Transfer Pricing within a Group: a Case Study

1 
INTRODUCTION 
International trade has risen quickly over the last decade. The role of multinational 
companies has significantly increased as well.  
There are several reasons justifying such rapid growth in world trade, ranging from the 
desire of MNEs to expand their production by taking into account cheaper labor costs, to 
the increasing demand from developing nations for wider ranges of goods and services 
from the first world. Another factor behind this expansion is the global increase in the use 
of technology, particularly computer systems, which has resulted in a vast array of 
information being accessible in seconds
1
. 
The global economy allowed international organizations to penetrate multiple markets with 
the immediate consequence that cross border intercompany transactions within global 
organizations expand continuously. 
Therefore, the recent globalization of economic activity and the rise of several 
multinational enterprises (MNEs) led management to adapt to the new circumstances and 
to define new operational and financial strategies.  
This increased availability and ease of exchange of information has assisted many 
companies in expanding their cross-border trade. A result of this revolution in information 
technology has been that transactions are being executed with less effort required and at 
lowering marginal costs. The volume, location or nature of products and services are no 
longer seen as obstacles to doing business. Increasing use of technology and decreasing 
transaction costs have meant profit opportunities in product, service and geographic areas 
that were previously considered unattainable. With such comprehensive and timely data, 
MNEs are now able to make decisions more effectively and decisively than ever before. 
The growth of these international companies would display complicated taxation issues for 
both tax authorities and the international enterprises themselves since the set of tax rules of 
a specific country cannot be viewed separately but must be framed within a broad 
international context
2
.  
Conducting business in the global market place presents MNEs with a myriad of 
international business issues – both risks and opportunities – that they must face on a daily 
                                                   
1
Adams C., Coombers R., (2003) “Global Transfer Pricing: Principles and Practices”, LexisNexis UK, 
Deloitte UK, p.2; 
2
 OECD, (2010), “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration”, 
preface, p.17;
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basis. Chief among the risks is that the intercompany prices set by the MNE will be subject 
to increasing and differing degrees of scrutiny from tax authorities around the globe. 
Among these complex issues it is possible to frame the transfer pricing phenomenon. 
Transfer prices can be defined as “the prices at which an enterprise transfer physical 
goods and intangible property or provides services to associated enterprises”
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.  
Transfer pricing would then refer to that practice of trading goods and services between 
related companies belonging to the same group. In particular, the major challenge would 
arise when determining the price to charge for goods and services from one enterprise to 
the other (within the same group). 
The transfer pricing “problem” (hereinafter “TP”) would arise where corporations have 
subsidiaries spread around the world, in countries with different tax regimes. These 
differences would simply mean that companies operating in high-tax regime will pay 
higher taxes than those located in low-tax regime.  
This problem would lead companies to use transfer pricing to shift their profit from high-
tax regime countries to low-tax regime countries, in order to reduce tax burden.  
The main idea behind this phenomenon is that prices set for intra group transactions should 
be derived from those prices which would have been applied by unrelated parties in similar 
transactions, under similar market conditions within the open market.  
This is what is normally referred to the arm’s length principle, real landmark of this 
analysis. The arm’s length principle is the key element upon which all the intra group 
transactions must rely on. Complying with such principle would simply reduce the 
possibility of tax advantages or disadvantages that would otherwise distort the competitive 
positions of the entities. 
 
The main goal of such work is to provide a clear and detailed overview of transfer pricing 
phenomenon, from the legal, economic and fiscal point of view. Great emphasis will be 
given in understanding how this phenomenon, considered as one of the most complex 
fiscal issue companies are nowadays facing, is disciplined both by OECD (Organization 
for Economic Co-operation and Development) and Italian jurisdiction.  
                                                   
3
 OECD, (2010), “Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration”, 
preface, p.19;
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Particular importance will be then given to the necessity of having an adequate TP 
documentation to rely on. Attention will be then dedicated to the comparability analysis, 
another crucial aspect of the transfer pricing phenomenon. The research and choice of 
potential comparable companies would result to be necessary in order to evaluate whether 
an intra group transaction has been carried out at the arm’s length principle or not.  
What described from a theoretical point of view will be then illustrated by a practical case 
study: the Italian Alpha Group will be analyzed, with special attention to the intra group 
transactions occurred among the holding, Alpha Electric Srl, and its subsidiaries, Alpha 
France and Alpha España. The aim of this practical analysis is to understand how a TP 
analysis must be effectively carried out in order to evaluate whether these transactions 
have been performed with respect to the arm’s length principle. 
 
