OECD Guidelines and Revenue Department Notification No. 400, Clause 4, recommend the consideration of five economic factors that may make the transfer prices incomparable with prices of independent enterprises as portrayed follows:
1. Contractual terms of the transaction - If a company sells a product at Baht 100 per unit with a 30-day credit term, the price would naturally be lower than a product sold with a 90-day credit term. This is because the money obtained from an earlier payment after 30-days could be reinvested, such as lending at a minimum loan rate of 7%, which would yield an additional interest income of Baht 1.17 per unit earned during 60 days before obtaining payment from the 90-day credit term sales.
2. Functions performed, assets employed, and risks assumed - A company that conducts R&D, builds its brand, markets, and distributes its products would typically earn a higher profit margin than a company that merely provides OEM manufacturing service to a brand-owning company.
3. Characteristics of the properties transferred or services provided - Even if pineapples and apples are sold in the same market, their prices cannot be compared apple-to-apple. Similarly, the plain T-shirts sold at a weekend flea market cannot be compared to the branded T-shirts sold in a department store.
4. Economic circumstances - Considering the purchasing power in different countries, pharmaceutical companies often set higher prices for their products sold in Europe and North America, compared to the same products sold in developing countries, such as Africa.
5. Business strategies - As part of a market penetration strategy, a company may set the price of a new product much lower than that of an existing market leader for a certain period. Alternatively, a company may price its product lower in a new market compared to other markets where it already operates.
In practice, companies conduct Comparability Analysis by examining the details of the selected independent companies to compare prices or profit margins based on these five economic factors. If there are differences that prevent direct comparability but can be adjusted, a Benchmarking Analysis will be conducted to determine an arm’s length transfer price in compliance with the law.
Next time, we will explore the second factor, i.e., the comparability in terms of functions performed, assets employed, and risks assumed, or the so-called Functional Analysis.
[Contact Person: Mr. Phongnarin Ratarangsikul | Partner]