Brattle principal Michael Cragg and associate David Hutchings recently published an article in Tax Notes discussing an economic framework for determining the tested party under the standard comparable profit method (CPM) for transfer pricing. Their proposed framework is consistent with the guidance under both the OECD guidelines and U.S. tax law.
The authors show how economic principles provide a proper approach to determining which is the “tested” party, and in particular tackling the often controversial issue of which is the “least complex” party. From an economic perspective, the authors argue that the degree of market competition is a critical component of tested party determination and choice of profit level indicator. According to Dr. Cragg and Mr. Hutchings, the party whose services are competitively supplied can be the tested party because the functions can be priced with reference to competitive benchmarks, which is consistent with the economic theories underlying the CPM.
The authors outline the technical aspects of implementing the CPM and relate to pending disputes involving tested party determination, including Eaton, Abbott Laboratories, Guidant, and Medtronic.
The article, “An Economic Framework for Identifying the Tested Party,” is available for download below.