The Strategic Corroborative Analysis
In transfer pricing, you rarely have the luxury of using two analysis methods to support your arm’s-length position. However, when you are fortunate enough to be in this position, I would argue that you should always attempt to corroborate your findings with both approaches. Why? Because in so doing you dictate the narrative rather than allowing tax authorities to do so.
First, I need to call out what a corroborative analysis is NOT—using two profit level indicators (PLIs) in the same TNMM analysis with the same comparable companies. While there can be a time and place for this, the true value of a corroborative analysis is when you have the ability to perform two distinct kinds of analyses—using two sets of benchmarks—to round out the story that your intercompany transaction is indeed arm’s-length.
Generally speaking, we see the opportunity for this type of corroboration when we have some form of CUP, be it internal or external, available to us. Let’s assume this is the case, and we have imperfect internal CUPs available to use to corroborate our TNMM for a tangible goods transaction. The obvious first thing to do is to see whether our CUPs do indeed corroborate our arm’s length stance. If they do, the case for using those CUPs to support our primary analysis is cut and dry—and I repeat, you should not miss the opportunity to utilize both analyses in your transfer pricing documentation.
But what do we do if those CUPs do not corroborate our TNMM? In this case it’s even more important to pause and ask why and determine how the CUPs may actually benefit our narrative. Often times, there are good reasons for internal CUPs showing different margins than our intercompany transaction—differences in volumes, seasonality, selling to a different level of the market or geographic differences can all lead to charging a different price to third parties than to a related party.
To the extent that we can quantify and reasonably adjust for such differences, we should. In so doing, we are removing the possibility of tax authorities using our CUPs against us. They can no longer argue the prices we charge to third parties should be used as our arm’s-length intercompany price, without any such adjustments. Don’t kid yourself into thinking that the tax authorities won’t do this—they will if it’s beneficial to them, and they will not bring up the fact that comparability adjustments are warranted, leading to drawn- out negotiations, all because we did not control the analysis by laying out the facts ourselves.
Another way to look at this is if the internal CUPs do not justify our arm’s-length position, we had better explain, in detail, why this is the case. Do not simply gloss over the fact that they are imperfect, and no adjustments could be reliably made. Instead, take the time to explain each comparability factor that is different between your CUPs and your intercompany transaction, why each adjustment cannot be quantified and made reliably, and why therefore the tax authorities cannot be justified in arguing your CUPs should be used as the arm’s length benchmarks, rather than your TNMM.
Should you find yourself in a position to perform both analyses, you must decide which method of analysis is the best, or most appropriate, and which is the supporting, or corroborative. Often, we find ourselves using a TNMM/CPM as the most appropriate, because the comparability standards for CUPs are technically much greater. Again, be sure to explain your choice in detail.. There is always a reason why one analysis is at least a bit more reliable than the other—and you need to take the opportunity to craft that story.
I’ve lost count of how many times I have told people over the years that a good transfer pricing report lays out all the facts, in a way that justifies the end goal—that the intercompany transaction is indeed at arm’s length. When the facts dictate that a corroborative analysis is possible, it is always worthwhile to perform it and either use it to support your position or take the ability away from the tax authorities to use it to their own benefit.