Understanding geographic screening criteria in benchmarking analysis
A benchmarking analysis aims to determine whether the results of a controlled transaction are consistent with what independent parties would have earned under comparable circumstances. To achieve this objective, taxpayers must consider not only the functions performed, assets employed, and risks assumed by potential comparable companies, but also the economic environment in which they operate.
This is where geographic screening becomes relevant. Geographic screening involves evaluating whether potential comparable companies operate in markets that are sufficiently similar to that of the tested party. The objective is to improve the reliability of comparisons by reducing the impact of market-specific factors that may materially influence financial performance.
The importance of geographic comparability is likewise recognized under Revenue Regulations (RR) No. 02-2013. The regulations acknowledge that prices may vary across different markets even where transactions involve the same property or services. As such, meaningful comparisons require consideration of the economic circumstances surrounding the entities or transactions being compared.
Similarly, the OECD Transfer Pricing Guidelines emphasize that identifying the relevant geographic market is a question of fact and should be assessed based on the circumstances of each case.
Depending on the industry, a regional market covering several jurisdictions may exhibit sufficiently similar economic characteristics to support reliable comparisons. Conversely, significant differences may exist not only between countries but even within the same jurisdiction.
Key points
- Geographic location and market conditions: Companies operating in different countries or regions may be subject to varying economic conditions, market opportunities, and business risks. These differences may influence pricing strategies and profitability.
- Market size and level of competition: The size of a market and the extent of competition may affect a company's financial performance. Businesses operating in highly competitive markets may generate different profit levels from those operating in more concentrated markets.
- Local versus regional comparables: Local comparable companies are generally preferred because they are more likely to operate under economic conditions similar to those of the tested party. However, reliable local comparables may not always be available. In such cases, taxpayers may broaden their search to include companies operating in other geographic markets, provided that sufficient comparability can be established and documented.
The objective of the benchmarking process is to identify the most reliable comparable data available, recognizing that perfect comparables may not always exist. Where independent transactions are scarce, a practical approach may involve considering companies operating in comparable industries or geographic markets, while carefully evaluating the impact of any differences on the reliability of the analysis.
Ultimately, geographic screening is not simply a matter of selecting companies from the same country or region. Rather, it involves assessing whether the economic circumstances surrounding potential comparable companies are sufficiently similar to those of the tested party. Proper geographic screening enhances the reliability of benchmarking analyses and strengthens the overall support for transfer pricing positions.
(Chapters I and III: OECD Transfer Pricing Guidelines, January 2022 and
Revenue Regulations No. 02-2013)
As transfer pricing analyses become increasingly subject to scrutiny, taxpayers should ensure that geographic screening is appropriately incorporated into their benchmarking studies. A well-documented assessment of geographic comparability can improve the reliability of transfer pricing conclusions and help support compliance with the arm's length principle.