Part 1 - AL-Tax

Chapter 77.4.2 Selection of the type of arm’s length analysisAs stated above, the Administrative Principles 2005 offer two variables, ‘functionaltype’ and ‘comparability’, to select the appropriate arm’s length test mechanism.The functional type has the features determinable risk versus coordinateduncertainty, while comparability measures uniqueness and can be assessed between‘yes, comparable’ and ‘no, not comparable’. Though a given sample of cases mayshow continuous distribution of observations on these two variables, at present wesuggest a dichotomous value type, as provided in Paragraph 3.4.10.2 of AdministrativePrinciples 2005. Figure 7.3 shows the basic types of arm’s length analysissubject to functional type and comparability.7.4.3 Functional type: Risk versus uncertaintyThe variable ‘functional type’ characterizes the organizational unit of a valuechain (e.g. related party or center unit) as to whether the risk is determinable andcan be quantified or whether it is uncertain and not quantifiable (or not quantified).In this model, the ‘prudent businessman’ includes risk in a cost calculation(either as cost factor or as insurance coverage cost), while uncertainty is dealt withFunction type(governing risk)Risk(determinable)Uncertainty(coordinated by entrepreneur)Routine partyHybrid partyComparableactivityYesDatabase-driven arm’s lengthtest(e.g. profit margins on basis ofC + , R − or TNMM)(comp. Tz. 3.4.10.2 a)Cost calculation andbudget-actual assessmentprior year-end(comp. Tz. 3.4.10.2 c)(functional density,functional scope)Hybrid partyEntrepreneurNoCost calculation andbudget-actual assessmentprior year-end(comp. Tz. 3.4.10.2 c)Allocation of residual profit tononroutine functions of thevalue chain(comp. Tz. 3.4.10.2 b)Figure 7.3 Basic types of arm’s length analysis as proposed by the German AdministrativePrinciples 2005161