Part 1 - AL-Tax

International Taxation Handbook7.2 Company typesBasically, documentation of transfer pricing is referred to as the arm’s lengthcomparison, subject to the underlying factual case pattern. The arm’s length comparisoncan be external or internal, subject to data availability, reasonableness,and company type. While data availability and reasonableness are facts whichthe taxpayer may not determine, the ‘company type’ is subject to the fact patternand, hence, can be strategically designed. Generally, the company type is determinedby the type of transactional exchange, as well as the features ‘functionaltype’ and ‘functional density’. Hence, the contractual nature of the related-partyexchange determines the company type and the type of economic analysis appropriateto demonstrate arm’s length behavior.In practice, three company types can be distinguished as proposed in theAdministrative Principles 2005:1. Business units which only perform routine functions.2. Business units which perform material functions in an entrepreneurialway and are responsible for strategy and risk bearing.3. Business units which perform more than routine functions, yet are not‘entrepreneurs’.7.2.1 Companies with routine functionsIn transfer pricing terminology, business units with routine functions are units(entities or center units) of the multinational group which show a limited scope offunctional activity and risk borne. Such units are, for instance, service providers,contract manufacturers, and distributors without marketing responsibility (‘lowriskdistributor’). Such companies normally do not bear the risk of bad debt lossand market risk. Asset deployment is limited; Investment risk is ‘hedged’ by meansof contracts with suppliers or customers, and strategies are assumed as given. In theabsence of economic turbulence, companies with routine functions achieve smallbut constant profit margins. For transfer pricing analysis purposes, such routinefunctions (or routine business units) are assigned with gross or net markups asreflected in the Cost Plus Method or Resale Minus Method.7.2.2 Entrepreneur as strategy unitIn contrast to the routine enterprise, the other pole along the functional scale is the‘entrepreneur unit’, often called the ‘strategy unit’. Such units are conceived tocontribute material tangible and intangible assets to the business. The entrepreneur154