What Is the TNM Methodology?
The Transactional Net Margin (TNM) method is one of the Transfer Pricing methods accepted by the Organization for Economic Co-operation and Development (OECD) for analyzing related party transactions.
The TNM evaluates the profitability of a related party transaction, comparing it with the profitability of independent party transactions. For its application, the tested party, the profitability indicator, the year(s) of analysis, the search for comparables, and adjustments to ensure comparability must be determined. Of the mentioned points, although analyzing the year under evaluation versus the year of the companies selected as comparables is conventionally accepted, the application of a multi-year analysis should be ruled out to obtain reliable market value results.
Use of Multi-year Information
Multi-year information may be advisable to obtain a more accurate and complete view of profit margins over several years if transactions whose business cycle or cycle of a product or service extends beyond one fiscal year for compliance with the Arm’s Length Principle.
Consequently, a multi-year analysis may be particularly relevant when there are significant variations from year to year in the financial indicators that could influence the comparability analysis, being useful to smooth the effects of atypical events. For multiple years, a more balanced view of profit margins can be obtained, reducing the effects of single factors.
Conversely, the use of multi-year information depends on the availability and reliability of data from previous years.
OECD Position
The OECD Transfer Pricing Guidelines can explain the multi-year analysis. The 2017 edition of these guidelines includes discussions on multi-year analysis.
Chapter III, point B.4, states: “The information obtained several years after the transaction may be significant for the Transfer Pricing analysis, but this must be cautioned in the retrospective approach. These data could compare different stages in the development of products in both related and unrelated transactions to determine whether uncontrolled transactions are appropriate comparables through a specific method.”
Likewise, in point B.5 of the same Chapter, the following concepts are established:
- Data for several years become those available for comparability analysis, although not a systematic requirement (3.75).
- In order to fully understand the facts and circumstances of the related transaction, data for the current and prior years can be verified. This may disclose facts that may affect transfer prices (3.76).
- Multi-year data helps to provide information on relevant business cycles and life cycles of comparable products. These differences can significantly affect the Transfer Pricing rules and should be assessed to determine comparability (3.77).
- Multi-year data can also improve the process of selecting comparable third parties (3.78).
- Using multi-year data does not mean using multi-year averages. In some cases, multiple years of data and averages can be used to improve interval reliability (3.79).
Multi-year analysis can address annual variability and ensure that comparisons are more consistent, especially for significant fluctuations affecting transfer prices from one year to the next. This approach could assist companies and Tax Administrations to obtain a more accurate and fair view of Transfer Pricing practices.
Evaluating Years of Analysis
The OECD Transfer Pricing Guidelines are essential for multinational companies and Tax Administrations due to the guidance these provide on the analysis of related-entity transactions in different jurisdictions to ensure compliance with the Arm’s Length Principles.
The multi-year analysis allows assessing the consistency of profit margins over several years. This is relevant because economic and market conditions can fluctuate, affecting the profit margins of comparable transactions. A one-year analysis may not accurately reflect these fluctuations and could lead to erroneous conclusions on whether transactions comply with the Arm’s Length Principle.
Although a one-year analysis (the reporting year) may be sufficient, there are situations where a multi-year analysis may be more appropriate to obtain a complete understanding of a company’s business practices. Conversely, multi-year analysis presents challenges, such as the availability of comparable data for the relevant years and the need to adjust those data to ensure comparability over time. Thus, the OECD does not prescribe a single approach but suggests that the decision to use a single-year analysis versus a multi-year analysis should be based on case-specific circumstances.
Conclusion
In summary, the OECD Transfer Pricing Guidelines recognize the significance and usefulness of multi-year analysis in certain circumstances but also highlight the need for flexibility and professional judgment in deciding when and how to apply it. The multi-year information for the TNM application may be advisable for a more complete and accurate view of profit margins over time.
