Transfer Pricing Functional Interviews, and 6 Steps to Successfully Perform Them
Borys Ulanenko
Functional analysis is an essential part of transfer pricing. Recent international tax developments and disputes have demonstrated that functions, risks, and assets play a critical role in determining the transfer pricing methodology to be applied in controlled transactions. The OECD’s approach to functional analysis was also amended during the BEPS project.
Functional analysis is a process of identifying and analysing economically significant functions executed by the parties, risks
taken, and assets used in the transaction. In real life, doing functional analysis
will usually require conducting a series of functional interviews.
A functional interview is a meeting with employees of an analysed company to clarify the
functions, assets, and risks of the business. Since there are at least two
companies involved in the transaction, it may be necessary to talk to
representatives of both.
It is worth recalling the main goal of functional analysis, which is the identification, analysis, and evaluation of economically significant functions executed by the parties of the transaction; the risks taken, and the assets used.
It is worth recalling the main goal of functional analysis, which is the identification, analysis, and evaluation of economically significant functions executed by the parties of the transaction; the risks taken, and the assets used.
It is sometimes the case that the entity is a pharmaceutical manufacturer, but the transaction under review is the provision of IT services to another group company (since the manufacturer also hosts an IT service centre). As the analysed transaction is IT services provision, we would focus on FARs that are relevant for this transaction and would be less interested in manufacturing FARs.
In terms of scope, a functional interview can still aim at identifying functions, assets, and risks of an entity as a whole, as information gathered can help to prepare functional analysis for several transactions at the same time.
The level of detail would also depend greatly on complexity, materiality, and tax risk associated with the transaction. For relatively small and less risky transactions, contracts and other background documentation may give a good picture of the transaction, and functional interview will simply aim at confirming the facts and conclusions of functional analysis. More complex and material transactions, though, may require dozens of functional interviews and discussions.
There are multiple internal guidelines developed by tax authorities, which describe functional interview process and recommendations. These guidelines are often publicly available and give valuable information about the tax authorities’ approach. We will further use them to study the best practices of functional interviews.
Why is
functional interview needed?
You sometimes
may hear that functional interviews are not necessary, as information about
functions, assets and risks can come from intercompany agreements, websites of companies,
annual reports, etc. However, the functional analysis should focus on the actual
conduct of the parties of the transaction. The information from documents usually
does not give a sufficient level of detail, nor it provides an insight into
actual conduct.
How should the functional interview be handled?
How should the functional interview be handled?
There are six
critical steps to a successful functional interview that are summarised in the
picture below. This is a general list, and you need to tailor your interview approach to the particular situation.
Here are a few
additional sources that may help you to prepare questionnaires (functional interview questions) for your
functional interviews, as well as follow-up questions and discussions:
- UN Practical Manual on Transfer Pricing for Developing Countries (2013 version), Appendix 1, Part 3 – Functional Analysis Checklist (p. 432-437)
- IRS Exhibit 4.61.3-4 (05-01-2006) accessible as Appendix 1 (p.105-112) of “A Toolkit for Addressing Difficulties in Accessing Comparables Data for Transfer Pricing Analyses”
For more details about key steps of functional interviews preparation, check our transfer pricing course (Module 4) or the textbook (Chapter 4).
What are your experiences with functional interviews? Share your hints and tips, and we will add them to the post!
For more details about the textbook and the course, contact us:
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