Understanding assets used in comparability analysis
Assets employed by a taxpayer are a key component of the Functions, Assets, and Risks (FAR) analysis, and play an important role in determining comparability. The nature and extent of assets used in a business often contribute to its ability to generate profits and significantly influences the arm's length price of related party transactions.
Importance of asset analysis
A proper asset analysis helps determine whether the allocation of profits between related parties is consistent with the arm's length principle. In conducting a comparability analysis, it is not sufficient to identify only the functions performed and risks assumed by each party. Taxpayers must also evaluate the nature and extent of assets employed in controlled transactions, as these assets frequently contribute to value creation and profitability.
As part of the FAR analysis, the assessment of assets supports the selection of reliable comparables by determining whether the tested party and independent companies utilize similar assets under comparable circumstances. Material differences in asset profiles may influence expected returns and affect the reliability of benchmarking results.
Types of commonly employed assets
Assets employed by the tested party generally fall into two broad categories: tangible and intangible assets.
Tangible assets include manufacturing plants, production facilities, machinery, equipment, warehouses, storage facilities, vehicles, and other operating assets. The scale and sophistication of these assets often reflect the complexity of the activities performed and the level of capital invested in the business. Accordingly, an enterprise that makes substantial investments in physical assets may reasonably expect a different return from a business that operates with only limited tangible resources.
On the other hand, intangible assets may include trademarks and trade names, software, patents and proprietary technologies, customer relationships, manufacturing intangibles, marketing intangibles, proprietary processes, know-how, right under contracts, licenses, goodwill, and other forms of intellectual property. Because valuable intangibles may provide competitive advantages and generate unique economic benefits, their ownership and control can significantly affect profitability and the allocation of returns among related parties.
How assets are evaluated
Evaluating assets used in a controlled transaction requires taxpayers to look beyond legal ownership and consider how the assets are actually utilized within the business. The analysis should identify the party that owns or controls the asset, the functions for which it is employed, the investment required to maintain it, and the extent to which it contributes to revenue and profit generation. Particular attention should be given to assets that create competitive advantages or generate benefits that independent parties would consider when negotiating a price.
For intangible assets, taxpayers should also determine which entity performs the development, enhancement, maintenance, protection, and exploitation (DEMPE) functions. An examination of these activities helps establish which entity makes substantive contributions to the intangible asset and whether the resulting allocation of profits is consistent with the arm's length principle.
Taken together, legal ownership, actual control, asset intensity, capital requirements, and contribution to value creation provide a sound basis for assessing whether the returns earned by the parties are commercially reasonable.
Why asset analysis matters in selecting comparables
The practical significance of these considerations becomes most apparent when comparables are selected. A routine service provider that relies primarily on its workforce and does not own valuable intellectual property would not ordinarily be comparable to an independent company that owns proprietary technology and derives substantial value from it. Similarly, a contract manufacturer that performs production activities on behalf of a related party without owning valuable manufacturing intangibles should not automatically be compared with a full-fledged manufacturer that owns production facilities, proprietary technology, and other manufacturing assets.
Since these enterprises deploy different assets and perform different economic roles, their profit expectations are also likely to differ. Accordingly, the selection of comparables should not be based solely on similarities in industry or business activity. It should also take into account the nature, ownership, control, and economic contribution of the assets employed by the tested party. ¹
Ultimately, for Philippine transfer pricing purposes, taxpayers should ensure that the assets used in controlled transactions are clearly identified, carefully analyzed, and adequately documented. Particular attention should be given to how tangible and intangible assets are owned, controlled, and utilized, since these factors can materially affect profitability and comparability. A well-supported asset analysis not only improves the selection of appropriate comparables but also strengthens the overall transfer pricing position and demonstrates compliance with the arm’s length principle during a BIR review.
¹ Section 6(b)(2), Revenue Regulations No. 2-2013; Revenue Audit Memorandum Order No. 1-2019; and Chapter I, Section D.1.2 and Chapter III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022).