The thesis is structure in three main chapters. 
The first chapter, the most theoretical of the entire work, aims to introduce the reader to the 
topic of transfer pricing, providing a general overview of the argument both from the legal 
and the fiscal/economic perspective. First of all it would be necessary to understand the 
concept of “Group of Firms”, with special attention to the difference among associated 
company and subsidiary and the importance of the concept of fiscal relevance. 
Understanding these items is the first step to fully comprehend how transfer pricing 
phenomenon would rise and then develops among multinational groups. 
After describing the five theoretical schools of thought (Economic Theory, Mathematical 
Programming, Accounting Theory, Organizational Behavior Theory, Strategic 
Management Theory) considered useful to provide different approaches of such 
phenomenon, the chapter focuses on the necessity among international companies to 
cooperate each other in order to avoid different evaluations made by different financial 
administration that may lead to distorting effects. 
To meet this requirements OECD has immediately risen after the II World War aiming to 
address the problem of economic cooperation and coordination among European countries. 
The several efforts of this Organization to achieve these results culminated with the 2010 
Guidelines, authentic cornerstone of this matter. 
As already mentioned before, the chapter stresses two crucial argument, strictly related 
each other: the arm’s length principle and the comparability analysis.
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The ratio behind the arm’s length principle would be that the transactions occurred among 
controlled parties shall be comparable to those occurred among uncontrolled parties.  This 
can be justified by the simple idea that transactions among independent parties would 
normally be determined by market forces, whereas transactions among controlled parties 
may not be affected by external market forces in the same way. This situation may 
undoubtedly lead to tax distortions if transfer pricing does not reflect market forces and 
arm’s length principle. This principle put both uncontrolled and controlled companies on 
the same level, providing equality of tax treatment. Since the multinational company 
belonging to a Group are treated as if they were independent entities, attention is then 
focused on the nature of the controlled (between those members) and uncontrolled 
transactions. This is why comparability analysis plays a pivotal role.  
Creating an adequate set of comparable companies becomes fundamental in order to 
determine whether transactions under review may be considered arm’s length or not. 
There are some factors that must be taken into account when conducting the comparability 
analysis: characteristics of property and service, functional analysis, contractual terms, 
economic circumstances and business strategies. 
The chapter ends stressing the absolute importance of having an adequate TP 
documentation, useful both for tax administrations to facilitate tax controls and evaluations 
and for tax payers to avoid possible sanctions and penalties.  
The second chapter focuses on comparability analysis, with special attention to the 
comparable selection process. In order to evaluate if transfer prices may comply with the 
arm’s length principle, it is necessary that the transactions must be comparable, displaying 
a certain degree of affinity, in terms of goods and services exchanged, functions 
performed, markets conditions and contractual positions. The main goal of the 
comparability analysis is to determine that price that would have been set in comparable 
transactions among independent subjects. 
It must be emphasized that this second chapter provides theoretical support to the third 
chapter, where a practical case study will be illustrated. 
The comparables selection process starts with the identification of years to be analyzed, a 
broad-based analysis providing general information about the tax payer, the selection of 
the tested party and the right TP method to adopt “according to the circumstances of the 
case”, methods provided both by OECD and Italian regulation.
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As far as concern the methodologies to evaluate transfer prices it is possible to distinguish 
two broad categories: traditional transaction methods (Comparable Uncontrolled Price 
method, Resale Price method and Cost Plus method) focusing directly on the transaction to 
be analyzed, and the transactional profit methods (Transactional Net Margin method and 
Profit Split method) focusing instead on profits generated by the parties. 
Once identified the methods to adopt, the process would keep on with the selection of the 
right comparable (or even a set of comparables) and the possibility to make adjustments, 
whether necessary. The choice of the right comparables would depend also on the selection 
of the right profit level indicator (PLI), considered an objective measure of the profitability 
of the tested party. 
The chapter ends with an argument that falls a bit outside what described above, but it is 
however necessary to give a complete overview of transfer pricing phenomenon: transfer 
pricing disputes. 
The concrete existence of different tax systems of those companies engaged in infra group 
transactions may lead to double taxation disputes, thus limiting the development of 
international businesses and investment flows. The OECD provides different ways to avoid 
these situations: Mutual Agreement Procedure (MAP), Advance Pricing Agreement 
(Advance Pricing Agreement) and Safe Harbors. The application of these tools requires the 
coordination and full cooperation among the parties and competent authorities involved. 
The third chapter may be considered the “core” of the entire work: a case study is then 
illustrated in order to understand how a transfer pricing analysis must be carried out in 
practice with the aim to determine whether concretely the transactions among the parties 
under review have been carried out satisfying the arm’s length principle.  
The case study begins with a detailed description of the Alpha Group, one the most 
important Group in providing mechanicals parts for the automotive sector, focusing on the 
activities performed by the Alpha Electric Srl (holding and the tested party in this 
occasion) and its subsidiaries as well as the organizational structure of the group and the 
strategies performed. Once identified the transactions under review (sales of finished goods 
from the holding to the subsidiaries) a reliable set of comparables is then identified.  
The process would keep on with the choice of the most suitable TP method (TNMM) 
according to the activities and functions performed by the tested party. A detailed 
description of why the other methods have been excluded is however provided.