ATAX MANAGEMENT ANSFER PRIG VOL 12, NO. 23 SPECIAL REPORT APRIL 14 2004 Europe as One Market: A Transfer Pricing Economic Analysis of Pan-European Comparables Sets By Peter Meenan, Roman Dawid, and Jorg Hulshorst Table of Contents B. General Comparability for the T lines I Introduction S-3 C Comparability Analysis Process II. The European Single Market Initiative he TNMM A. Treaty of Rome in 195 1. European Financial Database S-10 B Further Harmonization in the Eighties 2. Refining the Comparability Analysis.. S-11 C Monetary Union 3. Finalizing the Comparability Harmonization of Legal Framework Analysis S-11 E. Conclusion D. SI S-11 IiI Is Europe One Market? -Overview of V. Empirical Analysis of"Is Europe One Previous Research Appendices S-6 Market?' S-11 A. Price Convergence S-7 Specific Tests Intra-EU Trade Fl 1. Refinement of the Comparability European Financial Market Integration Selection Process for the specific D. Profit Convergence E, Summary of Previous Research 2. An Outcome of the Specific Tests- bility and ma rkets in the oecD Uneven Data Distribution by Guidelines and the TNMM Comparability Analysis Process s-9 3. Statistical Analysis of the Specific A Market Comparability for the TNMM S-14 the OECD guidelines S-9 B. Broader Tests 1. Overview of the Broader Tests Statistical Analyses Report No. 43 2. Interquartile Range Tests for Broader Tests Circulate this Special Report to practitioners 3. Supplementary Tests for Broader involved in transfer pricing C Conclusions Regarding the Emp Then FiLE behind the Special Reports tab in Analysis of"Is Europe One Marke the Tax Management Transfer Pricing VI Conclusion November-April binder. VIIL. Excerpts from EU Commission Paper on Taxation in the internal Market CPYRIGHT 2004 BY THE BUREAU OF NATIONAL AFFAIRS, INC., WASHINGTON, D. C. 20037 ISSN 1C63-2C69
s2(vo.12, 3 About the Authors Dr. Peter Meenan is a U. S. Principal who is located in Deloittes Tokyo offices as of June 2004. Meenan was previously in Deloitte's Dusseldorf and London offices, where he had specialized in European transfer pricing issues since his transfer to Europe in 1997. Meenan joined Deloitte's transfer pricing practices in the New York office in 1993. Before joining Deloitte Meenan was an economic professor at California Sate University and at Loyola College in the United States He holds a Chartered Financial analyst certification Dr. Roman Dawid is an economist and senior manager with Deloitte's German Transfer Pricing Group, and is based in Dusseldorf, Germany. Before joining Deloitte, Dawid worked as a research and teaching assistant at the university of Bochum Dr. JOrg Hulshorst is an economist and manager with Deloitte's german Deloitte, Hulshorst worked for over four years with a big multinational insurance group,holding positions in both the primary and the reinsurance businesses of the company. Prior to this he was a research and teaching assistant at the University of Dresden <6. This Special Report is provided to subscribers to Tax Management Transfer Pricing Report. Extra copies of s report are available for $250 each. The following quantity discounts are avail copies,15%, 26-50 copies, 20%; 51-100 copies, 25%. To order copies, call toll-free(800)223-7270, or in Wash- ington, D.C., call 785-7191 Copyright2004 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs, Inc. TMTR ISSN 1063-2069
ANALYSIS ol.12,no.23)s3 Analysis Europe as One Market: A Transfer Pricing Economic Analysis of Pan-European Comparables Sets By PETER MEENAN, ROMAN DAWID, AND JORG comparability HULSHORST' principles n for Economic fer pricing guide I.Introduction he transactional net ma widely used transfer p the operating profits o "tested", party) to an profits developed from nies. There is an eme whether the thi country pan-Eurc reliable whether pricing methods th country-specif portant for trans ners, and mu tently apply undue cost bt Pa ch as op- ng pront most frequentl tain forms of th range of results plus method, as e75th percentile, which is require the use of third ethod of determining an TAX MANAGEMENT TRANSFER PRICING REPCRT ISSN 1063-2069 BNA TAX 414-04
(Vo.12,No,23) ANALYSIS Executive Summary a Analysis compares pan-European results to country-specific results. This paper presents original Deloitte Touche re- search analyzing the issue whether pan-European comparables sets provide statistically different arms-length ranges of results compared to an arms-length range of results formed by European country-specific comparable companies a widely accepted statistical methods used. The approach is scientific in that the paper in our analysis. Arm'slength ranges of comparable companies are generated for al teet epted statistical Economic Cooperation and Development transfer pricing principles, conservative statistIc to test the reasonableness of these assumptions. The approach assumptions and statistical a Economlc evidence indicates that European markets are integrating or have integrated. As a prelude to the statistical analysis, the authors briefly review whether the critical legal factors that allow undistorted economic activities between he European states'markets are already in place, so that it is reasonable to test whether Europe is an integrated market for transfer pricing purposes. Further, economic studies that test