PodCast: Q&A with Solomon Choge – Transfer Pricing Methods

In this PodCast we talk to Solomon Choge.

Solomon is the head of sales in the Middle East and Africa for Royalty Range and has vast experience in Transfer Pricing and International Tax.

He has consulted extensively with both taxpayers and revenue authorities alike, and has previously worked at both Thomson Reuters and Bureau van Dijk.

Over and above all of that Solomon has been a senior lecture with the IITF’s Postgraduate Diploma in Transfer Pricing and the TP Masterclass Series for 8 years, where lectures specifically on TP Methods, Databases and Comparability Analysis.

In this PodCast we are sharing 11 questions dealing with Transfer Pricing Methods that our Postgraduate Diploma in Transfer Pricing students have asked Solomon in the past and that we felt might be relevant to you.

Please see questions below:

Question 1

One of the conditions that may affect the CUP analysis between controlled and uncontrolled transactions is volume.

For example, if Company A is selling 1.000 units for $10/unit for a related party, and is selling only 100 units for a non-related party for $18/unit, it is expected that the price to the unrelated party is higher than for the non-related party. Even though, it does not mean that the prices in the controlled transaction are not at arm’s length, as the volume is a drive for price reduction, in any market.

My question is, how is it possible to make a reasonable adjustment in this situation? I mean, if the selling company has an internal policy for price/volume, it seems to be a reliable source to establish a premise to adjust the prices. But if there’s no such formal policy? Is there any rationale that can be used to make the prices in both transactions become comparable through an adjustment?

Question 2

It seems that CUP is applicable just to transactions with the same product, as is the case of commodities (for example, coffee, soybeans and other agricultural culture). However, I have seen, in a TP Documentation produced by Big 4, that CUP is being used to test products such as refrigeration compressors, even though they differ among each other in the power capacity, power consumption, durability, etc. In the your opinion, does the use of CUP in products that are not 100% equal make the TP analysis weaker?

Question 3

In the resale price method, one relevant aspect that affects margins is whether or not a reseller has exclusive rights to sell a product. When preparing a benchmarking for a case like this how do you know when searching external comparables in a database, that the selected companies do have the same situation? (I guess such information is not part of the ones available in the Financial Statements that usually feeds the databases…).

Question 4

There is always the presumption that CUP, especially internal CUP is the most reliable method in TP analysis. Is it fair to say that it may be the most direct but not necessarily the most reliable? Even where the controlled transaction involves same or similar products as the uncontrolled transaction, until high comparability of the other factors is satisfied, none of the methods should give false comfort about reliability.

Question 5

With regards to CUP method you previously mentioned that there is a view that there can be a safe harbour of 5% mark-up for low-value-added services, but it must be determined that the service is not in fact a core service of the business, but just a low value-add service. Can you please elaborate on this

Question 6

Case Study

  • We have Co X in Zambia with a head office in the US,
  • Zambia Co X renders HR and back-office services to the US head office and charges for it.
  • There are other companies also charging US companies for similar services.
  • The other companies charging “3% of turnover or 3% mark-up on costs in similar contracts”.

The question is

Are these still CUPs when we are looking at a return on sales, e.g. “3% of turnover” or 3% mark-up on costs? Are those not other methods? In the example, if the pricing is determined as a % mark-up on costs, what is the practical difference between the CUP method and the cost plus method? Is it that for the CUP, the price for the tested transaction was actually worded and priced on that basis upfront in the agreement, e.g. “I will provide back-office services and you will pay me 3% of your monthly costs incurred in the provision of the services”, and for the cost plus method, the mark-up is determined after the fact when you are analysing the financial results of a comparable company?

Question 7

Do the transactional profit methods only use net OPERATING profits? As compared to TNMM.

Question 8

TNMM: If something is excluded from the determination of the net profit indicator/PLI, then do we literally just cut it out of the financial statements that we’re using and ignore it for purposes of the calculation?

Question 9

TNMM: Is there a benefit in using NACE rather than SIC? Or the other way around? Do they have specific advantages or disadvantages? When would you use the one and when would you rather use the other?

Question 10

If you use databases like Royalty Range or Thomson Rueters ONESource and you get your comparables, what is the difference between choosing to apply the CPM / RPM vs the TNMM? Is it just that you find that there is sufficient data available with a sufficient level of detail and comparability that allow you to apply a TP method based on gross margin?

  1.  i.e. does the availability of data make your choice of TP method for you?
  2. Do you build the information required for a certain method (that you’ve already chosen) into your criteria for searching for comparables? Or do you search for the comparables and then see what level of detailed data is available in the search results, and based on that you choose your TP method?

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