RoyaltyStat Blog

In transfer pricing, certain analysts prefer using “return on assets” even for businesses such as wholesale or retail trade in which assets are not expected to have a significant impact on operating profits. These analysts postulate a simple linear relationship between operating profits and accounting assets (variously defined) and calculate quartiles without respite. The econometric model underlying the single-variable computation of the quartiles of “return on assets” can be written as:

(1)     P(t) = β K(t) + U(t)

for t = 1 to T years of each selected comparable.

In transfer pricing, a frequent “comparability adjustment” to (gross or operating) profits involving inventories is spurious. The OECD is wrong disseminating misconceived guidance about “working capital” adjustment that includes inventories. The inventory adjustment to profits is bogus because inventory is included in cost of goods sold (COGS); thus, the same inventory variable appears on both sides of the adjustment equation, making the proposed adjustment false. Follow at your peril: OECD, Comparability Adjustments (July 2010), ¶¶ 16-17: http://www.oecd.org/tax/transfer-pricing/45765353.pdf 

The IRS has published similar argy-bargy: https://www.irs.gov/pub/irs-apa/study_guide_exhibit_d.pdf