the results of these European Union initiatives are re- viewed as to whether EU product and financial markets have converged in prices, intra-EU trade, profits, etc. The evidence demonstrates that the most significant market impediments among EU member states have been abolished, and that the foundation for a highly integrated European market is already in place the economic evidence indicates that Eu- ropean markets are integrating (or have integrated)and that in many ways the levels of price or profit differences among European countries are not meaningfully different from the differences found in integrated markets, such as japan or the United States B Economic evidence indicates that European markets are integrating or have integrated As a prelude to the statistical analysis, the authors briefly review whether the critical legal factors that allow undistorted economic activities betw for transfer pricing purposes. Further, economic studies that test the results of these European Union initiatives are re- viewed as to whether EU product and financial markets have converged in prices, intra-EU trade, profits, etc. The legal gnificant market impediments among EU member states have been abolished, and ed European market is already in place the economic evidence indicates that Eu- opean markets are integrating nd that in many ways the levels of price or profit differences amon European countries are not fferences found in integrated markets, such as Japan or the United states Two separate sets of tests. The paper's statistical analysis comprises two separate series of tests covering nine indus- is per formed to develop pan-European and country-specific arms-length ranges i tests, a detailed comparability analysis comparability analysis practice. The second series of tests takes a broader view of comparability, in that the arms-length ges are calculated from companies identified as comparable based principally on industry classification codes n Results clearly show that European arms-length ranges do not statistically differ from country-specif ranges. The results of the statistical analysis under both series of tests clearly show that European arm's-I do not statistically differ from country-specific arm'slength ranges in almost all cases. Specifically, out of ed testing the statistical equality of upper and lower quartiles of arms-length ranges using 95 per m s, 219 tests( approximately 94 percent of the tests) generate resuits supporting the equality of interquartile In other words, it is highly likely that a country-specific comparability analysis and a pan-European comparability would result in interquartile arm's-length ranges of results that were not statistically different at a 95 percent a When differences occur no pattern is evident. Further, when the country-specific arms-length range was statistically different from the pan-European arms-length range, there was no obvious bias or pattern of profit levels indicating that a particular European country's arm' s-length range of results is always statistic ally different from the rest of Europe. m Results clearly indicate that pan-European comparability searches produce reliable arm' s-length ranges. Pan-European comparability analysis may not be appropriate in all situations: the specific facts and circumstances in each case should be assessed in making this determination. However, the papers results clearly indicate that pan-European comparability searches do produce reliable arm'slength ranges of resuits relative to country-specific arm's-leng ges. Thus, the use of pan- European studies should generally be promoted, because they generate reliable resuits, as indicated by this study 41404 Copyright 2004 TAX MANAGEMENT NC,. a subsidiary of The Bureau of Nats cnai Affairs, inc. TMTR ISSN 1063-2069
ANALYSIS (vol.12.No.23) Further, given that the number of closely comparable liberalize exchanges of goods and services among companies in any given country for a given functional member states as far as possible by bution of comparable companies in our data below), the nating customs duties among member he goal of elimi and risk profile is limited or nonexistent(see the distri- n creating a customs union, with omparable companies will provide the most reliable arm's length range of results(and one that is consistent a eliminating quantitative restrictions (i.e, quotas with the OECd guidelines comparability requirements) ind measures having equivalent effect) to ensure the compared with country-specific comparables, which completely free movement of goods will often require less functional comparability to be The Treaty of Rome provided for completion of a common market over a transitional period of 12 years ending on 31 December 1969. However, its first goal, ll. The European Single the customs union was achieved in mid-1968 Market Initiative B. Further Harmonization in the eighties The economic question of whether profit results for rard the common mar tentially comparable third- party European com ket led the Community in the mid-1980s to consider a nies can produce statistically, similar, arm's-length more thorough approach to the objective of removing ranges esults is fundamentally dependent on the le- gal and political development process of the European trade barriers with more effective