INTM485120 - Transfer pricing operational guidance: Evidence gathering: Searching for comparables: range of results

Usually, the search for potentially comparable uncontrolled transactions will produce a range of possible results. Case teams must use all available evidence to conclude what the arm’s length price would have been. If the results of the tested party fall within the acceptable range of arm’s length prices, then no adjustment should be made. If the results of the tested party fall outside the arm's length range, teams will need to agree how to revise the tax computation so that the arm’s length price replaces the actual transfer price.

Key issues to consider with a range of results

Generally, there are three key issues to consider when looking at a wide range of results:

  • whether all comparables are equally reliable, or any less comparable independent companies can be eliminated from the set
  • whether comparability defects remain and there are a sizeable number of observations, such that the use of statistical tools would be appropriate to enhance reliability 
  • if the filed position falls outside the arm's length range, to which point in the range HMRC should adjust

Case teams should review each company individually to determine whether it truly is comparable. Even after they have carried out that exercise there may be a number of comparable companies, and the range of comparable results can be quite large.

Case teams need to be able to demonstrate that the arm's length range of results is based upon the most reliable set of data. To improve the reliability of the dataset, any independent companies with a lesser degree of comparability should be eliminated. 

The use of an interquartile range

A transfer pricing report usually contains a list of companies identified as comparables. An interquartile range is then often applied to the relevant financial results produced by these comparables. An interquartile range discards the results of the bottom quarter and top quarter of the range. The same exercise will also identify the median of the results, which is the result given by the middle comparable (or half-way between the two middle comparables).

There is nothing in either Part 4 TIOPA10 or the OECD Transfer Pricing Guidelines (TPG) that specifically says that an interquartile range must be used.

However, paragraph 3.57 of the TPG sets out that statistical tools that take into account measures of central tendency such as the IQR might enhance reliability in the following circumstances:

  • despite efforts to select accurate comparables and make adjustments where possible, comparability defects remain; and
  • there is a sizeable number of observations

The number of observations is not in an of itself an indicator of the reliability of the benchmarked range, but where there is a larger number of comparables and where comparability defects remain which cannot be identified and adjusted for, the use of the IQR is a helpful tool in further enhancing the reliability of the analysis. What is "sizeable" will depend on the facts and circumstances of a given case, but case teams should not aim to increase the number of comparables without those comparables being sufficiently reliable.

Factors to take into account when trying to narrow the range

To narrow the range of results case teams will have to consider the comparable companies put forward very carefully. This involves looking at the available information about the comparable companies, including what they say about themselves on their websites. Think about the following points:

  • should any of the companies obviously be excluded? Are there any other companies which should be included? This may involve a search of commercial databases
  • is there a subset of comparables within the larger range? For example, consider a company carrying out contract R&D in the field of computer software. The transfer pricing report may contain 16 comparable companies carrying out contract R&D in the computer field (ranging from hardware, operating systems, communications, switching and software), but that there are 3 companies involved in just software R&D. Why not use just those 3 companies as a starting point? These companies should in theory be more comparable to the tested party, subject to the consideration of other economically relevant characteristics.

Decide where, within a range of results, to set the transfer price

The OECD Transfer Pricing Guidelines say that if the results of the tested party fall within the arm’s length range of results (which may be the inter-quartile range where the criteria set out at paragraph 3.57 of the Guidelines are met), then no adjustment should be made. If they fall outside that range then the tax authority will need to determine where in the range the transfer price should be set (see paragraphs 3.60 to 3.62 of the Guidelines).

Paragraph 3.62 notes that "Where comparability defects remain as discussed in paragraph 3.57, it may be appropriate to use measures of central tendency to determine this point".

Most of the time the use of the median as a measure of central tendency maximises the likelihood that the adjusted price falls within the true arm’s length range.

The median is therefore likely to be the best position to adjust the price to, where it has been established that an adjustment is required because the filed position falls outside of the arm's length range. In particular, if MAP is available this will give HMRC the most readily defensible position and will form a good starting point for competent authority discussions.