A comparability adjustment transfer pricing 
model 
Jozua Johannes Loots 
T.H.E.D., B Comm., MBA (Cum laude) 
Student No. 11137894 
A comparability adjustment transfer pricing model 
Jozua Johannes Loots 
T.H.E.D., B Comm., MBA (Cum laude) 
Dissertation submitted in fulfilment of the requirements for the degree 
PHILOSPHAE DOCTORATE 
at the Potchefstroom Business School 
University of North West 
Study Leader: Prof. R.A. Lotriet 
Supervisor: Prof. J du Plessis 
May 2006 
u 
Table of Contents 
List of Figures xiii 
List of Tables xv 
Abbreviations xvii 
Acknowledgements xix 
Opsomming en samevatting van die studie 1 
Abstract 3 
Chapter 1 Introduction 4 
1.1 Problem Statement 5 
1.1.1 Economic theory underpinning the arm's length consideration 7 
1.1.1.1 Globalisation 8 
1.1.1.1.1 The multinational enterprise 9 
1.1.2 The transfer pricing of international transactions 10 
1.1.2.1 Arm's length principle 10 
1.1.2.2 Transfer pricing methodologies 11 
1.1.2.3 Comparability 12 
1.1.2.4 International trends pertaining to transfer pricing 13 
1.1.2.5 A pragmatic approach in transfer pricing 13 
1.1.3 ZA Case 01 14 
1.2 Objectives of the research 14 
1.2.1 Primary objective 14 
1.2.2 Secondary objectives 14 
1.3 Scope of the research 16 
1.4 Research methodology 16 
1.4.1 Literature study 16 
1.4.2 Empirical field investigation 17 
1.4.2.1 Interviews 17 
iii 
1.4.2.2 Confidential classification 18 
1.4.2.3 ZA Case 01 19 
1.5 Limitations of the research 20 
1.6 Terminology of the research 21 
1.6.1 Arm's length principle 22 
1.6.2 Arm's length range 22 
1.6.3 Business strategies 22 
1.6.4 Collectively exhaustive 22 
1.6.5 Comparability 22 
1.6.6 Comparability Adjustment Transfer Pricing Model (CATPM) 23 
1.6.7 Comparability analysis 23 
1.6.8 Connected person (party) 23 
1.6.9 Controlled (affected) transaction 24 
1.6.10 Economic circumstances 25 
1.6.11 Elasticity 25 
1.6.12 Elasticity of demand 25 
1.6.13 Financial ratio's 26 
1.6.14 Financial statement items 27 
1.6.15 Financial transaction 27 
1.6.16 Functional analysis 27 
1.6.17 Globalisation 28 
1.6.18 Intangible property 28 
1.6.19 Juridical double taxation 28 
1.6.20 Know-how 28 
1.6.21 Managed or Controlled 29 
1.6.22 Marketing intangible 29 
1.6.23 Multinational Enterprises (MNE's) 30 
1.6.24 Mutually exclusive 30 
1.6.25 Permanent Establishment 30 
1.6.26 Residence 32 
1.6.27 Royalty 33 
1.6.28 Safe harbour 33 
iv 
1.6.29 Section 31 of the Income Tax Act No. 58 of 1962 34 
1.6.30 Trade intangible 37 
1.6.31 Tax treaties 37 
1.6.32 Transfer prices 37 
1.6.33 Transfer pricing 37 
1.6.34 Tested party 37 
1.6.35 Uncontrolled transaction 37 
1.7 Layout of the research 38 
1.8 Summary 39 
Chapter 2 Transfer pricing in a globalising world 41 
2.1 Introduction 41 
2.2 The context of globalisation 42 
2.2.1 South Africa's economic integration 44 
2.2.1.1 Openness of the South African Economy 44 
2.2.1.2 South African branches of foreign entities 46 
2.2.2 Phases of globalisation 47 
2.2.2.1 Phase 1: Breaking down of traditional trade barriers 48 
2.2.2.2 Phase 2: Privatisation and deregulation 49 
2.2.2.2.1 Privatisation 49 
2.2.2.2.2 Deregulation 50 
2.2.2.3 Phase 3: International coordination, harmonisation and standardisation 52 
2.3 Multinational Enterprise 55 
2.3.1 Current environment 55 
2.3.2 Unequal Country Endowments 58 
2.3.3 International production 61 
2.3.3.1 Market power approach 64 
2.3.3.1.1 Central themes of the market power approach 64 
2.3.3.2 Complimentary Assets 66 
2.3.4 Transfer pricing implication of the market power approach 67 
2.3.5 The Transfer pricing challenge to classic theory 68 
v 
2.4 International taxation 69 
2.4.1 The Global context 69 
2.4.1.1 Multiple tax authorities 70 
2.4.1.2 Deferral and transfer pricing regulations 72 
2.4.2 Tax competition 74 
2.4.3 International tax competition 75 
2.4.4 Harmful tax competition 76 
2.5 Global transfer pricing trends 77 
2.5.1 Transfer pricing audit trends 79 
2.5.2 Susceptible transactions 80 
2.5.3 Transfer pricing audits and adjustments 81 
2.5.4 Country specific findings 82 
2.6 Conclusion 82 
Chapter 3 The pricing of cross border transactions 85 
3.1 Introduction 85 
3.2 The concept of transfer pricing 86 
3.2.1 Regulations and guidance 86 
3.2.1.1 Section 31 of the Act 86 
3.2.1.2 Practice Note 2 87 
3.2.1.3 Practice Note 7 88 
3.2.1.3.1 Financial transactions 89 
3.2.1.3.2 Double Taxation Agreements 89 
3.2.1.3.3 Reasonableness of transfer pricing guidelines 90 
3.2.2 The arm's length principle 91 
3.2.2.1 Determining an arm's length consideration 92 