methods to create single market initiative. If the legal and political frame- internal market. This approach was primarily set out in the Commission's White Paper of June 1985, and incor work for European economic integration is still at an porated in the Treaty of Rome by the 1986 Single Euro- earty sansactioevelopment, or if there are still signifi- pean Act(SEA). The White Paper was appr 300 legisla- ved in n costs from intra-European trade, test- ng for Europe as one market for transfer pricing pur. by the European Council. It outlined about poses would not be reasonable Briefly reviewed below tive measures to accomplish the three main objectives, hich to eli the legal and political ean market integration proces a physical frontiers, by abolishing checks on goods The process of European economic integration has and persons at internal country borders een characterized by more than four decades of the et a technical frontiers, by removing the barriers of na fective removal of economic boundaries and market tional regulations on products and services, by harmo barriers.In addition, a political and institutional frame- nization or mutual recognition; and work to enhance nomic activities between the tax frontiers, by overcoming the obstacles created cross-border transactions has been implemented. A by differences in indirect taxes through the harmoniza brief review of the history of the European single mar tion or approximation of VaT rates and excise duty ket initiative supports the conclusion that the most sig The internal market was intended to create "an area nificant market impediments among EU member states W have been abolished, and that the foundation for an in of goods, persons, services and capital is ensu tegrated European market is already in place. B Moreover, it was accompanied by changes in the Com munity legislative system, designed to encourage adop A. Treaty of Rome of 1958 tion of the meas SEa became effective in 1987; its main objectives in which together with the European Atomic Energy Com market strongly supported an objective already set out munity(EAEC jointly referred to as the Treaties of n the original Treaties of Rome. By the deadline, most of the 1992 targets had been met: over 90 percent of the establish a common market based on four freedoms- legislative projects listed in the 1985 White Paper had freedom of movement of goods, persons, capital, and been ado services-and the gradual convergence of economic The Treaty on European Union, signed in Maastricht policies. The treaty was intended to eliminate trade bar in 1992, came into force in November 1993. By institut- riers among member states with the aim of increasing ing a European Union, the Maastricht Treaty marked a conomic prosperity and cont ributing to"an ever closer new step in the process of creat ting an ever- closer union union among the peoples of Europe, "as described by among the European economies. The Union was based the treaty s authors on the European Community, supported by policies and To achieve these objectives the Eec Treaty laid new forms of cooperation. According to the treaty, the down guiding principles and defined the framework for Communitys task is to promote a harmonious, bal the legislative activities of Community institutions anced and sustainable development of economic activi- These involved policies such as a common agricultural ties, a high level of employment, sustainable and nonin transport, and commercial policy. The common market, flationary growth, a high degree of competitiveness and the Treaty of Rome's main objective was intended to onvergence of economic performance, and economic and social cohesion among member states. The Com munity pursued these objectives by establishing a com This section is largely based on an EU history fact sheet mon market and by initiating a coordinated economic foundathttp://www.europarl.eu.intfacts and monetary policy TAX MANAGEMENT TRANSFER PRICING REPORT (SSN 1063-2069 ENA TAX 4-14-04
vo.12,No.23) ANALYSIS C Monetary Union ll Is Europe One Market? As early as 1978 the European Council set up the Eu Overview of Previous Research ropean Monetary System(EMS) to solve the problem o monetary instability and to foster cohesion among The brief review of the history of European market member states. Established on a voluntary and differen- integration shows that the legal and political barriers tiated basis, the EMS depended on the existence of a that would have prevented market integration have ommon currency unit, the ECU. Through the Treaty or been removed or greatly reduced. However, what are European Union, a European System of Central Banks, the actual economic results of the EUs efforts toward a European Central Bank, and a European Investment ntegration? In other words did the elimination of mar- union were to finalize the completion of the single etary ket barriers actually lead to closer economic relations Bank had been set up The main aims of mor and to increased activities between compa ket by removing the uncertainty and costs inherent in consumers in the EU member states? If economic be currency-changing transactions, as well as costs of havior followed the policy initiatives, one should ol hedging against the threat of currency fluctuations, and serve market results, particularly