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Benchmarking study: its purpose in preparation of the transfer pricing file
article published on 4 May 2021
In general, the notion of benchmarking study refers to the performance of a series of actions and studies in order to discover which are the best performance that can be achieved – in a certain company, by a certain competitor or at the level of an entire industry. This information can then be used to identify gaps in the organization’s processes relative to the best performance.
Find out in the following lines what a benchmarking study (also known as a comparability study) represents in transfer pricing and what aspects need to be considered when preparing such a benchmarking study.
What is a benchmarking study in transfer pricing?
In transfer pricing, the notion of benchmarking study refers to (i) the process of identifying comparable companies that carry out activities similar to those of the company whose profitability is to be tested and (ii) determining compliance with the arm’s length principle of the profit margins earned by the tested party compared to the profit margins earned by companies carrying out similar activities.
More information on transfer pricing can be found in our article: Transfer pricing definition / what is transfer pricing?
Performing a benchmarking study is a complex process that requires examining public information sources and databases or commercial databases such as RoyaltyStat, Orbis, Amadeus, TP Catalyst, LoanConnector.
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What is the purpose of the benchmarking study?
The benchmarking study is a vital piece in any transfer pricing analysis given the need for comparison anchors to justify arm’s length (market) value and the correct allocation of taxable profits in related party transactions.
In practice, almost any transfer pricing file includes at least one benchmarking study prepared in commercial databases. In order to have a qualitative transfer pricing documentation file that is also in line with the provisions of the OECD Guidelines, it is required to prepare such a benchmarking study for each distinct typology of intra-group transactions.
It is important to remember at all times that any benchmarking study prepared at an appropriate level of quality can serve not only as part of a transfer pricing project but can also be used as a tool for analyzing competition and industry performance from a commercial perspective also.
What is the process for the preparation of a benchmarking study?
In order to prepare an adequate benchmarking study, it is necessary to first understand in detail the economic characteristics of the controlled transaction, as well as the role of each party to that transaction.
This will facilitate both the selection of the most appropriate method of setting of the transfer pricing but more importantly, it will help increase the quality of the process of manually selecting the comparables.
The preparation of a benchmarking study is often a structured process that requires to go through a set of steps, which are not necessarily standard but can rather be considered as a set of guidelines on the basis of which such an analysis could be performed:
- Step 1 – understanding the characteristics of the industry, the taxpayer’s business activities and controlled transactions, focusing on (i) collecting taxpayer information, (ii) correctly identifying the controlled transaction to be tested and (iii) assessing the appropriateness of analyzing transactions individually, or combined;
- Step 2 – evaluation of the comparability factors for the tested transaction, focusing on (i) the characteristics of the products or services, (ii) functional analysis of the tested transaction, (iii) the contractual conditions of the transaction (iv) economic circumstances and (v) business strategies;
- Step 3 – selection of the tested party or parties within the tested transaction(s);
- Step 4 – identification of the sources that can provide information on comparable transactions i.e. identification of databases in which to prepare the benchmarking study;
- Step 5 – choosing the appropriate method of testing the transfer pricing;
- Step 6 – actual identification of comparable companies based on data extracted from the databases in step 4 and taking into account the specifics of the transactions identified in step 1;
- Stage 7 – making comparability adjustments to the financial indicators of either the tested company or the comparables;
- Step 8 – interpretation and use of data extracted from databases, determination of profit margins at market value.
For the benchmarking study to be as plausible as possible, each step must be critically analyzed and justified from a legal and economic point of view, and finally the whole process must be thoroughly documented in a benchmarking study report.
In addition, the most common mistakes that are often made in preparing a benchmarking study in Amadeus / Orbis / TP Catalyst databases should be avoided.
Conclusions regarding the benchmarking study
The preparation of the transfer pricing file depends in most cases on a benchmarking study, which aims to determine a range of profits considered to be at market value and in accordance with the provisions of tax and transfer pricing legislation.
Although it seems simple in theory, the benchmarking study involves a laborious, difficult and time-consuming process. Searching for information, evaluating all data from various sources, documenting the analysis and substantiating the adjustments are all steps that require effort on the part of taxpayers and their consultants alike.
Therefore, if you need comparability analysis in order to attach them to the transfer pricing file or other projects, we can help you efficiently with them for all types of transactions so as to minimize the risks that may arise in tax audits but also to get a clear picture of the results of competitors and the industry in which your company operates across Europe.
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