Comparability: The 5 Factors and the 2 Screens

Definition

Comparability is the condition that makes one transaction (or one company) comparable to another for the arm’s length measurement — the basis on which the uncontrolled price (the CUP), the comparable’s profit (the TNMM pool), or the comparable’s cost (the cost plus) stands in for the controlled transaction’s. The OECD framework states it as the five comparability factors, and the practice enforces it as the two screens (the quantitative, the qualitative) — the factors are the standard, the screens are the mechanism.

The five comparability factors (the OECD’s):

The factor	The content	The typical treatment
The product / service characteristics	The quality, the brand, the functionality, the stage of the product cycle	Adjusted where the difference is quantifiable (the brand, the quality grade) — or the member excluded where it is not
The functions performed (the assets used, the risks assumed)	The FAR — the function, the asset, the risk profile	The core comparability — the member’s FAR against the tested party’s (the FAR match)
The contractual terms	The price terms, the volume, the duration, the payment terms, the warranty	Adjusted where the difference is quantifiable (the volume discount, the duration) — the intercompany agreement terms against the uncontrolled’s
The market conditions	The market size, the competition, the regulators, the geographic location	The regional vs local question; the country premium where the difference is the market
The economic circumstances	The inflation, the growth, the one-time events, the cycle position	The extraordinary events treatment; the multi-year averaging where the cycle is the difference

The two screens (the practice’s enforcement): the quantitative screen (the size, the sector, the financial-ratio filters — the data-driven pre-filter, the candidate population narrowed) and the qualitative screen (the company-by-company review — the products, the mix, the assets, the FAR — the fact-driven per-member decision). The comparability analysis guide has the factors in depth; the search design and the two screen guides have the mechanics.

The working read (the benchmarking study guide): comparability is imperfect by nature (no uncontrolled transaction is identical to the controlled one — the OECD’s own position) — the question is not the identity but the materiality of the difference: the difference that matters (the product, the FAR, the market) is adjusted (the working capital, the country premium, the extra event) or the member excluded (with the reason); the difference that does not (the minor, the quantifiably-trivial) is accepted (the comparability holds, the member stays). The documentation carries the materiality calls (the factor, the difference, the treatment, the reason) — the accept/reject record is the comparability’s record.

Example

The tested party (the Indian distributor) and a pool candidate (the comparable distributor): the five factors checked — (1) the product (the candidate carries the same product line, the brand licensed in both — comparable, the brand difference adjusted / accepted); (2) the FAR (the candidate’s distribution function, the inventory owned, the risks borne — against the tested party’s — comparable, the function match); (3) the contractual terms (the candidate’s resale to the unrelated, the volume terms — the volume discount adjusted where it is quantifiable); (4) the market (the same geographic market, the same competition — comparable, the country premium not engaged); (5) the economic circumstances (the candidate’s year without the one-time event — the extra event not engaged). The member stays, the adjustments applied (the working capital, the volume), the record kept (the factor, the difference, the treatment, the reason) — the comparability, enforced factor by factor, recorded.

See also

• Comparability in Transfer Pricing (the guide)
• Quantitative Screening · Qualitative Screening
• Functional Analysis (FAR)

FAQ

Are the five factors a checklist, or a standard? A standard — the five factors are the dimensions the comparability is judged on (the product, the FAR, the contractual terms, the market, the economic circumstances), not a pass/fail checklist. The materiality is the test: the difference on a factor that matters (the product, the FAR, the market) is adjusted or the member excluded; the difference that does not matter (the minor, the quantifiably-trivial) is accepted. The documentation carries the materiality calls (the factor, the difference, the treatment, the reason) — the comparability analysis guide has the factor-by-factor treatment.

What is the difference between the comparability adjustment and the exclusion? The adjustment (the working capital, the country premium, the extra event) is where the difference is quantifiable (the working-capital days, the country differential, the one-time item) — the member stays, the difference is adjusted out. The exclusion is where the difference is not quantifiable (the product mix, the FAR, the brand ownership — the comparability broken, not just different) — the member is removed, with the reason. The comparability adjustments guide has the adjust-vs-exclude boundary.

How does comparability relate to the best method? The best method is the method that gives the most reliable arm’s length result on the comparability facts available — the comparability is the input, the method is the choice on the input. The CUP (the direct price) is the best method where the comparability is tight (the identical product, the comparable circumstances); the TNMM (the margin benchmark) is the best method where the comparability is the pool’s (the one-sided, the comparables’ distribution). The best method rule and the how to choose guide weigh the method on the comparability facts — the comparability determines the method’s fit.