prices for goods and by ensuring the total comparability of costs and prices services, costs for factors of production, and-most im- hroughout the Union By facilitating business and helping consumers, the profitability among the EU national economies converg EMS was expected to stimulate intra-Community trade ing. Briefly surveyed next are studies that have investi nd increase economic activity to reinforce Europe's gated the economic impact of the EU single market pro- monetary stability. The stages of EMU during the 1990s were intended to phase in the transition to the single In evaluating the impact and outcome on eU market cur ncy so that results, one must consider that even in markets that are particularly through the prior achievement of considered fully integrated--for example ough convergence of economic and monetary policies States--regional market differences exist 3 the United Profit ability between geographic regions within states migh D. Harmonization of Legal Framework especially be driven by factors such as regionally differ phic conditions, market size To further support the integration of the European competitive situat vailability of substitute goods market, rules on competition were introduced that fo- levels of supply and demand, consumer purchasing cused on the following areas: competition policy and power, the nature and extent of government regulation concerted practices; abuse of a dominant position and production costs, and transportation costs. 0 In general a main difference between markets that are not consid akings and services of general interest. Moreover, Eu ered integrated and those that are considered to be in- member states'legislation were brought closer to a tegrated is the existence of regulatory and technical ommon base to promote economic cohesion, particu narket barriers that prevent or restrict economic activi larly in the areas of public contracts, company law ties between the markets by, for example, imposing banking, insurance and securities, intellectual, indus- CroSS-border transaction costs. As discussed above duties(alcohol and tobacco), energy taxation, personal in the EU market by the single market prograln moved and company taxation, and fiscal policy. Apparent market differences might also be induced Some issues regarding the letion of the internal by diverging regional preferences or by industry con market are still open. These include plans for further le factors that are not necessaril lated to market integration. For example, the concen statute for the European company, full freedom of facturing in certain regions is more likely a result of tax harmonization. Moreover, certain directives are not yet fully adopted in all member states, including those centration. These types of regional concentrations ar on public contracts, transport, and intellectual property also observable in economies that are considered fully n addition, further harmonization measures focus on integrated, for example, computer-related sectors with relatively lower levels of integration(such trated in the rust belt in the Midwest United States concentrated in Silicon Valley or steel industry concen- as the retail finance sector) similar l E. Conclusion that might be provided by local government withi states. Therefore, the relevant economic question is not The history of the European single market demon whether differences between markets exist, but how strates that the majority of market barriers that have significant these differences are and whether they are their origin in the separation of European markets more considerable than those observed in markets that through national borders have been abolished. More- are considered fully integrated over, national economic and monetary policies, the le Several studies have examined the impact of th gal framework for economic activities, and national ingle market program and the degree of integration egulations have been largely harmonized or are about be harmonized. Therefore, the authors believe the le gal and political framework for European economic in- 9 In this paper, "region"refers tegration is already in place, and it is reasonable to con- ider tests of Europe as one market for transfer pricing his list of factors that might constitute differences be- purposes tween market results foilows the OECD guidelines. These fac tors are discussed in more detail in section lll of this paper. 414C4 Copyright- 2004 TAX MANAGEMENT INC, a subsidiary of The Bureau cf National Affairs, Inc. TMTR ISSN 1063-2069
