The global tax environment is undergoing significant changes, with a particular focus on transfer pricing (TP), and Asia-Pacific countries are at the forefront of this transformation. Tax authorities across Asia-Pacific are increasingly aligning with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the OECD Guidelines). However, there remain diverging approaches to implementing and interpreting the OECD Guidelines, reflecting distinct economic environments and regulatory frameworks. In particular, this has led to diverse approaches to constructing an arm's-length range (ALR) when applying the transactional net margin method.
This article explores how legislators and tax authorities in selected countries across Asia-Pacific have typically approached the construction of the ALR within their jurisdictions.
The OECD does not mandate a uniform approach to determining the ALR, and the guidelines note “where the range comprises results of relatively equal and high reliability, it could be argued that any point in the range satisfies the arm’s length principle”. However, the OECD favours statistical measures that reflect the central tendency (e.g., the interquartile range (IQR) or other percentiles), particularly where the range includes a sizeable number of observations, to help to enhance the reliability of the analysis.
Approaches observed across the Asia-Pacific region
Singapore, Indonesia, and the Philippines apply the IQR as their standard ALR. Singapore and Indonesia also allow the use of the full range under certain conditions; for example, when applying the comparable uncontrolled price method or when data from only two equally reliable comparables is available. Taiwan also broadly follows the OECD Guidelines in constructing the ALR, accepting the application and use of the IQR.
Other nations adopt a stricter stance: Malaysia, Vietnam, and India apply narrower percentile ranges (37.5th to 62.5th for Malaysia, 35th to 75th for Vietnam, 35th to 65th for India). In India, this only applies where the number of comparable companies selected to construct the range is six or more. If the number of comparable companies selected is five or fewer, the range concept does not prevail. While tax authorities in these jurisdictions have not have explicitly explained their reasoning for applying these percentile ranges, narrower ALRs likely aim at enhancing TP compliance by minimising comparability issues and addressing data inconsistencies.
In South Korea, there is a specific method to calculate the IQR that is required under local legislation. This method differs from the typical Excel method of calculating quartiles, and is instead more closely aligned with the ‘IRS method’ observed in the US.
Conversely, other countries are less prescriptive in their local regulations regarding constructing the ALR. Thailand does not have specific guidance on the data points to be used. The ALR is determined based on the transaction’s unique circumstances and relevant financial indicators. Although the IQR is commonly applied, there are instances where taxpayers have successfully negotiated alternative ranges, such as the full range, on statistical grounds.
There is also no legislative requirement regarding the use of the full range or IQR in Australia. The Australian Taxation Office (ATO) has regard to the OECD Guidelines in applying the arm’s-length principle and in constructing the ALR. In practice, the ATO generally places heavier reliance on the IQR, especially when applying the transactional net margin method. However, during TP reviews and audits, as well as within advance pricing arrangements (APAs), the ATO regularly queries the appropriateness of the comparable companies and the point in the range (even where the tested party result sits within the IQR).
China
Similarly, in China, while the arm's-length principle is clearly defined in the TP regulations, the term "arm's-length range" is not explicitly mentioned. The absence of a direct reference to the ALR in the regulations does not mean that it is irrelevant. On the contrary, the Chinese approach to this issue is thought provoking and has profound implications for TP practice in China.
Unlike the OECD, which acknowledges that a single figure (e.g., price or margin) and a range of figures can be considered arm's length where appropriate, Chinese TP regulations seem to leave the choice of a single figure or IQR at the tax authorities' discretion when performing a TP assessment.
Article 25 of the State Taxation Administration’s Bulletin 6 states: "When analysing and evaluating whether the related-party transactions of an investigated enterprise comply with the arm's-length principle, the tax authorities may choose statistical methods such as the arithmetic mean method, weighted average method, or quartile method according to the actual situation and derive an average value or an interquartile range of comparables' profits or comparable prices on a yearly basis or a multi-year average."
At this point, one might infer that the IQR is accepted as the ALR. However, the full context of Article 25 reveals more complexity: "In analysing and evaluating the enterprise's profitability by using the quartile method, if the enterprise's profit level is lower than the median of the range of profitability established by comparables, in principle, the enterprise's profit should be adjusted up to a level not lower than the median of the range."
Throughout Bulletin 6, the term "median" appears only twice, exclusively in Article 25. It is easy to conclude that the median holds significant importance, while Bulletin 6 gives no consideration to the lower or upper quartile. This raises the question of whether this is all about the ALR. The answer is no. To derive an accurate interpretation of Article 25, we must consider it from a broader perspective. Bulletin 6 addresses special tax adjustments and mutual agreement procedures. Technically, Article 25 should be interpreted within the context of a TP audit. This does not mean it is irrelevant outside a TP audit scenario, but it would be inaccurate to conclude that the ALR does not exist in Chinese TP practice based solely on Bulletin 6.