3.2.2.1.1 Prescription 92 
3.2.2.1.2 The approach followed in practice 93 
3.2.2.2 Functional Analysis 94 
3.2.2.2.1 Economic Circumstances 96 
3.2.2.2.2 Business Strategies 97 
vi 
3.2.2.3 The concept of comparability 97 
3.2.2.3.1 Internal and external comparables 98 
3.2.2.3.2 Factors influencing comparability 99 
3.2.2.3.3 Assessment of comparability 100 
3.2.2.3.4 Comparability adjustments 100 
3.2.2.4 Transfer pricing methodologies 101 
3.3 Transfer pricing methods 102 
3.3.1 Traditional transactional methods 103 
3.3.1.1 Comparable uncontrolled price (CUP) 103 
3.3.1.1.1 CUP Application 104 
3.3.1.2 Resale price method 105 
3.3.1.2.1 The Resale Price Method Application 107 
3.3.1.3 Cost-plus method 109 
3.3.1.3.1 A Cost-plus method application 110 
3.3.2 Transfer pricing transactional profit methods 113 
3.3.2.1 The Transactional Net Margin Method 114 
3.3.2.1.1 Profit level indicators 115 
3.3.2.2 Profit split 117 
3.3.3 Alternative methodologies 120 
3.3.3.1 Comparable uncontrolled transaction method , 120 
3.3.3.2 Comparable profits method 121 
3.3.4 Practical test of transfer pricing methods 123 
3.4 Alternative to arm's length principle 124 
3.4.1 Global formulary apportionment 124 
Vll 
3.5 Conclusion 126 
Chapter 4 A comparability analysis and transfer pricing adjustments 128 
4.1 Introduction 128 
4.2 Comparability considerations in transfer pricing 129 
4.3 A comparability adjustment transfer pricing model 131 
4.3.1 The CATPMproposition 132 
4.3.1.1 Price determination 133 
4.3.1.1.1 Basic concepts of price determination 133 
4.3.1.1.2 Price determination under perfect competition 135 
4.3.2 Price determination in accordance with transfer pricing principles 138 
4.3.3 Working capital adjustments 139 
4.3.3.1 Working capital comparability adjustment 140 
4.3.3.1.1 Accounts Receivable Adjustment 140 
4.3.3.1.2 Inventory Adjustment 141 
4.3.3.1.3 Accounts Payable Adjustment 143 
4.3.4 Interest rate adjustment 144 
4.3.5 Risk fundamentals 145 
4.3.5.1 Allocation of business risk 146 
4.3.5.2 Measuring risk 149 
4.3.5.3 Risk - return trade off 151 
4.3.5.3.1 Entity characterisation and risk - return interaction 152 
4.4 Fundamentals of a Comparability Adjustment Transfer Pricing Model 153 
4.4.1 CATPM components 155 
4.4.1.1 Supply side 155 
4.4.1.1.1 Leverage 155 
4.4.1.1.2 Business ratio analysis 156 
4.4.1.1.3 The Extended DuPont Analysis of Profitability 159 
4.4.1.2 Demand side 162 
4.4.1.2.1 Reference to the Capital Asset Pricing Model 163 
4.4.1.3 Market analysis 163 
viii 
4.4.2 CATPM regression equation 165 
4.4.2.1 Sample size 166 
4.4.3 Positioning analysis 167 
4.5 CATPM test 168 
4.5.1 Comparability Analysis 168 
4.5.1.1 Comparable Search 168 
4.5.1.1.1 Industrial Classification 169 
4.5.1.2 Data source 169 
4.5.1.2.1 South African Source 169 
4.5.1.2.2 Bureau van Dijk's Amadeus Database 169 
4.5.1.3 Functional Determination - Screening Criteria 169 
4.5.1.4 Quantitative screening 170 
4.5.1.4.1 Geographic Region 170 
4.5.1.4.2 Independence 170 
4.5.1.4.3 Industrial classification 171 
4.5.1.4.4 Financial items 171 
4.5.2 CATPM Modelling 172 
4.5.2.1 Interpretation of multiple regression results 175 
4.5.2.2 Application of the CATPM regression output 178 
4.6 Conclusion 180 
Chapter 5 The arm's length consideration: A n empirical application in the SA 
automotive industry 182 
5.1 Introduction 182 
5.2 Industry overview: Company ZA Case 01 183 
5.2.1 General market overview 183 
5.2.2 Commercial vehicle sales 184 
5.2.2.1 Some factors influencing commercial vehicle demand 184 
5.2.2.1.1 Road infrastructure 185 
5.2.2.2 Motor vehicle age distribution 186 
5.2.2.3 Commercial vehicle sales 186 
5.2.3 Industry Employment 187 
ix 
5.3 A brief company overview 188 
5.3.1 Product expansion 189 
5.3.2 ZA CASE Ol's market performance 189 
5.3.3 Analysis of functions, risks and markets of ZA Case 01 191 
5.3.4 Affected transactions of ZA Case 01 192 
5.3.5 Market 194 
5.3.6 Risk 195 
5.3.6.1 Demand related risk 195 
5.3.6.2 Supply related risk 196 
5.3.6.3 Transactional risk 197 
5.4 Requirements of the arm's length principle 197 
5.4.1 Comparability in practice 197 
5.4.1.1 Objective of comparability 198 
5.4.1.2 Assessment of comparability 198 
5.4.1.3 Comparability and functions performed 199 
5.4.2 Comparable search 199 
5.4.2.1 Industrial Classification 199 
5.4.3 Screening Criteria 199 
5.4.3.1 Quantitative screening 200 
5.4.3.1.1 Geographic Region 200 
5.4.3.1.2 Independence 200 
5.4.3.1.3 Intangible assets 200 
