Contents - AL-Tax

60 4 Some Alternative Approaches to Transfer PricingEnterprise and Related Information. Companies are permitted to equate reportingunits with operating segments or “one level below.”Where reporting units are equated with operating segments, valuations for goodwillimpairment testing will be unhelpful, because they are likely to require a prioradjustment to transfer pricing. Because the valuation is one step along the analyticalroad to establishing arm’s length transfer prices, the exercise becomes circular inthis event.In view of the difficulties in valuing entity-specific equity capital in a reasonablyreliable way, some means of reducing compliance costs under the proposedrequired return method is quite important. As previously noted, taxing authoritiescould mutually agree to accept a baseline valuation done at multi-year intervals,absent significant changes in the business, with informed estimates of percentageincreases or decreases in value in the interim. The latter should be related to percentagechanges in the value of publicly traded companies in the same or similarlines of business.Alternatively, tax authorities might agree that, for transfer pricing purposes, individualgroup members’ equity capital can be valued by reference to standard valuationmultiples that do not have earnings (net income, EBITDA, cash flow, etc.) astheir denominator. For example, tax authorities might establish a convention that theequity value of a subsidiary operating in Country X that sells exclusively to thirdparties will be determined by reference to the median price-to-sales ratio for all publiclytraded firms operating in the same, comparatively narrowly defined industry inCountry X. If the tested party operates in more than one line of business, a weightedaverage multiple would have to be used.4.3.2 Cost of DebtIndividual members of a controlled group may borrow from a centralized internaltreasury facility. Taking as given the amount, maturity date, seniority andother features of intercompany indebtedness, one can estimate an individualgroup member’s arm’s length, market-determined cost of debt as of a givendate by: Estimating the group member’s credit rating (by reference to financial ratiosdesigned to measure its ability to pay interest and repay principal on a timelybasis); 11 Assembling a sample of publicly held firms that have similar credit ratings, andhave issued publicly traded debt with similar maturities and other characteristics;and,11 Standardized templates that can be used to estimate credit ratings using simple accounting dataare available, and generally produce reasonably accurate results.