The Profit Test and the Local Report are two important components within Transfer Pricing compliance, but they fulfill different objectives and requirements. Here we explain the main differences between the two:
What is the Profit Test?
- Objective: The Benefit Test is a specific assessment that seeks to determine whether an intra-group transaction, particularly in the case of intra-group services, generates an economic or commercial benefit for the entity receiving those services.
- Focus: It focuses on verifying that the services received provide an advantage or benefit that justifies the compensation paid for them. In other words, it evaluates whether the independent entity in comparable circumstances would pay for those services.
- Application: It is usually applied in the analysis of intra-group services, such as administrative, financial, technology services, among others, to ensure that the receiving entity pays arm’s length compensation for the economic value received.
- Documentation: Although it is not a formal document as such, it can be included in the Transfer Pricing documentation, specifically in the justification of payments for intra-group services.
- Key Aspect: It is a qualitative rather than quantitative analysis, as it is based on the perceived value and need for the service, rather than on the precise pricing of the transaction.
What is a Local Report?
- Objective: The Local File is one of the three reports contemplated in Action 13 of the OECD BEPS Plan, which seeks to provide tax authorities with a detail of intra-group transactions carried out by a local entity with its related parties, and to ensure that the Transfer Pricing policies applied comply with thearm’s length principle.
- Approach: Aims to document and justify intra-group transactions at the local level. It includes an economic analysis to support that the prices of related party transactions are in line with the arm’s length principle.
- Application: Applies to all relevant transactions with related parties, such as sale of goods, provision of services, licenses, loans, among others.
- Documentation: It is a formal and extensive report that includes a functional and risk analysis, financial information of the company, detailed descriptions of the controlled transactions and the Transfer Pricing methods applied.
- Key Aspect: It is a mandatory document filed with local tax authorities, with specific requirements that vary from country to country, and is usually much more comprehensive in terms of economic and financial information.
| Feature | Profit Test | Local Report |
| Purpose | Verify the real benefit of intragroup services. | Document all transactions with related parties, whether domiciled or not (depends on the local transfer pricing regulations of the entity under analysis). |
| Focus | Intragroup services and their economic value for the receiving entity. | Formal reporting is mandatory according to the country and OECD framework. |
| Documentation | Part of the intra-group services analysis (although it is not a formal or required document, it will depend on the minimum information requested by the corresponding Tax Administration to evaluate compliance with the Benefit Test). | Formal and mandatory reporting according to the country and OECD framework. |
| Method | Qualitative assessment of perceived benefit. | Quantitative and qualitative analysis of the arm’s length principle. |
| Application | Evaluation of intragroup services. | Applicable to all relevant intra-group transactions (depends on country setting). |
Conclusion
Both the Local File and the Benefit Test are fundamental tools to ensure compliance with Transfer Pricing regulations. Understanding their differences and applying them correctly is essential for multinational companies seeking to optimize their tax management and avoid penalties.
Call to Action
At TPC Group we have a team specialized in the preparation of Local Reports and the analysis of the Benefit Test to ensure that your company complies with the Transfer Pricing regulations. Contact us today for a personalized consultation.
Source: OECD, "Guidelines for the application of Transfer Pricing to Multinational Enterprises and Tax Administrations," 2017.