5.4.3.1.4 Industrial classification 201 
5.4.3.2 Qualitative screening 201 
5.4.3.2.1 Financial item 201 
5.4.3.2.2 Individual screening 202 
5.4.4 Current approach in determination the arm's length consideration 203 
5.4.4.1 Transactional Net Margin Method results 205 
5.4.5 Bond Yield adjustment to enhance comparability 206 
5.4.5.1 Positioning of the ZA Case 01 in the inter quartile range 210 
5.4.5.2 Government bond yield benchmark 211 
x 
5.5 A Comparability Adjustment Transfer Pricing Model 214 
5.5.1 Comparable Analysis results under the CATPM 215 
5.5.2 CATPM results 217 
5.5.3 Interpretation of regression results 218 
5.5.3.1 Coefficient of determination 218 
5.5.3.2 Standard error 218 
5.5.3.3 Test for overall fit 219 
5.5.3.4 Application of the CATPM regression output 221 
5.6 Conclusion 223 
Chapter 6 Conclusions and recommendations 225 
6.1 Conclusions 225 
6.1.1 Specific conclusions on arm's length consideration 228 
6.2 Recommendations 229 
6.2.1 Recommendation for further research 230 
6.2.1.1 Establishment of CATPM database 230 
6.2.1.2 Market forms 231 
6.2.1.3 Levels of Economic Development 231 
6.2.1.4 Impact of tax havens on MNE's effective tax rate 231 
6.2.1.5 Profit split transfer pricing methodology 231 
6.2.1.6 Ethical Dimension 232 
Bibliography 233 
Appendix 1. Branches of foreign entities operating in South Africa 239 
Appendix 2. Industry classification 241 
Appendix 2.1. Industry classification on Amadeus database 241 
Appendix 2.2. NACE Revision 1.1 Industry classification 242 
Appendix 3. Comparabil ity Adjustment Transfer Pricing Model 252 
Appendix 3.1. CATPM origin 252 
xi 
Appendix 4. CATPM Results 255 
Appendix 4.1. CATPM comparable PLI dataNACE 341 and 342 255 
Appendix 4.2. CATPM comparable ratios data NACE 341 and 342 260 
Appendix 4.3. CATPM net-cost-plus stepwise regression 269 
Appendix 4.4. CATPM comparable ratios data with fitted and residual values 271 
Appendix 4.5. Net-Cost-Plus (NCP) Scatter plot 280 
Appendix 4.6. CATPM arm's length NCP consideration 287 
Appendix 5. ZA CASE 01 288 
Appendix 5.1. Transfer pricing evaluation process planning 288 
Appendix 5.1.1. Cross-border dealings amongst the connected parties 288 
Appendix 5.1.2. Selecting the appropriate transfer pricing method 289 
Appendix 5.1.3. Application of the pricing method or methods 290 
Appendix 5.1.4. Determination of the arm's length consideration 291 
Appendix 5.2. Functional Analysis Questionnaire 291 
Appendix 5.2.1. Intangible property 291 
Appendix 5.2.2. Operations 292 
Appendix 6. Comparable Data according to current approach 299 
Appendix 6.1. ZA CASE 01 Comparables 299 
Appendix 7. Comparable Data according to CATPM 300 
Appendix 7.1. ZA CASE 01 CATPM response variables 300 
Appendix 7.2. ZA CASE 01 CATPM positioning analysis 301 
Appendix 7.3. Step wise regression of net-cost-plus 302 
Appendix 8. Profit split methodology research 303 
Appendix 8.1. Equal allocation of non-separable returns 303 
Appendix 8.2. Proportional return 303 
xn 
List of Figures 
Figure 1: Openness of South African Economy 45 
Figure 2: Branch Profits 46 
Figure 3: Three perceived ways in which global capitalism might fail 53 
Figure 4: Cross border merger and acquisition with values over US$ 1 billion 56 
Figure 5: Incidence of transfer pricing examination by annual parent company revenue since 1999 79 
Figure 6: Transactions perceived susceptible for transfer pricing audits between 2001-2003 80 
Figure 7: Completed transfer pricing audits and adjustments 81 
Figure 8: Comparable Uncontrolled Price Method 104 
Figure 9: Resale Price Method 106 
Figure 10: Resale Price Analysis 107 
Figure 11: Cost-plus method 109 
Figure 12: Cost-Pius Method Analysis 110 
Figure 13: Contract and fully-fledged manufacturer 112 
Figure 14: The contribution analysis approach 119 
Figure 15: Comparable Uncontrolled Transaction 121 
Figure 16: Comparable profits method 122 
Figure 17: Transfer pricing methods in practice 123 
Figure 18: Comparability analysis consideration 130 
Figure 19 Marginal income and profit maximization 134 
Figure 20 Price determination in a competitive market 135 
Figure 21: Profit under different price quantity combinations 136 
Figure 22: Manufacturing entity characterisation 147 
Figure 23: Risk Return based on entity characterisation 152 
Figure 24: A Comparability Adjustment Transfer Pricing Model 154 
Figure 25: Extended DuPont Analysis 159 
Figure 26: Scatter plots NCP, inventory and liquidity 173 
Figure 27: Fitted values 178 
Figure 28: ZA Case 01 Ownership Structure 189 
