TNMM's applikation af armslængdeprincippet: Fornuftstridigt eller underbygget af rationelle sammenhænge?

Steffen Astrup & Lasse Amstrup Olesen

Student thesis: Diploma thesis


This thesis examines how the Transactional Net Margin Method (TNMM) applies the arm’s length principle from a theoretical standpoint. The subject is relevant as determining arm’s length behaviour is based on what independent parties would have done. As the name of the method implies, TNMM does not compare controlled transactions with uncontrolled transactions but approximates that realised profits are what would have been expected if the transaction had been between third parties. As the timing of implementation of Transfer Pricing processes plays a significant role in determining arm’s length behaviour, the timing issues of such procedures will be treated in this thesis as well. The study begins with a thorough examination and interpretation of OECD’s Model Tax Convention article 9 that determines the arm’s length principle. OECD Transfer Pricing Guidelines which is the OECD interpretation has a significant influence on tax authorities and tax payers why this is being included in this part of the thesis. In order to determine how arm’s length behaviour is obtained and determined, an exhaustive examination of comparability analysis is made. The comparability analysis is a general guidance on identifying conditions and factors that have influence on the transfer price. These conditions and factors must then be taken into account or adjusted when comparing with third party transactions. OECD recognises five methods of setting and testing transfer prices of which one of them is TNMM. The five methods are accounted for to understand the strengths and weaknesses of each method in determining arm’s length behaviour. The five methods span from directly comparing controlled transactions with third party transactions to TNMM that determines by choice of Profit Level Indicator if returns are what would have been expected by an independent party. Criteria of selecting transfer pricing methods and the factors and circumstances considered when selecting the most appropriate transfer pricing method are essential for choice of method why these are also being taken into account in the thesis. TNMM shows to be a method developed by need rather than being the starting point of determining arm’s length behaviour which is valid knowledge when trying to determine the appropriateness of the method. Understanding the development of TNMM through history is deemed useful in the overall problem area. As the theoretical aspects of transfer pricing are in place as well as an understanding of the key influences on transfer prices an examination on how TNMM applies the arm’s length principle is now relevant. Key findings indicate that the matter of implementation and timing hereof plays a significant role in TNMM’s appropriateness of applying the arm’s length principle from a theoretical standpoint. Benchmark analysis is the tool of which the comparability analysis and chosen method is being utilised in practice. The benchmark analysis sets criteria for search of comparables in commercial databases containing financial information on companies worldwide. These data and results are being used to calculate the returns of which the comparability analysis and TNMM approximate as arm’s length behaviour. The coherence between the comparability analysis and benchmark analysis is of crucial importance in order to apply the arm’s length principle reliably. It is our conclusion that TNMM in theory applies the arm’s length principle by taking into account all variable conditions and factors that influence the transfer price. By doing this in a reliable and comparable manner, the last undetermined variable, the price, must be at arm’s length behaviour as well. Thereby the determined net margin does not only proof that the profit is at arm’s length but also the actual transaction. Complications by applying TNMM in practice relate to measuring comparables reliably and being able to reasonably accurately adjust deviations. In addition to this, theoretical best practice often requires exhaustive amounts of resources why there appears to be a general consensus in the transfer pricing community of focusing on price setting and testing on material conditions and transactions which leaves undetermined conditions to potentially soften the impact of the comparability analysis by applying the TNMM. The practical challenge becomes even more complicated as tax authorities have different opinions on TNMM's application and testing transfer prices ex-ante or ex-post. This means that although an associated company has implemented transfer prices that fulfil the theoretical requirements of TNMM, the different opinions and interpretations between tax authorities might still impose a threat of local tax compliance issues and in worst case double taxation. To prevent these issues, tax payers should aim for being at arm's length on a recurring basis which is also supported by the theoretical interpretation.

EducationsGraduate Diploma in Accounting and Financial Management, (Diploma Programme) Final Thesis
Publication date2014
Number of pages83