> Little

The Challenge (In EECA) “Simply put, the application of a principle that relies on a comparison of the conditions in controlled transactions with the conditions in comparable uncontrolled transactions is extremely difficult, if not impossible, where the requisite information is not available or does not exist.” Number of records with revenue and net profit data that are independent (2011) Countries ≤ 10Turkmenistan, Macedonia FYR, Kosovo, Kyrgyzstan, Albania, Georgia, Tajikistan, Armenia, Uzbekistan, Azerbaijan 10-1,000Moldova, Belarus, Montenegro, Kazakhstan, Croatia 1,000-5,000Lithuania, Serbia, Bosnia & Herzegovina, Slovenia, Turkey 5,000-10,000Latvia, Hungary 10, ,000Ukraine, Slovakia, Estonia, Poland, Czech Republic, Bulgaria 100,000 +Romania, Russian Federation Source: Analysis of BvD ORBIS Database (17 Dec 2013)

Understanding the (lack of) data Factors impacting the availability of comparable information in EECA: – Market structure – Regulatory framework – Administrative framework and compliance behavior – Collation of information by database providers

Dealing with lack of data – possibilities/options Various different approaches discussed in literature/adopted in practice: – Modified selection criteria Foreign comparables, different industries, different functional profiles and lower ind. requirements – Use of alternative information sources Internal rates of return, industry averages, secret comparables and customs data – Administrative measures Safe harbors, advance pricing agreements – Legislative measures Fixed margins (Brazil), 6 th Method

How is it dealt with in practice? Selected results of survey of over 50 transfer pricing practitioners, covering 25 countries in the EECA region: How often do you face difficulties obtaining information on domestic comparables? Approaches adopted/observed in absence of information on domestic comparables? Is there any guidance/law on use of foreign comparables?

Guidance?! Selection: In Europe, wide recognition for regional comparables following creation of single market conditions (Kroppen 2004); or sub-regional selection (Benelux, Scandinavia) Adjustments: No clear guidance, but multiple proposals – Buettner: use of differential in 10 year bond yield – Gonnet et al (2014)/Starkove et al (2014) Weighted Average Cost of Capital (Bond yield (gov and corporate), Equity Risk Premium – Baker McKenzie – propose use of Damodaran (2003) Additional practical challenges: Accounting standards & language

Using foreign comparable information - A valid solution? Basic assumption underlying country adjustments is higher (country) risk linked to higher returns. A number of studies look at firm performance and country specific drivers: – Hawawini et al (2004), Makino et al (2004), Goddard et al (2009) estiblish relevance of country level determinants – Burstein and Godlzmidt (2011) find greater country effects in emerging than in more developed economies Confirms potential importance of country effects. Any adjustment criteria should explain some of the variation in observable firm performance.