Figure 29: ZA Case 01 SACU Market Share 190 
Figure 30: ZA Case 01's relative market share compared to five competitors 191 
Figure 31: ZA Case 01's connected party dealings 192 
Figure 32: Production scheduling 193 
Figure 33: Liquidity fitted values 220 
Figure 34: Net-Cost-Plus CATPM Inventory Scatter plot 280 
Figure 35: Net-Cost-Plus CATPM Receivable Scatter plot 281 
Figure 36 Net-Cost-Plus CATPM Liquidity Scatter plot 282 
Figure 37: Net-Cost-Plus CATPM Activity Scatter plot 283 
Figure 38: Net-Cost-Plus CATPM Solvency Scatter plot 284 
Figure 39: Net-Cost-Plus CATPM Financial leverage Scatter plot 285 
Figure 40: Net-Cost-Plus CATPM Taxation leverage Scatter plot 286 
xiv 
List of Tables 
Table 1: Failures of global capitalism in seven countries 54 
Table 2: Disinvestment after Merger 57 
Table 3: Four main types of FDI 59 
Table 4: MNE's competitive advantage opportunities 61 
Table 5: Key global transfer pricing trends - a comparative survey 78 
Table 6: Selected country specific responses 82 
Table 7: Distribution structures 108 
Table 8: Manufacturing structure 113 
Table 9: Transfer pricing methodologies and profit level indicators 116 
Table 10: Transfer pricing methods used by parent companies 124 
Table 11: Identified manufacturing entity characteristics 148 
Table 12: Selection of ratios of the automotive and component industry of South Africa 157 
Table 13: Ratio's measuring functions, assets and risk 161 
Table 14: Demand variables 165 
Table 15: Screening Results - Geographic Region 170 
Table 16: Screening Results —Independence 170 
Table 17: Screening Results - Intangible Assets 171 
Table 18: Screening Results - Industrial classification 171 
Table 19: Screening Results - Financial Item 171 
Table 20: Correlation Matrix CATPM factors 1998 to 2002 174 
Table 21: CATPM Net-cost-plus regression 175 
Table 22: Summary Statistics for CATPM factors 176 
Table 23: CATPM Result 179 
Table 24: Domestic production, exports and imports of SA motor vehicles (Units) 184 
Table 25: Road infrastructure in the South African Economy 185 
Table 26: Median age of SA motor vehicles 186 
Table 27 Different categories of vehicle sales 187 
Table 28: Past decade's employment in vehicle manufacturing 187 
Table 29: Annual Employment in the Automotive Industries 188 
Table 30: Screening Results - Geographic Region 200 
Table 31: Screening Results - Independence 200 
Table 32: Screening Results - Intangible Assets 201 
xv 
Table 33: Industry sub-sector code description 201 
Table 34: Screening Results - Industrial classification 201 
Table 35: Screening Results - Financial Item 202 
Table 36: Screening Results - Individual screening; functionality and market segment 202 
Table 37: Screening Results - Individual screening; Shareholding 202 
Table 38: Screening Results - Individual screening; Financial Information 202 
Table 39: Summmary of Screening Results 203 
Table 40: Net-cost-plus - Unadjusted results 204 
Table 41: TNMM results at median 205 
Table 42: Return on Assets - Unadjusted results of the comparable EU dataset 207 
Table 43: Bond Yield Rate 208 
Table 44: Return on Assets- Adjusted results 209 
Table 45: Net-cost-plus - Adjusted results 210 
Table 46: Inter quartile range positioning of ZA Case 01 211 
Table 47: Bond Yield Adjustment 212 
Table 48: CATPM Summary Statistics for 1996 through 2002 215 
Table 49: Correlation Matrix CATPM factors 1996 to 2002 217 
Table 50: Net-cost-plus regression results 218 
Table 51: CATPM Result 1996 to 2002 222 
Table 52: Amadeus database industry classification sources 241 
Table 53: NACE Revision 1.1 Codes 242 
Table 54: Transfer pricing model comparison 253 
xvi 
Abbreviations 
CAPM Capital asset pricing method 
CATPM Comparable adjustment transfer pricing model 
CP Cost plus 
CUP Comparable uncontrolled price 
FDI Foreign direct investment 
GDP Gross Domestic Product 
M&A Merger and Acquisition 
MNE Multinational Enterprise 
NCP Net-cost-plus 
OECD Organisation for Economic Co-operation and Development 
OM Operating margin 
Pli Profit level indicator 
PN Practice Note - A practice note is a guideline provided by the SARS 
PS Profit Split 
RP Resale price 
SARB South African Reserve Bank 
SARS South African Revenue Service 
the Act Income Tax Act 19 62 (Act No. 56 of 19 62) 
TNMM Transactional net margin method 
UNCTAD United Nations Conference on Trade and Development 
DEDICATION 
I dedicate this research to my wife Marie, daughter Janette and son Hendri who supported me 
throughout the duration of the research. 
