Do You Have to Perform Fresh Transfer Pricing Analyses Every Year? Here’s Why You Should.14 February 2023
When speaking with customers, I regularly receive this question: Why should I redo my benchmarking search every three years? If nothing has changed, can’t I (or shouldn’t I) just keep refreshing the financial data of my comparables until something changes?
It’s a fair question. After all, Chapter 5 of the OECD Guidelines (Paragraphs 5.37 and 5.38) recommend updating your functional and economic analysis annually, but float the option of refreshing financial data of accepted comparables and only re-running the search fully every three years, if facts remain the same. But pay special attention to the OECD’s wording in the paragraphs that reference the frequency of documentation—it’s chosen very carefully.
The OECD notes that “in general,” the master file, local file, and CbCr “should be reviewed and updated annually. It is recognized, however, that in many situations business descriptions, functional analyses, and descriptions of comparables may not change significantly from year to year.” This tells me the OECD actually prefers contemporaneous, annual documentation, even when some aspects of the documentation do not change.
The OECD also states, “In order to simplify compliance burdens on taxpayers, tax administrations may determine, as long as the operating conditions remain unchanged, that the searches in databases for comparables supporting part of the local file be updated every three years rather than annually. ”
In the quote above, the OECD is essentially saying that local tax authorities might allow a taxpayer to refresh comps’ financials for two years. But both of these statements are a far cry from the OECD endorsing this kind of behavior, once you read them carefully.
Taking these paragraphs at face value—and only gleaning dispensation from them—is very risky.
First, always remember that the guidelines themselves are not regulations. While many tax administrations will employ transfer pricing legislation that complies with OECD guidelines, the OECD itself has no legislative authority. The vast majority of countries have legislated that transfer pricing documentation be prepared contemporaneously every year—and in doing so, most will not clarify whether a fresh analysis is only required every third year. In these cases, you can bet that the tax authorities will latch onto taxpayers that merely perform a financial data update of accepted comps and they’ll run their own comparables search in an attempt to see if they can adjust the arm’s-length-range median to be more preferential to them. A prudent approach is to perform a search annually and remove the tax authorities’ ability to dictate the analysis.
Arguing that facts and circumstances have not changed year over year is looking at transfer pricing through a very narrow microeconomic lens when there are dynamic macroeconomic factors that impact your transfer pricing analyses on an annual basis. As other experts have noted, whether it be regarding the COVID pandemic, or uncertainty surrounding a potential recession, analyses must be examined based on the current economic environment. The only way to do that is to perform contemporaneous analyses.
The COVID pandemic is a good example of this. In 2020, the OECD stated that during the time of COVID, benchmarks will require “good judgment and flexibility”—meaning taxpayers should approach benchmarks differently during those years to account for the impact of stay-at-home work orders, broken supply chains, and government assistance. Assuming you did that for 2020 and 2021 tax years, you would then need a different approach for 2022, as it presented a very different economic environment.
The bottom line, as always, is to put yourself in the driver’s seat with tax authorities—which, in this case, means running your comparables search annually. A reactive approach can only lead to trouble.