Unlike low-value-added intra-group services, for which the OECD Guidelines provide a simplified approach based on a 5% margin over certain costs, services that do not meet the conditions of that regime require, for Transfer Pricing purposes, a specific analysis in accordance with the arm’s-length principle.
In this context, strategic activities, specialized technical services, certain financial functions, activities related to intangibles, or functions involving significant risks may require a more in-depth analysis. However, the fact that a service falls outside the simplified regime does not automatically mean that it should be considered a “high-value” service or that a cost-based method is inappropriate.
The core issue is that the simplified markup cannot be automatically applied to services whose economic nature, functions, and risks are different.
Why Cost Does Not Always Determine Compensation
When a service does not meet the conditions for applying the simplified approach, its compensation must be determined in accordance with the arm’s-length principle.
This requires analyzing the functions performed by the service provider, the assets used, the risks assumed, the characteristics of the service, the economic or commercial benefit to the recipient, and the existence of comparable transactions.
The cost of providing the service may still be a relevant benchmark. Nevertheless, cost alone does not necessarily determine what the arm’s-length remuneration should be.
Therefore, automatically applying a standard percentage to costs—without analyzing the economic characteristics of the service or the available comparables—may result in remuneration that does not adequately reflect the terms that independent companies would have agreed upon.
The method must be consistent with the functional profile of the service
There is no single method applicable to intragroup services that fall outside the simplified regime.
Depending on the circumstances, methods such as the Comparable Uncontrolled Price Method (CUP), the Cost Plus Method, or the Transactional Net Margin Method (TNMM) may be appropriate.
In particular situations, the Residual Profit Split Method may also be appropriate, especially when the parties make unique and valuable contributions, have a high degree of integration, or share economically significant risks.
The choice must be based on the functional analysis and the availability and reliability of comparable information, not just on the name assigned to the service.
The benefit test remains essential
Before analyzing how much a transfer-priced service should be compensated, it must be determined whether a service eligible for compensation actually exists.
The so-called benefit test requires analyzing whether the activity provides the recipient with economic or commercial value that maintains or improves its position and whether, under comparable circumstances, an independent company would have been willing to pay for that activity or perform it internally.
For more complex services, the documentation should clearly identify which activity was performed, who received it, what economic or commercial benefit was obtained or reasonably expected to be obtained, and why that activity would have value to an independent company.
This does not mean that an immediate increase in revenue or earnings/profit must always be demonstrated. The benefit may be expected, indirect, or manifest over a longer time horizon, provided there is a reasonable economic relationship between the service and the recipient’s position.
Beyond the simplified approach, documentation takes on greater importance
Once it has been determined that the service does not qualify as low value-added, the analysis must explain why the selected methodology is appropriate.
The documentation should support, among other things:
- the nature and scope of the service;
- the functions performed by each entity;
- the assets used and risks assumed;
- the benefit obtained or reasonably expected by the recipient;
- the cost basis used, when applicable;
- the criteria used to determine the margin or compensation;
- the reasons why the selected method reflects conditions of perfect competition.
Therefore, the problem does not lie in using a cost-based method, but rather in applying a standard margin without demonstrating that such a method and such remuneration are appropriate for the specific characteristics of the service.
At TPC Group, we evaluate each intra-group service to determine whether it meets the conditions of the simplified approach for low-value-added services or whether it requires a specific valuation analysis, taking into account the functions performed, the assets used, the risks assumed, and the economic contribution of the parties involved.