XVlll 
Acknowledgements 
Various individuals and institutions made a special contribution to this research. 
Acknowledgement is given to the following people and institutions that made this research 
possible: 
• Northwest University's Potchefstroom Business School who supported the research. 
• Professor Ronnie Lotriet for his encouragement, support and leading the research. 
• The South African Revenue Services, in particular Joseph Rock, Ivan Pillay and Mark 
Kingon who granted permission to undertake this research and commitment to evaluate 
and consider implementation of the recommendations. 
• Ms Antionette Bisschoff for proof reading this research. 
The following people and institutions from commerce that contributed in the research: 
• Bureau Van Dijk for providing use of the Amadeus Database. 
• Chris van der Walle Regional Manager of Bureau Van Dijk in Brussels Belgium. 
• Bernard Damsma of the Organization for Economic Co-operation and Development in 
Paris France. 
• Sean Kruger Partner Ernst & Young Transfer Pricing Southern Africa. 
The following technical specialists form the South African Revenue Services (SARS) provided 
valuable technical review of the research: 
• Joseph Rock Operations Manager Large Business Centre of SARS. 
• Ahmed Jooma Sector Manager Large Business Centre of SARS. 
• Eras Reyneke Practice Leader International Tax Large Business Centre of SARS. 
• Michael Fortmann Transfer Pricing Team Leader Large Business Centre of SARS. 
xix 
Opsomming en samevatting van die studie 
Agtergrond 
Oordragprysvastelling behels 'n proses waardeur multinasionale ondernemings (MNO) interne 
pryse van goedere en dienste vastel. Hierdie oordragpryse wat deur die MNO gebruik word het 'n 
direkte invloed op die wins of verlies wat gerealiseer word in die lande waarin die MNO handel 
dryf. Indien 'n nie-markverwante prys betaal word vir die oordrag van goedere en dienste sal die 
wins wat die onderskeie dele van die MNO realiseer uit die transaksie nie in ooreenstemming wees 
met hulle ondeskeie ekonomiese bydrae tot die transaksie. 
Sodaning distorsie as gevolg van nie-markverwante pryse beinvloed winsgewendheid sowel as 
belasting aanspreeklikheid van die partye tot die transaksie in die lande waar die partye besigheid 
bedryf. Om manupilasie van interne pryse binne die MNO wat kan lei tot kunsmatige winste of 
verliese te beperk is oordragprysvastelling wetgewing werelwyd ingestel. 
Belasting ooreenkomste tussen lande allokeer die reg om belasting te hef met betrekking tot die 
winste van 'n MNO. Spesifieke artikels in die belasting ooreenkomste handel oor spesifieke 
aspekte van internasionale beleasting. Oordragprysvastelling word aangespreek in terme van 
Artikel 9 wat vereis dat die transaksie tussen lede van die MNO vergelyk moet word met 'n 
soortgelyke, vergelykbare transaksie tussen onafhanklike partye, in effek, 'n hipotese. Die 
uiteinde van sodaninge vergelyking is om effek te gee aan 'n transaksie waarby die partye tot die 
transaksie poog om die bes moontlike kondisie en opbrengs te beding, 'n gewillige koper verkoper 
beginsel, die arm lengte beginsel. 
Om sodaninge vergelyking te tref in die praktyk is subjektief en die subjektiewe aard van sodanige 
vergelyking word erken en aanspraak word gemaak op oordeel. Oordeel word vereis ten opsigte 
van metodologie seleksie, vergelykbaarheids analise (keuse van vergelykbare, onafhanklike 
ondernemings) en aanpassings tot die data wat gebruik word om die arm lengte vergoeding vas te 
stel. Onsekerheid, veral ten opsigte van die hipotese wat 'n onafhanklike onderneming sou gedoen 
het (arm lengte beginsel), beklemtoon die belangrikheid om 'n werkbare oplossing te vind om 
onsekerheid en subjektiwiteit te beperk. 
1 
Doelwit van die studie 
Die studie poog om 'n vergelykbaarheids aanpassings oordragprysvasstellings model te ontwikkel, 
definieer en te toets om sodende 'n bydrae te lewer om subjektiwiteit en onsekerheid ten opsigte 
van die arm lengte beginsel uit die weg te ruim. 
Bereik met die studie 
Deur die ontwikkeling van 'n vergelykbaarheids aanpassings oordragprysvasstellings model is die 
volgende nagevolg en bereik: 
• Verbetering van die vergelykbaarheids analise deur gebruik te maak van finansieele 
verhouding analises. Finansiele verhoudings en winsgewendheid aanwysers verskaf 
meting van funksies, bates en risiko's wat gebruik word in die bepaling van wat geag kan 
word as 'n arm lengte vergoeding. 
• Uitbreiding van die vergelykbaarheids analise deur die kwantitatiewe beraming van 
gewigte van veranderlikes wat winsgewendheid beinvloed. 
• Uitbreiding van die vergelykbaarheids analise deur die formulering van objektiewe meting 
gebasseer op meervoudige regressie analise vir die kwantitatiewe beraming van punt 
ramings van die arm lengte vergoeding relatief tot die inter-kwartiel reeks. 
