You're reading: Performing benchmarking studies: which comparison period to choose?

At the end of 2018, the Ukrainian transfer pricing rules have been changed by the Law of Ukraine No. 2628-VIII. Among other things, the Law determines that the taxpayer must explain and justify the use of data for several tax periods (years) for the purposes of the arm’s length range calculation in the TP documentation.

It is to be recalled that currently Ukrainian TP rules provide for two options for choosing a period for the arm’s length calculation: based on comparable financial data for the same reporting year in which the controlled transaction took place (“year to year analysis”) or using several years preceding the year in which the controlled transaction took place (“multiple year analysis”). Insofar as Law No. 2628-VIII requires justification only for the use of multiple data, this indirectly prioritizes a “year to year analysis” over a “multiple year analysis”.

What is the purpose of such an amendment? Is it more about the unified statistic approach to arm’s length calculation (like it was with the weighted average approach), or the issue is driven from the perspective of comparability analysis? And finally, how exactly the use of multiple year data could be justified in the TP documentation?

The tax authorities probably prefer a “year to year analysis” because they believe that such arm’s length range ensures the most accurate results considering that the controlled and comparable transactions took place in the same year and, thus, were performed in the similar economic environment. This means that the tax authorities believe this to be a comparability issue.

In practice, using multiple year period often provides important benefits in terms of comparability. To justify the use of such approach, the taxpayer may refer to OECD TP Guidelines (while being not officially recognized in Ukraine, they are often used as an important source of interpretation of the TP principles and rules). The OECD Guidelines outline the following advantages of using multiple year period:

  • obtaining a complete understanding of the facts and circumstances surrounding the controlled transaction (e.g., to exclude or further investigate the loss-making companies)
  • providing information about the relevant business and product life cycles of the comparables
  • improving the process of selecting third-party comparables e.g., by identifying results that may indicate a significant variance from the underlying comparability.

Nevertheless, there are many cases where arm’s length range calculated on a year to year basis provides a more accurate comparison, for example:

  • significant changes in the economic circumstances – a striking example is a period of 2014-2015 in Ukraine when many exporting industries lost their markets whilst the importers of goods and services incurred significant FOREX losses due to rapid devaluation of Hryvnia.
  • enactment of legislative initiatives that affect the profitability (e.g., new customs duties), etc.

The TP study becomes a more complex exercise for Ukrainian taxpayers as the comparability analysis should include not only the analysis of commercial or financial conditions of the controlled and comparable transactions, functional profiles of the parties, but also timing issues and economically relevant circumstances of those relations.

One more crucial practical issue that complicates the use of a “year to year analysis” is that the financial information on comparable companies may be limited or not represented at all at the certain reporting date.

Commercial database providers (such as Bureau Van Dijk) gradually gather publicly available data disclosed by the companies as a result of regulatory reporting requirements imposed by specific countries, and the gap between the filing periods of reporting entities is usually quite substantial – e.g., financial data for FY 2018 is uploaded into the databases during 2019 – 2020, depending on the database. For this reason, FY 2018 controlled transactions may be adequately tested under a “year to year approach” only after the respective database is fully updated. In our experience, BvD Ruslana database (which contains financial data on Ukrainian, Russian and Kazakh companies) updates its financial information for the latest reporting year only at the end of July – beginning of August of the following year. The update of financial data in BvD Amadeus database (which includes European companies) takes considerably more time – the process is usually completed only within a year after the controlled transactions took place.

The statutory deadline for submission of the transfer pricing report is 1 October of the year following the reporting one. Considering the timing of updating the databases described above, it is quite possible that by this reporting deadline the taxpayers would not have appropriate comparable information for the last year as required under “year to year analysis”.

According to OECD Guidelines, “Each taxpayer should endeavor to determine transfer prices for tax purposes in accordance with the arm’s length principle, based upon information reasonably available at the time of the transaction. Thus, a taxpayer ordinarily should give consideration to whether its transfer pricing is appropriate for tax purposes before the pricing is established and should confirm the arm’s length nature of its financial results at the time of filing its tax return”.

In our opinion, the above arguments demonstrate that the tax authorities should not discriminate “multiple year analysis” without valid reasons. In any case, they may not require that a taxpayer performs such analysis before the statutory reporting deadline (1 October of the next year), because the required comparability data would not be available yet.

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