ANALYSIS reached in the European market, with the goal of as- For most goods, the overall price dispersion is much sessing whether EU markets are highly integrated eco- arger in the United States than in the European Union. omic markets where economic activities of market Moreover, price dispersion for tradable goods in the Eu articipants are highly interdependent across national ropean Union was reduced by 50 percent between 1990 borders. This question has different interrelated as- ferential in the European Union in comparison to other a Does market integration lead to a convergence of OECD countries. 4 They report that the border effect in the price formation process, and do prices of goods and the European Union is significantly lower than that ob services and production costs in the different EU coun served between Canada and the United States tries therefore converge? n Have trade flows between the states'markets been convergence among EU member states. Its studies increased and become as intense as intrastate trade? show price convergence during the 1990s, but a decel Are European capital markets becoming more in. erated convergence process since 1997. Most notably, tegrated and do interest rates in Europe converge? a As a result of increased market integration, are the tions. Moreover, price convergence among the six returns of European companies converging andfor is ounding member states is very tight the variability of their profitability decreasing relative to B Intra-EU Trade flows The following briefly reviews the results of studi Trade flows among EU member states, measured that examine these questions relative to gross domestic product increased signif cantly since the early 1990s. Moreover, trade border A Price Convergence effects. which measure whether international trade de viates from intranational trade, seems to have An indicator of the degree to which EU markets have creased substantially from the late 1980s to the integrated is price convergence, or the degree to which 1990s. This indicates that the market has become much prices for the same goods or services have come close more integrated through the single market progr together. Price convergence is expected to be more The European Commission reports steady growth of closely aligned when trade flows between the me states are high, since increased trade flows suggest that cent of EU trade. 17 Only trade in the services sector is arbitrage betwe low; further integration in the services sector would re- can occur. However, because prices also differ within a quire the more intensive application of mutual recogni en member state the determination of the degree of orice convergence among the EU member states re- quires the economist to measure price convergence be C. European Financial Market Integrati tween states on a relative basis, for example relative to the degree of price convergence in other integrate The Euro area government bond market is consid ed highly integrated. The elimination of exchar rate risk led to a significant convergence in bond yield a recent study of international price comparisons among the Euro area member states althe ough minor to evaluate the existence of price convergence in the vield spreads have persisted mainly due to still existent EU, researchers concluded that price differences within institutional and size factors. The 19 integration of the erbank market is goods, the researchers found that price differences be- tween the United Kingdom and the rest of the eU were bodies and regulators. Europe's between supervisory corporate bond grew ences gnificantly at the ample, the EU and the United States. In another study However it suffered under difficult market conditions commissioned by the U. K. government, ACNielsen con- d increased investment risks during the last twc cluded that for the bulk of goods for which comparisons could be made, there was no significant difference in Integration appears to be still in process in prices between EU member countries, as price diffe ket, the corporate loan market and ences were not larger than the spread of prices within market conditions. However, in general, the he countries. I financial sector experienced a significant If one compares the degree of price dispersion in the United States to that in the European Union, the Euro- pean Union seems to have come very close to the de- +4 A de serres et al., The width of the Intra- European E gree of price convergence found in the United States. 13 nomic Borders, OECD ECO/KP(2001)30 intemal market en update/ agen Economics, p. 17 if. I See haskel and Wolf. "From Big Macs to iMacs: What Do ning of EU Product See ACNieisen, A Report on International Price Com Adam et al. Analyse, Compare, and Apply Altermative In Copenhagen Economics: The internal market and the rel- dicators and Monitoring evant geographic market, 2003, p 21 ff tion of Capital Market Integration, Salerno 2002 TAX MANAGEMENT TRANSFER PRICING REPORT ISSN 2C63-2069 ENA TAX 4-14-04
s8(vol.12,No.23) ANALYSIS change, with deeper integration of national markets profit indicators measured, EU variances in profitability ents and intermediaries. 20 s always lower than that of Japan, but not always lower In equity markets the introduction of the Euro elimi- ROA for the EU chemical industry has a lower variance border equity investments. l Internationalization of eg: from this analysis that the variance of profitability in border mergers and acquisi the European Union is not generally higher than that of tions, and the consolidation of stock exchanges have other markets considered fully integrated, particularly enforced cro sS-border activities. In addition it is also Japan. Therefore, based on their analysis, there is no evident that investor behavior has changed fror country-based toward cross-border investments. Al reason to conclude that company profits in the euro- pean Union are more dispersed than in other fully inte though national differences between stock markets re- main with respect to market capitalization and the A comparison of the profitability spreads between number of initial public offerings(IPOs)22 these are enterprises of different size(small versus large)on the probably more an indication of in ncreased regional spe cialization and concentration of equity markets (ex basis of the BACH database results in a considerably lower profit spread for the observed eur hanges) in an integrated European market. However, tries than in Japan and the United States. 