• Verskaf objektiewe toepassing van die oordragprysvastelling metodologiee en 
gepaardgaande winsgewendheid aanwysers. 
• Beperk onsekerheid en vae toepassing van die arm lengte beginsel deur gebruik te maak 
van die vergelykbaarheids aanpassings oordragprysvasstellings model. 
• Gebruik van 'n mark gebaseerde ekonomiese aanwyser vir risiko aanpassing ten opsigte 
van die arm lengte beginsel. 
• Bewusmaking en internalisering van die bestuur van MNO oor die belangrikheid van 
oordragprysvastelling. 
2 
Abstract 
The birth of democracy in South Africa on 27 April 1994 brought about irrevocable change. 
Markets opened up, economic activity and trade accelerated resulting in the South African 
economy being catapulted into the global market. 
Globalisation became a reality. Globalisation comprises structural transformation that affects 
enterprises and countries giving rise to new relationships and interdependencies. Globalisation 
creates a multiplicity of linkages and interconnections amongst countries and societies that 
constitutes the present world economic system. The multiplicity of linkages and interconnections 
aligns the Multinational Enterprise (MNE) as it relates to an integrated production and market 
network spread over various geographic locations. 
Historically, South Africa had stringent exchange controls to limit capital flows. Since 
democratisation in 1994, South Africa introduced transfer pricing legislation to administer transfer 
prices of goods and services within an MNE. The goods and services transferred within an MNE 
are not geographically bound and do not necessarily reflect economic market conditions. Hence, 
the approach used in transfer pricing is to determine the arm's length consideration based on what 
a willing buyer and seller would do, the market price. 
To establish the arm's length consideration, comparative benchmarks are used. Comparability, in 
this context, give effect to "what would have been if a willing buyer and seller" transacted. The 
concept of "what would have been", the comparative benchmark, could be ambiguous. Ambiguity 
is the result of the interpretation of "what would have been". In order to minimise ambiguity 
insofar as comparability, a comparability adjustment transfer pricing model (CATPM) is designed 
to recognise factors obtained from comparative benchmarks. 
The CATPM provides greater clarity insofar as the determination of the arm's length 
consideration. Clarity is achieved despite constraints such as unavailable South African 
comparable information with inconsistent use of foreign comparable data that results in 
ambiguous, subjective conclusions on the arm's length nature of transactions. 
3 
Chapter 1 Introduction 
The South African economic landscape has evolved significantly since the birth of the democratic 
dispensation on 27 April 1994. Foreign Direct Investment (FDI) flows are indicative of the new 
horizons opening up to the African continent, but more specifically, to the rainbow nation. As a 
result, Africa's FDI has escalated to significantly higher levels since 1999 (US$ 9 billion) to 2001 
(US$ 17 billion), (UNCTAD, 2002: xvii). Large projects in Morocco and South Africa, for 
example, contributed to the considerable increase in FDI (UNCTAD, 2003: 8). It would not be 
sustainable as tragedy struck one of the leading countries supporting FDI in Africa. 
Looking at the United States of America (USA), the devastating 9/11 attack on the pinnacle of 
American prosperity, The World Trade Centre in 2001, global economic volatility had a profound 
effect on FDI flows to Africa in 2002. UNCTAD (2003: 8) recorded a 4 1 % decline of FDI flows 
to Africa in 2002. 
Giving global perspective to the above, the FDI flows to Africa amounts to a mere 2% of global 
FDI flows. Despite meagre inflows of FDI and a volatile global economy, opportunity for 
expansion in Africa is abundantly alive. 
Globalisation is gaining momentum with global shareholding of 64 000 multinational enterprises 
controlling 870 000 foreign affiliates increased by 10 per cent in 2002 and amounting to more than 
US$ 7 trillion (UNCTAD, 2003: 14). Value added activities by foreign affiliates in 2002 are 
estimated to account for about 10 per cent of world Gross Domestic Product (GDP) with global 
sales by multinational enterprises reaching US$ 18 trillion. 
Globalisation stretches across national boundaries, which in turn, exert pressure on tax 
administrations to ensure the protection of their tax base by introducing and administering 
legislation to prevent untaxed profits to emigrate. Various policy measures have been devised by 
administrations to address the erosion of the tax base. These include transfer pricing legislation 
and double taxation agreements to provide certainty and transparency in the assessment of 
international transactions. 
South Africa has historically strict exchange control measures which provided some level of 
protection against the significant manipulation of transfer prices aimed at profit transfers from 
4 
South Africa to other and sometimes, low tax jurisdictions. In anticipation of the further 
relaxation of exchange controls and the envisaged adverse effect of capital flight and profit 
shifting on the South African tax base, Section 31 of the Income Tax Act 1962 (the Act) was 
introduced in 1995. 
Against this background, this research proposes a transfer pricing model. Such a model is founded 
on theoretical and empirical evidence in the determination of the arm's length consideration, as 
recognised in South Africa and internationally. 
1.1 Problem Statement 
Transfer pricing involves a process by which MNE's determine the prices at which they transfer 
goods or services internally. Transfer of goods and services within an MNE does not necessarily 
reflect market conditions. Hence, the approach in transfer pricing concerning an MNE is to 
determine the arm's length price based on what a willing buyer and seller would do, the market 
price. The market price is the culmination where each party strives to get the utmost benefit from 
the transaction. 
