Location Specific Advantages -- Principles

20 June 2011
By Sébastien Gonnet, Pim Fris, and Tommaso Coriano

This article, by NERA Principal Sébastien Gonnet, Special Consultant Pim Fris, and Economic Analyst Tommaso Coriano, is the first of a series of three articles from BNA's Transfer Pricing International Journal focusing on the transfer pricing challenges involved with the concept of "location savings." Lacking an official definition, location savings in transfer pricing parlance are often understood to be (net) cost savings realized by multinational enterprises exploiting price differences in the factors of production between alternative jurisdictions, as well as any extra profits arising thereof. The subject has been garnering significant attention in the global transfer pricing debate given the explosive growth of foreign direct investments in emerging economies such as the BRICS countries (Brazil, Russia, India, China, and South Africa), with India and China leading the way. These developments emphasize the importance of the fair treatment of location specific advantages resulting from lower labor costs or access to promising domestic markets. This article provides an analytical framework and economic tools for identifying, quantifying, and apportioning super-profits arising from location advantages.
The second article of the series, to be published in July 2011, will apply the above concepts and framework in a manufacturing context, as well as in the distribution and service provision contexts. With practical examples, the second article will assess in which circumstances location advantages may arise in the operations of a taxpayer in various settings and how to treat these advantages from a transfer pricing perspective.
The third article of this series, to be published in September 2011, will focus on China and provide specific insights relevant to this country, notably by discussing in which circumstances location advantages arise in China, and how these should be treated from a transfer pricing perspective, as well as by providing some insight on the current views of the tax authorities (at a central and local level) on these issues.