Sixth method – valuation techniques in transfer pricing

Transfer prices can impact the amount of income taxed in different countries. To ensure compliance, set these prices at the same level that unrelated parties would use in their transactions. Here’s how to do it.

Various transfer pricing verification methods are used to assess the prices set between related parties. There are five basic methods, including the cost-plus method and the comparable uncontrolled price method (CUP).

However, market value cannot always be accurately determined using these methods alone. In such cases, a sixth method—valuation techniques—can be utilized. This approach is especially helpful when standard methods are either insufficient or inadequate.

What is the sixth method – valuation techniques?

Valuation techniques involve determining the value of a transaction based on market valuation methods, such as income, cost, or comparative approaches.

These techniques are primarily used when comparable market transactions cannot be found, often in cases of transactions involving unique intangible assets like patents, trademarks, or know-how. Valuation techniques are also employed when assessing the value of businesses or other assets with values or market prices that are difficult to determine or in a commodity transaction.

How to apply the sixth method in practice?

To determine the value of the transaction, a detailed financial and market analysis is required. You have several approaches to choose from:

• Income approach: This method assesses the value based on the future cash flows that the asset can generate. For instance, the value of a patent can be determined based on its projected profits.
• Comparative approach (market approach): This approach involves comparing the transaction price to similar transactions completed by independent parties in the market. It can also include comparisons based on the profitability multipliers of comparable entities.
• Cost approach: This method determines the value based on the replacement or purchase cost of the asset or commodity. An example would be valuing a factory based on its construction costs.

Differences in the use of the sixth method in OECD countries

In general, OECD countries apply the same basic transfer pricing rules, but there are significant differences in their interpretation. Here are some examples:

• Availability of market data: In some countries, such as the U.S., access to detailed comparable data is much better than in others. This can affect the choice of method and the precision of valuation for taxation purposes.
• Detail of national regulations: Each country has its own specific regulations governing transfer pricing methodology. For example, in Poland and the United States, six transfer pricing verification methods are provided for. In contrast, regulations in France, Finland, or Norway do not explicitly specify any particular methods.
• Acceptance of valuation techniques: Valuation techniques are not universally accepted as a transfer pricing method. In countries like Germany or the United Kingdom, valuation techniques are not specified in the regulations as one of the transfer pricing methods. However, the situation is different in Poland, Denmark, or Spain, where these techniques are recognized.
• Country risk: Countries differ in their business risk levels, which impacts the valuation process. For instance, the risk associated with a highly developed country like the United States will be significantly lower than that of a developing country like Mexico or Paraguay.

Summary

Valuation techniques, also known as the sixth method, are tools whose application may vary depending on local regulations, data availability, or the specifics of the rules. When verifying the market nature of remuneration, a taxpayer must consider differences between countries.

Contact our experts to discuss how valuation techniques might apply to your company. Together, we will develop a strategy that helps you avoid disputes with tax administration and ensures the marketability of your transfer pricing.