2 The same due to the liberalization of capital markets and global study also compares profitability results among differ zation, the market for wholesale financing has devel ent European countries. However, because no statistical oped substantially and has become more integrated and test is applied the results are difficult to interpret, and ompetitive. It seems that larger companies in particu- no clear result regarding profit convergence can be de- lar have access to international financing markets rived. An extensive study of financial structure and whereas only very small firms still depend on their local profitability based on the Bach database does not de- financial system." rive results regarding the comparability of European companies'profits either, and therefore does not con- D. Profit Convergence tribute to the authors' investigation 30 The same conclu- sion applies to a study of the German Bundesbank com- (defined as profits after operating ex hich finds that be. s)convergence by independent companies oper- cause of diverging financial structures this PlI does not the eu member states is the mea provide a reliable basis for international profitability convergence that is most consistent with the transfer pricing question "Is Europe One Market? ""for the appli Criton and Walton examine the ratio of profits to ation of the TNMM and related transfer pricing meth capital employed of Euro-area countries and their ma- ds. Although no research was found that directly ad- or trading partners and concl dresses this question from a transfer pricing perspec ive, there is research that investigates company furthe ged in the Euro area, 3a houe that profits have not described (unclear database and num profitability within the EU and compares and contrasts re, the authors cannot the findings to those in other significant markets, such evaluate how representative their results are. Further as the United States and Japan more, their conclusions are not based on statistical Meric et al. compare the profitabi of Japanese, EU tests. Moreover, their profit level indicator seems to be and U.S. manufacturing firms operating in three major based on an arbitrary determination of the asset base manufacturing industries(chemicals, industrial In addition, their potential explanations for the devia hinery,and electronics)over the 1996-2000 period. 2-4 tions (investment flows are insufficient to reduce profit the operating profit margin (OPM,and the return on area, that is, EU Company data constitutes one sample which using a multivariate analysis of variance. 2One of the is compared to the U.S. and the Japanese data samples findings is that, for the ROA, OPM, and other relevant aged by the European Commission(DG for Economic and Fi- zed Databank"is ncial Affairs). It contains aggregate and harmonized infor 2o See"Commission of the European Communities, The covers 11 European countries, Japan and the U.S. for the years Euro Area In The World Economy-Developments In The First 1990-1996. It includes less than /40, 000 European companies Three Years, "p, 30 ff n of the European Communities, p. 34 f The data is mainly provided by Central banks or Ministries of See Et the respective policy, Rest the 2002 scoreboard, SEC (2002)1213 Commission, Directorate-General For Economic and Fiscal Af an Commission, Directorate-General For eco- Than Meric et al."A Comparison of the Financial Char- nomic and Fiscal Affairs, Supplement A, No 11/12,1998 acteristics of U.S. E U, and Ja Firms mparison Between the Finan The OPM is the ratio of operating profit (profits related to operating activities before interest and taxes) to sales. Ope Using the BACH Database, " Economic Paper,Nr155,July ating profits and net profits are used interchangeably in this 3I The ROE is equai to a fiscal year's after-tax income di The ROA is equal to operating profit (profits related to vided by the book value of equity operating activities before interest and taxes) divided by aver- lur Unternehmensrentabilitat They use the Disclosure Worldscope database for the riton, Laura, Walton, Richard:"International Compa analysis. The EU is considered as one integrated economic 2002 on of Company Profitability, " Economic Trends, No 587 1404 Copyright 2004 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs. inc. TMTR SSN 1063-2069
