Common Flaws in Implementing Payment Terms Adjustments: The Effect of Benchmark Choice on the Arm's-Length Test

Wed Nov 13 15:24:38 EST 2002
By Nihan Mert-Beydilli with former NERA Senior Analyst Esra Suzme

When sufficient external transactional pricing data is not readily available from public sources for testing the arm's length nature of transactions between affiliated entities, the analysis of arm's-length prices relies on publicly available data from comparable companies. In cases where the profitability of outside companies is used, comparability with respect to certain variables affecting each firm's profitability and capital structure becomes an important issue. One such variable is the level of payment terms.

This article examines the significance of selecting different benchmarks for implementing terms adjustments. It demonstrates how and when the choice of benchmark payment terms -- the days payable and receivable of the tested party, the comparables, or some other norm -- can materially affect the final test result. As a general proposition, the authors conclude that the choice of the benchmark affects the final result and therefore that the benchmark should ordinarily be determined by the arm's-length payment terms of the comparables.

This article was published in BNA's Tax Management Transfer Pricing Report Vol 11 No 14. It is reproduced here by permission of Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc., all rights reserved.