RoyaltyStat Blog

At the 90^th minute (or 11^th hour to those in the U.S.) of 2022, the Brazilian government issued draft legislation to align Brazil’s transfer pricing regulations with the international standards set by the OECD Transfer Pricing Guidelines.

Operating profit indicators such as the operating profit margin (μ), defined as the quotient of operating profits to net sales revenue, can vary between enterprises in the same industry:

The U.S. transfer pricing regulations prescribe under 26 CFR 1.482-1(e)(2)(iii)(B): “The interquartile range [IQR] ordinarily provides an acceptable measure of this [arm’s length] range; however[,] a different statistical method may be applied if it provides a more reliable measure.”

The U.S. transfer pricing regulations refer to “most reliable” or “more reliable” -- which means (following the statistical principle of minimum variance) the narrowest range computed from the dataset. See Wonnacott (1969), Chapter 7-2 (Desirable properties of estimators), pp. 134-139.

"The true theorist in economics has to become at the same time a statistician."

– Ragnar Frisch (1930), p. 30.

Many transfer pricing reports (against Ragnar Frisch’s advice) are devoid of economics or statistics principles. Here, I show that the usual transfer pricing application of "return on assets" (ROA) is disreputable.

U.S. transfer pricing regulations about the “rate of return on capital employed” (ROA) are misconceived because they rely on untested assumptions. For example, 26 CFR 1.482-5(b)(4)(ii), states:

It’s often stated that crude oil and natural gas (hereafter energy) prices are determined by supply and demand conditions. The empirical evidence shows that this notion is false because energy prices follow an autoregressive mechanism. Energy prices approach a random walk in which the autoregression slope coefficient is not different from one.

Asset intensity adjustments to operating profits, which I reviewed performing audit assistance, lack economic or statistical merit and are inconsistent with guidance provided in the transfer pricing regulations.

The Income Tax Appellate Tribunal (ITAT) of Bangalore, India issued its decision on 04 January 2022, in the case of Randox Laboratories India Private Limited V. The Assistant Commissioner of income tax (IT(TP)A No 2576/Bang/2019) that the Resale Price Method (RPM) is the most appropriate method (MAM) for benchmarking inter-company transaction pertaining to import and resale (without any value addition) of finished goods.

The subject of this article is transfer pricing in Brazil with a focus on financial transactions. The topic of financial operations was recently updated both in the Transfer Pricing Guidelines of the Organization for Cooperation and Development (OECD TPG), in 2020, and in the UN Practical Manual on Transfer Pricing for Developing Countries (UN Manual), in 2021, which was launched last year at the 22nd Session of the United Nations Committee of Experts on Taxation.

The company-level operating profit markup can be estimated as a power function or a linear function between Net Sales (SALE) and Total Cost = XOPR = COGS + XSGA. The difference between Net Sales and Total Cost (measured by XOPR) is OIBDP (operating income [profit] before depreciation and amortization, or EBITDA). Some analysts include DP (depreciation and amortization) in total cost; however, DP is subject to substantial accounting discretion (such as including acquisition related impairment charges), which can prejudice cross-section comparisons.