ANALY SIS (vo.12,No.23)s9 ability differentials letely integrated markets tax rates)are not substantiated by further economic velop the authors'model for empirical testing: d to de- and insufficient data--especially no observation of post a The paper now turns to an analysis to review what e oecd guidelines detail about the issue ar Therefore, no systematic statistical analysis of com IV. Comparability and Markets in the pany profitability within the European Union has yet been prepared that provides an answer to the question OECD Guidelines and the TNMM whether it is economically justifiable to perform pan- European comparability studies under the tnmm or re- Comparability Analysis Process lated methods as compared to country-specific TNMM ility studies. However To test whether under the applicable OECD compa of the existing rability criteria, a pan-European comparability analysis cK company profitability generally seem to indi e variability of profits in the European Union for the TNMM and related methods is justified, a sig. nificant number of statistical tests were performed us rable to that in fully integrated markets such and the United States ng TNMM comparables results. specifically the au- thors generated a large number ta sets consisting of both closely and broadly comparable third-party data E Summary of Previous Research and statistically compared the country-specific arms- ngth ranges to the pan-European arm's-length ranges Previous research has been analyzed to determine This statistical analysis is presented in the next section This next section also presents the transfer pricing whether it addressed or provided valuable insight into foundations of the tests that follow in the next section the question whether pan-European comparability analysis could be appropriate when applying the In particular, the OECD guidelines' discussion regard- NMM and other relevant methods using databases of ng markets and eco rd-party comparable companies. The previous re- Next, the OECD guidelines'comparability criteria ap earch that was reviewed includes studies on price con plicable to the TNMM is reviewed. Finally, the process ergence, intra-EU trade, European financial market in- of identifying comparable third-party companies under the TNMM is described in the context of the oeCD egration, and profit convergence. In general, the body guidelines are integrating(or are already integrated) and that in A. Market Comparability for the TNMM mong European countries are not meaningfully differ In the OECD Guidelines ent than the differences found in integrated markets such as Japan and the united States The OECD guidelines do not specifically address market comparability issues that are relevant for the Of all studies that were reviewed those that come losest to the authors' investigation are the studies that application of the TNMM.Instead, comparability of conomic and market circumstances is addressed as xplore profit convergence. However, none of the stud comparability factors to be considered when evaluating stion from a transfer ic- all transfer pricing methods under the general compa- ng comparability perspective. The studies that address rability discussion found in Paragraph 1.30. The guid rice convergence are very important, but for transfer ance is therefore general in nature, with a greater em- pricing purposes are generally more directly relevant to hasis on pricing factors relevant to the cup than on he application of the comparable uncontrolled price profitability factors relevant to the application of the ods(for instance, the resale price s and cost-plus meth ods. The studies that evaluate the level of intra-eu The oeCd guidelines recognize that price across markets. Therefore, the markets in which the trade and the level of European financial market inte- comparable companies and the related parties o,o the gration are important from a consistency perspective should be comparable, or that any differences integration are important mechanisms to ensure the or thar s should not have a material effect on the price because intra-EU trade and European financial market market differences. 8 member states In evaluating market comparability, the OECD guidelines suggest that the economic circumstances OECD guidelines, the CUP method is a transfer pricing method that compares the price for propert a geographic location or services transferred in a controlled transaction to the price I the size of the markets charged in a comparable uncontrolled transaction under com- nt of competition in the markets and the parable circumstance itive positions of th ers and sellers .S According to the oECd guidelines, the resale price a the availability of substitute nd services thod is a transfer pricing method that compares the gros proft mard ction to the gross profit margin earned in compa- that an associated enterprise earns in a related i: That is, market comparability is not addressed as part of According to the OECD guidelines, the the TNMM comparability factors discussed at Paragraphs 3.34 is a transfer pricing method that compares the ot cost that an associated enterprise eams One would presume that this reference to price ansaction to the profit per unit of cost earned in y ences can also apply to profit differences across market hird-party transactions ole though this point is not explicitly ddressed in th TAX MANAGEMENT TRANSFER PRICING REPCRT SSN 10632069 BNA TAX -14-0