In addition to Bulletin 6, China has two other major TP regulations:
Bulletin 42, concerning related-party reporting and contemporaneous documentation; and
Bulletin 64, concerning APAs.
Bulletin 42 does not provide further guidance on whether, or what, statistical methods should be used after identifying comparables.
Article 12 of Bulletin 64 states: "In an APA, the quartile method is used to determine pricing or profit levels, and during the APA period, if the actual operating results of the enterprise for any year fall outside the interquartile range, the tax authorities can adjust the actual operating results to the median of the interquartile range. Upon the expiration of the APA execution period, if the weighted average of the enterprise's operating results for the APA period is lower than the median of the range and has not been adjusted to the median, the tax authorities will not accept applications for renewal."
At first glance, Article 12 of Bulletin 64 seems consistent with Article 25 of Bulletin 6, as both emphasise the median. However, there is a clear nuance between Article 12 of Bulletin 64 and Article 25, which should by no means be neglected: there is no substantial difference in the way an ALR works in an APA context in China from its treaty partners.
Addressing comparability factors
Generally, despite differing methods in constructing the ALR across Asia-Pacific, it is important that taxpayers, whether applying traditional transaction methods or transactional profit methods, ensure they have undertaken a systematic and careful analysis of the five comparability factors specified in the OECD Guidelines when determining the most appropriate and reliable point in the range.
In addition, while countries across Asia-Pacific may not have specific regulations in respect of tax authorities adjusting to a point in the range during an audit, many are increasingly seeing adjustments being made to the median in practice, where the tested party result is outside the ALR.
Approaches to the use of multiple-year data
The OECD Guidelines also discuss the appropriateness of using multiple-year data when comparing financial results, to reduce the potential distortion caused by business and product life cycles. The OECD Guidelines do not specify the number of years to use. Rather, the number of years of data to use should reliably capture the effects of any business, economic, and cyclical forces on the financial profitability of the tested party and the comparable companies. Again, this has led to differing approaches being applied by tax authorities across the region.
An approach accepted in many countries involves analysing data for the comparable companies identified over a three-year period in determining the appropriate net profit results and constructing a range. Typically, this would involve looking at the year under review (if the data is available) and the two prior years. While many countries would test one year of tested-party data against three years of comparable data, other countries adopt different approaches.
Taiwan requires multiple years of tested-party data to be tested against multiple years of comparable data. However, if the tested party only has one year of financial data, it is acceptable to use one year of tested-party data against three years of comparable data. In Thailand, in practice, the approaches used in TP documentation and audits involve looking at three years (tested party) versus three years (comparable data), as well as one year (tested party) versus three years (comparable data).
On the other hand, it is local tax authority practice in South Korea to look at one year of tested-party data versus one year of comparable data. In addition, as per local TP regulations in Vietnam, arm’s-length conclusions are required to be made using one year of comparable data, with contemporaneous data or data of the prior year (if contemporaneous data was not available at the time of preparing the TP documentation).
The ATO’s practice in relation to the use of multiple-year data when applying the transactional net margin method and constructing the range is to use a five-year analysis, considering the year under review (where available) and the preceding four years. While this is not required under local legislation, it is the approach currently applied by the ATO in reviews, audits, and APAs.
Geographic comparability
There are also differing regulations and approaches across the Asia-Pacific region with respect to the use of local comparable data and the acceptance of regional comparable data. Many countries have a strong preference for the use of local comparable data, where available, to enhance the comparability of economic circumstances. Other countries, however, accept comparable data across the region to ensure a sufficient number of comparable companies are identified to construct a range.
Final thoughts on the arm’s-length range in the Asia-Pacific region
Ongoing dialogues with tax authorities suggest no imminent changes to the ALR, particularly in Indonesia and Malaysia, which recently updated their guidelines. However, in the Philippines, recommendations to the Bureau of Internal Revenue hint at potentially tightening the ALR.
As tax authorities further refine their ALR applications, businesses must stay informed of the nuances of each jurisdiction's guidelines to navigate the complexities and ensure compliance. The dynamic nature of these regulations underscores the importance of continuous dialogue with tax authorities and expert advisers to mitigate risks and align with the shifting contours of Asia-Pacific’s TP landscape. Businesses may also consider adopting analyses that take into account local regulations and best practice when applying the transactional net margin method for certain countries, considering the size and/or nature of their operations.
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