What are the most effective KPIs for measuring transfer pricing policy effectiveness?

1 Gross Margin Ratio

The gross margin ratio measures the percentage of revenue that remains after deducting the cost of goods sold (COGS). It reflects the efficiency and profitability of the production and distribution process. A higher gross margin ratio indicates a lower COGS and a higher value-added by the entity. You can use the gross margin ratio to compare the performance of different entities within the same group or industry and to assess the reasonableness of the transfer prices. For example, if the gross margin ratio of an entity is significantly lower or higher than the industry average or the comparable uncontrolled price, it may indicate that the transfer price is not arm's length and may trigger tax adjustments or disputes.

2 Effective Tax Rate

The effective tax rate measures the average tax rate that an entity pays on its taxable income. It reflects the tax burden and the tax efficiency of the entity. A lower effective tax rate indicates a higher after-tax profit and a lower tax risk. You can use the effective tax rate to compare the tax impact of different transfer pricing policies and to optimize the allocation of income and expenses among different jurisdictions. For example, if the effective tax rate of an entity is significantly lower or higher than the statutory tax rate or the group average, it may indicate that the transfer price is not aligned with the economic substance and may attract tax scrutiny or challenges.

3 Return on Assets

The return on assets measures the percentage of profit that an entity generates from its total assets. It reflects the profitability and productivity of the entity. A higher return on assets indicates a higher efficiency and a higher return on investment. You can use the return on assets to compare the performance of different entities within the same group or industry and to assess the allocation of functions, assets, and risks among related parties. For example, if the return on assets of an entity is significantly lower or higher than the industry average or the comparable uncontrolled profit, it may indicate that the transfer price is not consistent with the functional analysis and may result in economic distortions or inefficiencies.

4 Operating Expense Ratio

The operating expense ratio measures the percentage of revenue that is spent on operating expenses, such as selling, general, and administrative expenses. It reflects the cost structure and the operational efficiency of the entity. A lower operating expense ratio indicates a lower overhead and a higher operating margin. You can use the operating expense ratio to compare the cost management of different entities within the same group or industry and to evaluate the impact of transfer pricing on the operating expenses. For example, if the operating expense ratio of an entity is significantly lower or higher than the industry average or the comparable uncontrolled cost, it may indicate that the transfer price is not fair and reasonable and may affect the incentive or performance of the entity.

5 Intercompany Revenue Ratio

The intercompany revenue ratio measures the percentage of revenue that an entity derives from transactions with related parties. It reflects the degree of integration and dependence of the entity within the group. A higher intercompany revenue ratio indicates a higher exposure and complexity of transfer pricing issues. You can use the intercompany revenue ratio to compare the diversification and the risk profile of different entities within the same group or industry and to monitor the compliance and documentation requirements of transfer pricing. For example, if the intercompany revenue ratio of an entity is significantly higher or lower than the industry average or the group average, it may indicate that the transfer price is not transparent and consistent and may increase the audit or dispute risk.

6 Here’s what else to consider

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