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Transfer pricing methods
Which transfer pricing methods are used in your jurisdiction and what are the pros and cons of each method?
Ukrainian tax legislation prescribes the possibility of using all methods described in Chapter II of the Organisation for Economic Cooperation and Development Guidelines – in particular:
- the comparable uncontrolled price method (CUP);
- the resale price method (RPM);
- the cost plus method (CPM);
- the transactional net margin method (TNMM); and
- the profit split method (PSM).
The CUP method is based on a comparison of prices used in controlled transactions with the price and/or range of prices in comparable non-controlled transactions. The information about the prices in the comparable non-controlled transactions, which were actually performed by the taxpayer or other parties, are used.
The CUP method may be used:
- when exchange quotations are available;
- in transactions involving intellectual property (eg, royalties);
- in financial transactions (eg, loans and bonds); and
- in comparable transactions with non-related parties, if reliable information on the comparable transactions is available.
RPM may be used, for example, during resales of goods if the following functions are performed:
- the goods are prepared for resale and transportation (eg, division of goods among the parties, forming deliveries, sorting and repacking); and
- the goods are mixed, if the characteristics of the final (prefabricated) product is not significantly different to the mixed goods.
CPM may be used, for example, in the following cases:
- providing work or services in favour of related parties; and
- sales of goods, raw materials or semi-finished products under contracts in favour of related parties.
TNNM applies if the information that allows taxpayers to reasonably apply the previous transfer pricing methods are absent. It is often used in:
- resales of goods;
- the provision of work or services; and
- the production of goods (in case of capital-intensive activity).
PSM is often used when other methods cannot be applied, particularly where:
- a significant relationship exists between controlled transactions and other transactions undertaken by the parties of controlled transactions with related parties; and
- parties of the controlled transaction hold the rights on intangible assets that have a significant impact on profitability.
Preferred methods and restrictions
Is there a hierarchy of preferred methods? Are there explicit limits or restrictions on certain methods?
According to the Ukrainian legislation, the CUP method takes priority over the other methods. If the CUP method is inapplicable, taxpayers can apply other methods specified in Article 39 of the Tax Code. However, where RPM, CPM, NPM or PSM are available, the first two methods are preferred. The application of methods that are not prescribed by the Tax Code is prohibited.
The transfer pricing method selected should be the most appropriate based on the facts and circumstances of the controlled transaction.
The main criteria for selecting the most appropriate transfer pricing method are:
- the nature of the controlled transaction, which is often determined by a functional analysis of the controlled transaction (including the functions performed, assets employed and risks assumed);
- the availability of complete and accurate information, which is necessary for the application of the selected transfer pricing method(s); and
- the level of comparability between the controlled and non-controlled transactions, including the reliability of any comparability adjustments that can be used to eliminate differences between such transactions.
What rules, standards and best practices should be considered when undertaking a comparability analysis?
According to Ukrainian legislation, controlled and non-controlled transactions are recognised as comparable if:
- there are no substantial differences between them that may significantly affect the financial results; or
- if such differences exist, they can be eliminated by adjusting the conditions and financial results of uncontrolled transactions to avoid the impact of these differences on the results of the analysis.
During the comparability analysis of the conditions of controlled and non-controlled transactions, the following elements must be taken into account:
- the description of the goods, works or services which are the subject of the transaction;
- the functions performed by the transacting parties, including the assets that they employ and the allocation of risks, rewards and responsibilities between them;
- the common practice of relationships and terms of agreements concluded between the transacting parties which substantially affect the price of the goods, works or services;
- the economic conditions of the transacting parties’ activities, including an analysis of the relevant markets that significantly affect the price of the goods, works or services; and
- the transacting parties’ business strategies (if any) that significantly affect the price of the goods works or services in the controlled transaction.
In addition, there are several criteria for the selection of comparable legal entities, which must be met simultaneously:
- The activity must be comparable with the activity of the tested party within the controlled transaction. ‘Comparability’ is determined by the national (ie, Ukrainian only) or international classifiers of economic activities.
- Comparable companies must not have operating losses in more than one reporting period within the analysed period.
- comparable companies must not directly or indirectly own more than 20% of the corporate rights in another company. Further, the shareholders of the comparable company must not be legal entities with more than 20% direct of indirect ownership per shareholder.
Are there any special considerations or issues specific to your jurisdiction that associated parties should bear in mind when selecting transfer pricing methods?
The CUP method should be used to verify whether prices for commodities listed on commodities exchanges are arm’s length. The list of such commodities and exchanges is determined by the Cabinet of Ministers of Ukraine. The range of prices is determined based on the exchange quotations for the decade preceding the performance of the controlled transaction.
If the controlled transaction is performed based on a futures or forward contract, the range of prices is determined based on futures or forward quotations for the decade preceding the effective date of the relevant futures or forward contract, provided that the taxpayer notifies the tax authority of entering into such a contract within 10 business days from the effective date thereof.
If a taxpayer uses a method other than CUP to determine the level of prices in the abovementioned transactions, it must provide information on all related parties that participated in the controlled transaction (up to the first non-related party), including information on profit level indicators of related parties. Otherwise, the tax authority is authorised to determine the level of prices based on the CUP method.
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