Terms adjustments or working capital adjustments are pervasively accepted in transfer pricing analyses under Section 482 and the OECD transfer pricing guidelines. Such adjustments account for differences in accounts receivable and accounts payable along with differences in inventory levels, between the tested party and the comparables, especially when an income-statement-based profit level indicator (PLI) is used in the comparable profits method (CPM) or the residual profit split method. In such cases, terms adjustments are employed to eliminate imputed interest in accounts receivable and accounts payable. However, in practice, terms adjustments are often omitted when a balance sheet-based PLI is selected, based on the notion that a balance sheet-based PLI already adjusts for differences in the underlying trading assets or capital employed.

In this article from BNA Bloomberg’s Tax Management Transfer Pricing Report, NERA Vice President Yuko Saito and former Senior Consultant Emre Furtun examine the use of terms of trade adjustments, specifically receivables and payables adjustments, as financial comparability adjustments under Section 482 regulations and the OECD guidelines and argue for the need for both receivables and payables adjustments, even in cases where a balance sheet-based PLI is used. Using the US automotive industry as an example, the authors evaluate whether comparability adjustments on the balance sheet are necessary when there are substantial differences in the working capital structure between the tested party and the comparables due to different trade terms.

Reproduced with permission from Tax Management Transfer Pricing Report, Vol. 23 No. 15, 11/27/2014. Copyright 2014 by The Bureau of National Affairs, Inc. (800-372-1033) http://www.bna.com