How to improve the estimation of intra-firm prices for financial and tax reporting during economic downturns

Abstract

In this article, we propose an approach that can be employed to estimate prices in intra-group trade at times of economic turmoil, and to improve financial, management, and tax reporting by using current macroeconomic data to adjust historic benchmarks. We explored the use of a predictive model, that employs macroeconomic data, and in particular changes in GDP, to predict company profitability and arm’s length profit ranges. The results of our analysis show that there are correlations between changes in GDP and changes in certain P&L items of companies operating in Europe. While the relation might or might not be explained by a causal/inference model (Granger causality), it may have a practical use: to predict changes in the profitability of companies when company data are not available in real time (Shmueli, 2010).

Keywords:

• Intra-firm trade
• transfer pricing
• international financial reporting
• tax reporting
• intra-group transactions

JEL Classification Codes:

• M41
• F23
• H25

Acknowledgements

The authors acknowledge fruitful discussions with Filippo Bertoletti and Rocco Talia. The authors presented the preliminary results of the analysis in a workshop at Vienna University of Economics and Business, where the comments and questions from the audience were very helpful.

The data presented in this article have been included for illustrative purposes only. They are not meant to constitute advice or to be used in setting prices as any pricing analysis should be based on company-specific facts and circumstances. The views expressed in this article are those of the authors and do not necessarily reflect those of KPMG. Other usual disclaimers apply (Weisberg, 2005).

Disclosure statement

No potential conflict of interest was reported by the author(s).

Notes

1 Some companies may use two different transfer prices for the same transaction: one for financial reporting and tax (i.e. fiscal transfer prices or FTP), which is aligned to the OECD requirements, and one for management reporting (i.e. management transfer prices or MTP), which is aligned to the informational needs of management. While FTP aim to replicate what would happen between independent parties, management may want to see other KPIs in their management accounts, often based on the consolidated performance of the group in a certain market or business/product line, which does not require the price to be set as if each group company were an independent company.

2 The arm’s length principle (‘ALP’) has been for many decades the golden standard for intra-firm pricing and for the taxation of multinational firms in the large majority of countries. Recently this principle has been subject to criticism and, as a result, a broad debate is currently taking place at the OECD level on the revision of the principles of the international corporate tax system, including the ALP, which may, in the future, arrive at the modification of the principle and it use. The aim of this article is not to address the strengths and weaknesses of the ALP and the merits of the current debate on the international tax system but rather to focuses on how to improve the application of the ALP during economic downturns.

3 See IRS 2019, p. 9 and Agenzia delle Entrate, 2010, p. 9.

4 Financial data of public companies do not suffer from this time lag, but comparable companies would usually not be drawn from public companies (but from private companies) as these are generally not multinational groups and hence are not suitable as ‘independent comparables’.

5 We used 12-year data (2006–2018) from the Bureau Van Dijk Orbis database.

6 The correlation coefficient was first developed by Auguste Bravais and Francis Galton. It was defined as a product-moment and its relationship with linear regression was studied.

7 In line with transfer pricing best practice, we used the Operating Margin ratio (i.e. EBIT/Turnover) for wholesale companies and the Net Cost Plus ratio (EBIT/Total Costs) for production companies.

8 To apply the second approach, all the three regressions (change in upper quartile, median and lower quartile with respect to change in GDP) have to be statistically significant.

Additional information

Notes on contributors

Gianni De Robertis

Gianni De Robertis has a MSc in Economics from the London School of Economics and a BA in Economics and Business from the University of Ancona. He is the chief economist of KPMG Studio Associato in Italy and the head of KPMG transfer pricing analysis in the EMA region.

Denis Kondi

Denis Kondi has a first and second level degree in BA and a Ph.D. in Statistic Economics (Sapienza University). After working for few years as credit and risk analyst in banking sector he joined KPMG where he is currently a manager in the global transfer pricing analysis team in Italy.