Since 1995, transfer pricing remains the prominent international tax issue for MNE's (Ernst & 
Young, 2001:5). Eighty-six per cent of parent and ninety three per cent of subsidiary respondents 
to the Ernst & Young survey identified transfer pricing as the most important international tax 
issue they currently face (Ernst & Young, 2003:7). 
Transfer pricing is formulated on the requirements of Article 9 of the Organisation for Economic 
Cooperation and Development (OECD) Model Tax Convention, which states "... [When] 
conditions are made or imposed amongst ... two [associated] enterprises in their commercial or 
financial relations which differ from those which would have been made amongst unconnected 
parties (own emphasis), then any profits which ... have not so accrued, may be included in the 
profits of that enterprise and taxed accordingly" (OECD, 2000:7). 
Article 9 requires a comparison between the affected transaction of the MNE and a comparable 
transaction of comparable enterprises (unconnected parties), which are not part of an MNE. 
Ensuing from these comparative benchmarks, effect is given to "what would have been if a willing 
buyer and seller" transacted upon which the arm's length consideration is based. 
5 
The formulation of "what would have been", the comparative benchmark, could be ambiguous. 
Ambiguity arises from transfer pricing and the arm's length consideration being regarded as a non­
exact science and "requires judgment" (South Africa, 1999:9, OECD, 1995:I-5J-19JV-3). 
Judgment concurs to methodology selection, selection of comparables, adjustments to enhance 
comparability and determination of the arm's length range. Ambiguity and subjective 
interpretation of the arm's length range is acknowledged by the OECD, "...price may have to be 
estimated within a range of acceptable figures. Also, the choice of methodology for establishing 
arm's length transfer pricing will not often be unambiguously clear" (OECD, 1995:IV-3). 
Globally, transfer pricing guidelines promulgated by the OECD, referred colloquially to, as the 
OECD Guidelines exist. In South Africa, the South African Revenue Service (SARS) has issued, 
Practice Note (PN) 7, which is based on the OECD Guidelines, in 1999. PN 7 provides guidance 
insofar as transfer pricing in South Africa (South Africa, 1999:1); however, these are guidelines 
without authoritative or prescriptive requirements. 
Uncertainty, and in particular the what would have been hypothesis, which forms the basis of the 
arm's length principle accentuates the need to clarify the ambiguity surrounding transfer pricing, 
especially comparability. Currently no objective measure is promulgated by either the OECD 
Guidelines or PN 7 apart from casual reference to economic circumstances to be adjusted. The 
lack of clear guidance and an objective measure that complies with economic theory and the 
arm's length principle, which can be regarded as a fair proxy for comparability, provides impetus 
for this research. 
In order to ensure consistent administration of transfer pricing in South Africa in accordance with 
the international norm, as recognised in the OECD Guidelines and PN 7, a model founded on the 
requirements to determine the arm's length consideration (price or margin determined that is based 
on the arm's length principle) is imperative. The comparability adjustment transfer pricing model 
(CATPM) aims to minimise ambiguity insofar as comparability. The CATPM is designed to 
establish comparative benchmarks in accordance with comparability requirements as well as the 
comparative benchmarks' impact on profitability, the arm's length consideration. Furthermore, a 
consistent framework, as put forward by the CATPM will have insurmountable value to 
management of MNE's and tax administrations in terms of establishing transfer pricing in 
accordance with the arm's length principle. 
6 
1.1.1 Economic theory underpinning the arm's length consideration 
A price for a particular good or service should be a fair representation of the market forces of 
supply-demand equilibrium under a given set of circumstances. Transfer pricing recognises the 
free market principle and acknowledges that numerous factors such as government regulations, 
terms and conditions of transactions influence prices and, consequently transfer prices (OECD, 
1995:1-1,1-7; South Africa, 1999:12). In following such an approach, a transfer pricing model 
should be based on the market dynamics of supply and demand, as well as the interaction thereof. 
In order to capture market dynamics of supply and demand as well as factors such as government 
regulations, transfer pricing is based on an analysis of independent transactions. Substantiating 
this approach is the premise that independent transactions amongst unconnected parties are 
characterised by the behaviour of the transacting parties where each party to the transaction strives 
to derive the utmost benefit from the transaction that is the economic principle of minimum input 
and maximum output. 
The transaction motive to derive the utmost benefit from the transaction undertaken is not as 
profound in connected transactions compared to independent transactions. This is evident when 
semi-finished goods are transferred amongst members of MNE when a market for such goods does 
not exist or when transactions are viewed at a consolidated basis rather than a series of individual 
transactions. Transfer pricing is concerned with the pricing of individual transactions. 
In order to comply with transfer pricing regulations as well as the administration thereof, a market 
is imposed in accordance with the authoritative statement of the arm's length principle is found in 
paragraph 1 of Article 9 of the OECD Model Tax Convention. Paragraph 1 of Article 9 forms the 
basis of bilateral tax treaties involving OECD Member countries and a number of non-Member 
countries, such as South Africa. Article 9 provides that "...[When] conditions are made or 
imposed between ... two [associated] enterprises in their commercial or financial relations which 
differ from those which would be made between independent enterprises, then any profits which 
would, but for those conditions, have accrued to one of the enterprises, but, by reason of those 
conditions, have not so accrued, may be included in the profits of that enterprise and taxed 
accordingly" (OECD, 2000:7). 
