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Transfer pricing

The nine steps for determining transfer pricing

Author: Marko Rebane

Enterprises conducting transactions with related parties, such as companies in the same group or persons related to the owners of the company, must take into consideration domestic and international transfer pricing rules. The idea of transfer pricing rules is to prevent related persons from agreeing to sell each other goods and services at lower or higher than market price, thereby also transferring profit and income tax base.

The principle of an arm’s length transaction is at the heart of these rules – related persons must determine the transaction prices (transfer prices) for mutual transactions just as non-related persons would do in the same or similar circumstances. Under subsection 50 (4) of the Income Tax Act, the tax authority imposes income tax on the amount which the taxpayer would have received as income or the amount which the taxpayer would not have incurred as expenses if the value of the transaction with the related party were the same as the value applied in similar conditions by not related independent parties.

Subsection 14 (7) of the Income Tax Act establishes the same principle on transactions conducted between a sole proprietor and a person associated with the sole proprietor and subsection 53 (4) establishes the same principle on profit attributed to a non-resident’s permanent establishment which has been taken out of the permanent establishment. The methods for determining the value of transactions between related parties are described in Minister of Finance regulation no. 53 of 10 November 2006.[1] Pursuant to Section 20 of the regulation, the application of the regulation is supported by the guidelines for transfer pricing prepared by the OECD.[2] 

Steps for determining transfer price

A typical transfer pricing process is illustrated by the nine steps set out in the OECD’s guidelines. These steps reflect good practice but aren’t explicitly compulsory to attain a result corresponding to arm’s length value.

Step 1: determination of the years to be covered.

Step 2: broad-based analysis of the taxpayer’s circumstances (sector, competition, economic and regulatory environment etc) – placing the transaction in a context that may be material from the standpoint of the parties’ pricing.

Step 3: understanding the controlled transactions, based on functional and risk analysis. This is used to define the tested party, the transfer pricing method most appropriate to the circumstances of the case, financial indicators to be tested (in the case of a transactional profit method) and to identify significant comparability actors that should be taken into account.

As a rule, it can be said that the more important the functions fulfilled by the party and the higher the business risks it takes, the greater its expectation as to the transactional profit.

Step 4: review of existing internal comparables, if any, (i.e. the taxpayer's own transaction prices, mark-up percentages, net margins etc.) with independent persons comparable to the transactions conducted between the controlled related parties.

Step 5: determination of available sources of information on external comparables, where such comparables are needed, taking into account their relative reliability (i.e. comparable transaction prices, mark-up rates and net margins between unconnected parties in market conditions).

Step 6: selection of the most appropriate transfer pricing method and, depending on the method, determination of the relevant financial indicator (e.g. determination of the relevant net profit indicator in case of the transactional net margin method).

A more detailed overview of the methods can be found in Minister of Finance regulation n. 53 sections 11‒17 (

Step 7: identification of potential comparables: determining the key characteristics to be met by any uncontrolled transaction in order to make a comparison to determine an arm’s length price for the controlled transaction in accordance with step 3 and the OECD guidelines 1.38-1.64 (see below.)

Step 8: making comparability adjustments where appropriate.

Step 9: interpretation and use of data collected, determination of the arm’s length remuneration.

Determination of steps as comparability analysis

In very general terms, the transfer pricing process can be seen as comparability analysis. Comparability of a controlled transaction between related parties and comparable transaction between not related parties are influenced by a number of conditions and transactional circumstances. In accordance with subsection 3 (2) of Ministry of Finance regulation no. 53, when making decisions on comparability, all of the characteristics of a transaction, parties and environment that can have an influence on the transaction value are analysed. Above all, the following are compared:

1) characteristics of the object of the transaction;
2) functions fulfilled in the context of the transaction that are identified in the course of analysis of activity;
3) transaction conditions;
4) economic conditions that influence fulfilment of the transaction;
5) business strategies of the parties to the transaction.

In practice, transfer pricing thus means quite a complex analysis centred on finding appropriate comparables reflecting arm's length value (i.e. depending on the selected method, the price of comparable transaction between unconnected parties, mark-up percentage added to the expenses, profit margin and other information). Several databases and software programs can aid in this process, e.g. TP Catalyst[3] developed by Bureau van Dijk, which is also used by Grant Thornton in its advisory services.

Grant Thornton’s specialists are happy to share additional information and help their customers in analysing, documenting and controlling transfer prices.

[1]Ministry of Finance regulatin no. 53 of 10 November 2006, Seotud isikute vahel tehtud tehingute väärtuse määramise meetodid (Methods for transfer price determination for transactions between related persons,

[2]OECD. Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. OECD Publishing, Paris, 2017. Available online: