The Functional Analysis Strategies: Part 1

In order to conduct a thorough transfer pricing analysis, it's important to have a complete understanding of how the multinational enterprise is laid out. An interview is a great place to start: you'll want to ask questions about the raw material input, manufacturing processes, technology, know-how, and intangibles. Who holds inventory? What is the operational infrastructure? Ultimately the goal is to show where operations begin and where they end.

Once you understand the big picture of the transaction, you should look closely at the entities involved. You need to see why individual entities or elements have each function. Functional analysis is specific to the actual intercompany transaction that is being analyzed. It should not be based on how entities typically function. Song explains. “It doesn’t necessarily mean a functional analysis for the whole entity. You have to look at specifically what it is in the transaction that’s being analyzed.”

On your report, mark each function in a straightforward chart by checking the box each entity performs—manufacturing, invoicing, distribution, marketing, advertising, purchasing, and so on. Then, summarize how the functions work inside the company. You’ll also want to address questions related to specific functions. Who is responsible for what?  Where are the functions taking place? Who manages the process? Or, for an entity that conducts research-and-development, you might ask, “How important is the development of patents in the industry?”

In the area of transfer-pricing, arguably one of the most important parts is to answer any questions before tax authorities have a chance to ask them. This means that the documentation you are used to preparing is much more important. As example R&D function of a pharmaceutical company varies significantly from the R&D function of a software company. It’s one thing to say, ‘This company has an R&D function’—but what does that mean?” says Song. What is R&D relative to that particular company?”