Understanding industry screening criteria in benchmarking analysis
A transfer pricing study is only as reliable as the comparable companies selected. Before a taxpayer can compare profitability or pricing with independent entities, it must first identify companies that operate under sufficiently similar circumstances. This process is commonly referred to as industry screening.
The OECD recognizes that comparisons should be based on economically relevant characteristics rather than solely on industry classifications. Accordingly, industry screening serves as a preliminary filter designed to identify businesses that are likely to share similar value drivers, functions, assets, and risks. While industry classifications, such as NAICS or SIC codes, may serve as useful starting points, they do not, by themselves, establish comparability.
Key points
- Similarity of core business activities: Comparable companies should engage in business activities that are similar to those of the tested party. Similarity in core operations provides an initial indication that the entities may be operating under comparable economic conditions.
- Functional similarity: Potential comparable companies should be evaluated based on the functions performed, assets employed, and risks assumed. A proper functional analysis remains a critical component of the comparability assessment.
- Industry specialization and business models: Beyond industry classifications, it is important to assess the specific business model of each potential comparable. Companies operating within the same industry may nevertheless perform different functions, serve different markets, or assume different levels of risk.
- Economic circumstances: Profitability may be significantly influenced by the environment in which a company operates. Relevant economic circumstances may include geographic market, competitive landscape, market size, customer purchasing power, regulatory framework, level of economic development, and industry maturity.
- Segmental consistency: Where a potential comparable operates multiple lines of business, the use of segmental financial information is encouraged to improve the reliability of the comparison.
- Qualitative review of business descriptions: Comparability should be assessed based on the actual economic substance of a company's activities rather than solely on its formal industry classification or business description.
The importance of industry screening becomes more evident in the context of benchmarking analyses performed under profit-based transfer pricing methods. Industry benchmarking is generally relevant when applying profit-based transfer pricing methods, particularly the Transactional Net Margin Method (TNMM). Under TNMM, the profitability of the tested party is compared to that of independent companies performing similar functions under comparable circumstances. As a result, the reliability of the analysis is significantly influenced by the appropriateness of the comparable companies selected through the benchmarking process.
In addition, industry screening criteria should be based on publicly available information that can be independently verified. Common sources include annual reports, company websites, regulatory filings, stock exchange disclosures, business databases, and other publicly accessible information describing a company's operations, products and services, markets served, and financial performance.
Industry screening is far more than a preliminary database filter. Under the OECD framework, it is an integral part of the comparability analysis that supports the application of the arm's length principle. A reliable screening process requires taxpayers to look beyond industry classifications and evaluate the actual economic activities, functional profiles, assets, risks, and operating environments of potential comparable companies.
Ultimately, the objective is not merely to identify companies operating within the same industry, but to identify companies whose profits are driven by similar business activities and economic circumstances. When conducted properly, industry screening enhances the reliability of benchmarking analyses and strengthens the overall defensibility of transfer pricing positions before tax authorities.
(Chapter III: Comparability Analysis, OECD Transfer Pricing Guidelines, January 2022 and Revenue Regulations No. 2-2013)
Staying on top of these developments helps ensure that transfer pricing documentation remains compliant, accurate, and defensible.