10 (vol.12,No.23) ANALYSIS a the levels of supply and demand in the market as a generally appropriate for the comparison between whole and in particular regions, if relevan tested party taxpayer and the third-party comparable consumer purchasing power; the nature and extent of government regulation of he mar Given this understanding of the oeCd guidelines a costs of production, including the costs of land, la TNMM comparability criteria, the correct methodologi bor, and capitai uating the question of ■ transport costs European comparables set versus a country-specific the level of the market (retail or wholesale); and comparables set is to test whether there are"material factor(s) "that cause the results of the a the date and time of transactions The comparability factors indicated above can be im arms-length range to differ from the results of the country-specific arm' s-length range. In other words, if kets are comparable to one another, but they do not of- he arms-length range of results determined on a pan- fer a transfer pricing practitioner clear guidance on length range of results determined for specific coun tries, then there are no material factors that make the purposes of applying the TNMM. It is clear, however ountry-specific arm's-length ranges more compara that there is no explicit language in the OECD guide than the pan-European range. Therefore, the OECD lines that defines a market by national boundaries. But guidelines would not require that a country-specific guidelines guidance oes not di rectly address the issue of using pan-European versus comparability criterion be added, and a pan-European comparables analysis approach would be defensible untry-specific comparable companies and provide reliable resul There are certain characteristics in the eu market that appear at least consistent with a"Europe is one market"argument based on the oecd guidelines list C Comparability Analysis above, For example, the Eu member states are prima- Process Under TNMM rily geographically contiguous, have a harmonized level of government regulation, have a commonality of cur- This section explains the comparability analysis pro- rency in many member states, and low barriers to the cess under the TNMM and describes this process to ovement of goods, people, and capital. Nevertheless, both outline the approach that has been applied to gen while these factors are consistent with market conver- erate statistical samples for pan-European and Euro gence,they in and of themselves do not clearly lead to pean country-specific comparables data sets in the next a conclusion that Europe should be considered one section, and to review, in a very practical way, how market for TNMM transfer pricing purposes. Empirical country-5Pa European country-specific comparability pecific comparability criteria would be sp testing is required to analyze this issue. fied for search versus no country-specific comparability criteria B General Comparability for for a pan-European comparability analysis the tNMM in the oECD Guidelines hether pan-European or European country-specific Deloitte's European transfer pricing practices gener- third-party data is more appropriate when ally use the 1,000,000 company version of the Amadeus TNMM and other relevant methods that use Europear database published by bureau van Dijk; this database is databases. Therefore, the OECD guidelines'TNMM also widely used by European tax authorities an nd other comparability criteria are important factors in analyz- transfer pricing practitioners. 39 The Amadeus database ng the issue of pan-European versus country-specific contains a large distribution of financial data for com comparables set panies located in every European country, although the The OECD guidelines indicate that taxpayers should representation of companies whose financial data is re assess the following general factors when establishing ported by country is not homogeneous. It is widely comparability under the TNMM roduct and functional similarity not file their financial results with the authorities, so dustry forces, such as the threat of new competi that this information does not appear in the Amadeus tion, varying cost structures, the cost of capital, indus- database. The authors'report on the distribution of the try experience, etc. and companies used in the empirical tests in the next sec a the ability to measure profits consistently between tion also confirms that the representation of companies the taxpayer and potentially comparable companies is uneven. 0 Therefore, taxpayers in certain countries The basic intent of the TNMM comparability criteria who use the TNMM have little choice but to use third the oeCd guidelines is to ensure that the net operat party comparable companies from other countries; this ing profit comparison between the third- party compa rable companies and the taxpayer provides a clear indi cation as to whether the taxpayer is employing arm's 39 pendix I provides a description of the different euro leng tth transfe licies Therefore. other mate pean databases aggregated to the Amadeus 1,000, 000 com- al factors that could cause a difference in the profits earned by third-party comparable companies relative to al fa a taxpayer tested party should be reasonably elim at will also affect this representation, including potential nated. The OECD guidelines recognize that it may not ry concentrations in certain geographic regions or cour be possible to eliminate all functional, risk, and other nd the fact that certain European countries are much differences so that an arm's- length range of results and therefore have fewer companies relative to large 04 Copyright. 2004 TAX MANAGEMENT INC, a subsidiary of The Bureau of National Affairs, inc. TMTR ISSN 1063-.20
