In this section we will analyze what functional analysis is, what are the functions and why it is necessary
What does functional analysis mean?
In accordance with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, Function, Assets and Risk (‘FAR’) Analysis is defined as an analysis of the functions performed (taking into account the assets involved and the risks assumed) by associated (related) enterprises in controlled transactions and by independent enterprises in comparable uncontrolled transactions. In accordance with subpara. 39.2.2.2 of Article 39 of the Tax Code of Ukraine (hereinafter – the “TCU”), “when determining the comparability of transactions, the following elements of controlled and comparable transactions are analyzed: functions performed by the parties to the transaction, assets used by them, conditions of distribution of risks and benefits between the parties to the transaction, distribution of responsibilities between the parties to the transaction and other conditions of the transaction (hereinafter – functional analysis)”.
What are the functions?
The list of functions that need to be investigated is given in subparagraphs 39.3.1.2-39.3.1.4 of Article 39 of the TCU.
The analysis of the functions used by the parties to the transaction in the performance of their duties, in particular, but not exclusively, includes: design and technological development of goods; production of goods; assembly of goods or their components; installation and/or installation of equipment; research and development; acquisition of inventory; wholesale or retail sales; advertising of goods (works, services); storage of goods; transportation of goods; provision of consultations, information services, etc.
Also, when analyzing a transaction, it is necessary to take into account the risks of the parties to the transaction related to the conduct of business activities that affect the terms of the transaction, in particular, but not exclusively, the following: changes in market prices, changes in the official exchange rate, loss of property, credit conditions, etc.
When conducting the research, it is also important to analyze the parties of assets, such as equipment, intangible assets, securities and financial instruments that are important in terms of the implementation of specific transactions. The lists of functions, risks and assets provided in the TCU, OECD guidelines or the UN Guidelines are not exhaustive and may be supplemented taking into account the provisions of contracts, peculiarities of the business transaction and its parties.
Для чого потрібен функціональний аналіз?
Метою цього аналізу є визначення ролі кожного учасника операції.
In accordance with subparagraph 39.3.2.7 of Article 39 of the Tax Code of Ukraine, the party to be investigated is the party
- for which the application of such method (combination of methods) is the most reasonable
- for which the most comparable transactions and/or comparable persons can be found
- for which there is the most complete and documented information on the financial indicators of the controlled transaction, which are used to calculate profitability indicators
also which:
- assumes the least complex functions in relation to the controlled transaction;
- assumes the least economic (commercial) risks in relation to the controlled transaction;
- does not own intangible assets that have a significant impact on profitability.
The result of the functional analysis is the determination of a simpler, “lighter” party, that is, a party with a lower functional, risk load and with fewer assets used in the controlled transaction. The choice of the party under study makes it possible to focus on assessing the applicability of the methods to each relevant transaction and analyzing the factors that affect it – the availability of information on prices for comparable goods or services in open sources, specialized publications, commercial databases, the availability of internal comparable transactions, etc.
Thus, the purpose of functional analysis is to find and systematize the data of the parties in the controlled transaction. Prices applied in any transaction should reflect the characteristics and take into account the risks assumed and assets used. Qualitative functional analysis is the key to the correct identification of the party of the study and one of the prerequisites for choosing the most appropriate transfer pricing method. In addition, such analysis will help to strengthen the position of the taxpayer in possible disputes with the tax authorities.
Author – Taras Mishchenko / senior tax consultant
