Part 1 - AL-Tax

International Taxation Handbooksuch entrepreneur units requires quantitative value chain calculation, based onthe function and risk analysis in a broader sense.What this logic also shows is that the indirect arm’s length analysis where theprofit (and not the transfer price) is tested considers the residual profit allocation atthe entrepreneur unit subordinated to margin analysis and budget-actual assessment.Hence, the test on arm’s length situations of the entrepreneur unit needs to bepart of a value chain analysis. A demonstration of the arm’s length situation at otherfunctional units (routine and hybrid units) is a precursor to any assessment of appropriateprofit allocation at the entrepreneurial unit. Analytically, we propose threesteps to analyze transfer pricing at the entrepreneur unit (cf. Paragraph 3.4.11.5):●●●Assessment of functions, risks, and assets subject to the related-partytransactionAllocation of profit margins to routine and hybrid units of the value chain(for the latter, profit margins are used to support the results of planning andbudget-actual assessment)Demonstration of the residual profit/loss situation at the entrepreneur unitand if applicable, split among such units along the value chain.It is worth mentioning that value chain analysis via these three steps regularlyallows a lowering of the number of database-driven margin analyses of comparablethird-party quantities. Simultaneously, it increases the level of plausibility ofsuch margin analyses.7.6 ConclusionThe objective of this chapter is to illustrate the conceptual logic of an economicallysound model of arm’s length analysis for documentation purposes in thearea of transfer pricing and income allocation. The message is that the type andprocedure of arm’s length analysis primarily depends upon the economics of thetransfer pricing case, which needs to be investigated by means of a wellconceptualizedfunction and risk analysis in the broader sense. From this functionand risk analysis, we can derive whether it is sufficient to base the arm’slength test of transfer prices on traditional database-driven searches with thirdpartymargin analysis, more complex planning calculations with continuousbudget-actual assessments, or residual profit allocations to entrepreneur units.For that, the function and risk analysis in a broader sense (‘in principle’) distinguishesbetween function type (contractible risk versus entrepreneurially coordinateduncertainty) and functional scope (comparability versus uniqueness).166