Comparability Challenges in Transfer Pricing: Lessons from Key Disputes

This article is part of a series that builds on my previous article: Lessons on the Arm’s Length Principle, Economic Substance, Documentation, and Comparability Challenges – For proper context, read that article first.

The following articles are also related:

Comparability data is the cornerstone of transfer pricing compliance, providing the benchmarks necessary to ensure that intercompany transactions adhere to the Arm’s Length Principle (ALP). However, obtaining reliable and relevant comparables can be one of the most challenging aspects of transfer pricing, particularly in disputes involving unique industries or complex transactions.

This issue was prominently highlighted in the disputes involving Refinitiv (Thomson Reuters Group), Glencore Energy UK Ltd, and GE Canada. Each of these cases underscores the critical role of comparability data and the difficulties inherent in its application.

The Foundation of Comparability in Transfer Pricing

The concept of comparability lies at the heart of the ALP. It requires that intercompany transactions be benchmarked against similar transactions between independent entities. This involves analyzing the economic characteristics of the transaction, including functions performed, risks assumed, and assets utilized, to identify appropriate external comparables. However, the process is rarely straightforward. Differences in industry practices, market dynamics, and transaction specifics often make finding exact comparables difficult, requiring adjustments and professional judgment.

The importance of comparability data extends beyond compliance—it forms the basis for defending transfer pricing positions during audits or disputes. Tax authorities rely on benchmarks to assess whether the terms and pricing of intercompany arrangements reflect market conditions. Where comparables are lacking, the absence of clear benchmarks can lead to disputes, as seen in these three cases.

Comparability Challenges in the Refinitiv Case

The Refinitiv case illustrates the complexities of benchmarking in transactions involving intangible assets. The UK entities within the Thomson Reuters group provided services related to developing and enhancing intangible assets, including software and intellectual property. The challenge lay in determining whether the cost-plus methodology used in the APA adequately compensated the UK entities for their contributions.

Intangible assets, by their nature, are difficult to value and even harder to benchmark. The uniqueness of these assets means that comparable market data is often scarce or nonexistent. In this case, HMRC argued that the cost-plus method failed to reflect the true economic value created in the UK, necessitating a profit-split approach instead. The dispute highlights the limitations of traditional benchmarking techniques in the context of high-value intangibles and the need for innovative methods to address comparability challenges.

Comparability in the Glencore Case

In Glencore’s dispute with HMRC, the focus was on the pricing of commodity transactions—a sector notorious for its volatility and lack of stable comparables. The company used a pricing mechanism that sought to account for market fluctuations, but HMRC contended that the mechanism did not adequately reflect the market risks borne by the respective entities.

The challenge in commodity transactions lies in their inherent volatility. Prices can shift dramatically due to external factors such as geopolitical events, natural disasters, or supply chain disruptions. As a result, identifying comparable transactions that capture the same risk and reward dynamics is exceptionally difficult. Glencore’s case emphasized the need for robust and defensible adjustments to account for these market conditions, ensuring that the benchmarks used accurately reflect the economic realities of the transaction.

Comparability in the GE Canada Case

The GE Canada case dealt with the pricing of financial guarantees, a highly specialized transaction that presented unique comparability challenges. The Canadian Revenue Agency (CRA) argued that the fees paid for explicit guarantees exceeded arm’s length rates, especially given the implicit support inherent in the parent-subsidiary relationship.

In financial transactions, comparability often hinges on understanding credit risk, ratings, and the cost of capital. However, external benchmarks for such transactions are not always readily available, particularly for implicit guarantees. The court’s analysis involved examining the economic benefits derived from the explicit guarantees versus the implicit support, underscoring the need for nuanced comparability analyses that take into account both explicit and implicit factors.

Common Comparability Challenges Across Cases

The disputes in Refinitiv, Glencore, and GE Canada reveal recurring challenges in applying comparability data:

Scarcity of External Comparables: Unique transactions, such as those involving intangibles or financial guarantees, often lack direct market comparables, requiring innovative approaches to benchmarking.
Market-Specific Dynamics: Industries like commodities are subject to unique market conditions that make standard benchmarks insufficient or unreliable.
Adjustments and Assumptions: Even when comparables are available, significant adjustments may be needed to account for differences in risk, function, or market conditions, which can open the door to disputes.
Subjectivity in Analysis: Benchmarking involves a degree of professional judgment, which can lead to disagreements between taxpayers and tax authorities over the appropriateness of selected comparables or adjustments.

Addressing Comparability Challenges: Lessons Learned

The lessons from these cases emphasize the importance of a proactive and tailored approach to benchmarking. MNEs must go beyond standard databases to explore alternative sources of comparability data, such as industry-specific reports or innovative methodologies like profit-split or cost-sharing arrangements. Adjustments should be carefully documented and justified, with clear explanations of how they address the specific challenges of the transaction.

For tax authorities, the focus should be on developing clear and consistent guidelines for assessing comparability. Providing transparency in how benchmarks are evaluated can reduce uncertainty and foster cooperation with taxpayers. Additionally, investing in expertise to understand industry-specific dynamics can improve the quality of comparability analyses.