Part 1 - AL-Tax

Chapter 7Further work is needed to clarify the approach. In particular, questions on how toeliminate the effects of risk insurance on the revenue and profit indicators have notbeen discussed. To a large extent, such costs determine the level of risk insurance,uniqueness, and routine. 10 While the risk premiums can be identified in principleand in size in the books of the related-party companies, available data from commercialdatabases do not provide information for such analysis. Hence, we always lackinformation on the comparability of the tested party and the ‘comparable’ third parties.The same effect applies, among others, for the market-based profitability of assetsdeployed, which in some cases is part of the costs assumed and in other cases not.The economic analysis of transfer pricing in international taxation is at a farfrom satisfying level. With respect to the increasing relevance of cross-borderbusiness in general, and the large share of such business conducted within multinationalgroup companies in particular, it is valuable to further elaborate on economicmodels to assess the nature and degree of the arm’s length structure oftransfer pricing cases. To our mind, topics such as vertical and horizontal profitallocation, function and risk profiles, or role of intangibles will gain relevance.Economic analysis of income allocation for tax purposes is, indeed, in need ofgreater theoretical and empirical foundation.AcknowledgmentsThis chapter has emerged from ongoing discussions on new transfer pricing documentationprovisions in Germany. The chapter was conceptualized and draftedduring the second author’s research and teaching visit to the Indian Institute ofManagement, Ahmedabad. The usual disclaimers apply.Notes1. Transfer pricing methods are transaction-based methods such as Comparable Uncontrolled PriceMethod (CUP), Cost Plus Method (C), Resale Minus Method (R), Transactional Net MarginMethod (TNMM). Examples of profit-based methods are Comparable Profit Method (CPM) andProfit Split Methods (PS), including the Residual Profit Split Method (RPS). Some countries alsoconsider Formula Apportionment using certain allocation factors (e.g. assets, sum of wage,turnover) as an appropriate transfer pricing method (TPM).2. In emerging countries such as India, significantly longer litigation periods are possible.3. To our knowledge, the largest transfer pricing dispute in 2006 was GlaxoSmithKline against US IRSwhich was finally settled at a US$3.1 billion additional tax change – the largest ever single paymentto the IRS (International Tax Review, 2006).167