7 
The arm's length principle follows the approach of treating the members of an MNE group as 
operating as separate entities rather than as inseparable parts of a single unified business (OECD, 
1995:G-1; South Africa, 1999:5). Because the separate entity approach treats the members of an 
MNE group as if they were independent entities, attention is focused on the nature of the dealings 
between those members. The focus is on adjustment of profits by reference to the conditions, 
which would have been obtained between independent enterprises in comparable transactions and 
comparable circumstances (OECD, 1995:1-8; South Africa, 1999:29). 
1.1.1.1 Globalisation 
Adherence to transfer pricing legislation as well as administration thereof is concerned with the 
pricing attached to transactions amongst members of multinational enterprises. The multinational 
enterprise is closely associated with the advent and escalation of globalisation. South Africa's 
democratisation resulted in dramatic changes over the last decade. The increased level of 
economic openness is indicative of the globalisation thrust experienced in the domestic market 
(refer to section 2.2.1.1 with South Africa as an illustrative example for more details). 
The significance of the multinational enterprise within the context of globalisation is 
comprehensible from merger and acquisition (M&A) activity. UNCTAD (2003:1) states that 
M&A cases have declined significantly from 7 894 cases in 2000 to 4 493 cases in 2002, with the 
average value of these cases declining from US$145 million to US$82 million over the same 
period. M&A activity in deals worth more than US$1 billion declined since 2000. However 81 
such deals were concluded in 2002, still an indication of the significance of these deals. 
Against the background of increased economic openness and increased activity of M&A, transfer 
pricing is instituted to protect the domestic tax base. Tax competition amongst countries is a 
reality and internationally, organisations such as the OECD attempts to limit harmful tax 
competition through the establishment of international standards to give rise to global 
harmonisation. The focus of this research is transfer pricing. However, reference to tax 
competition is made in Chapter 2 to position transfer pricing within the domain of international 
tax. 
1.1.1.1.1 The multinational enterprise 
Transfer pricing is practiced within the MNE, commonly referred to as intra-group trade, hence the 
evolution of the MNE influences transfer pricing. Transfer pricing, within the context of this 
research, is concerned with intra-group trade, which spans across national boundaries. The 2002 
UNCTAD World Investment Report estimates that 64 000 MNE's with 870 000 foreign affiliates 
across the world realised sales of almost US$ 19 trillion in 2001. The report estimates that foreign 
members of MNE's in 2001 accounts for 10% of world Gross Domestic Product (GDP) and one-
third of world exports (UNCTAD, 2002:i). The value of MNE activities associated with non­
equity relationships (shareholding) is estimated to account for larger shares in global aggregate 
Gross Domestic Product (GDP) and exports (UNCTAD, 2003:14). MNE activities that give rise 
to transfer pricing include the following: 
• International subcontracting where the MNE subcontracts part of global contracts to 
subsidiaries. In a South African context, the defence procurement programme requires an 
MNE with defence procurement contracts to meet particular counter trade requirements. 
These counter trade requirements include procurement from South African entities or 
investment in South Africa. Some of these MNE's such as FerroStahl (Germany) has 
established operations in South Africa and invested in South African enterprises. 
• Licensing where MNE's licence the right to manufacture or distribute products and 
services in specific regions or countries to various members of the MNE, commonly 
referred to as connected parties (the colloquial term used in the research). 
• Contract manufacturing where MNE's divest in their subsidiaries in terms of assets and 
consequently risk with the controlling entities within the MNE assuming the manufacturing 
risk. The contract manufacturer provides an assembling service to the MNE with the MNE 
realising a bigger reward because of assuming the manufacturing risk. This particular 
tendency is evident in the automotive sector where companies such as BMW and 
DaimlerChrysler operate as contract manufacturers for their respective MNE parent 
companies. 
In order to administer transfer pricing rules, understanding the faster evolution of the MNE within 
the context of globalisation provides some light on organisational dynamics and transfer price 
9 
setting, as well as realizing the increasing importance of the managing thereof in the business 
environment. 
1.1.2 The transfer pricing of international transactions 
Transfer prices are prices at which various connected parties transfer physical goods, services and 
intangible property amongst one another amongst national economies and corresponding 
legislative frameworks. The transfer prices adopted by an MNE have a direct bearing on the profit 
or loss it derives from its activities in each country it operates. If a non-market value is paid for 
the transfer of goods or services the profit attributed to each of the members of an MNE will be 
inconsistent with their relative economic contributions (South Africa, 1999:5). 
The distortion amongst the non-market value paid for goods and services and relative economic 
contribution of transactions amongst members of MNE's impacts on the level of profitability, tax 
revenues and tax liabilities realised in the relevant tax jurisdictions in which they operate. In order 
to minimise the detrimental effect such distortions have on a country's economy, transfer pricing 
legislation have been introduced in various countries in the world. South Africa, is no exception, 
the issues relating to transfer pricing in South Africa are primarily dealt with by the introduction in 
1995 of Section 31 in the Income Tax Act 1962 (Act No. 56 of 1962). 
The impact of transfer pricing on the South African economy falls outside the scope of the 
research, the focus is on the prevalence thereof. Transfer pricing, within this research, is 
concerned with the pricing of transactions amongst members of an MNE across national 
boundaries. 
1.1.2.1 Arm's length principle 
The administration of transfer pricing regulations is based on the separate entity approach being 
applied to intra group transactions. In essence, according to the separate entity approach, group 
members of an MNE must transact as stand-alone enterprises (unconnected parties) would 
transact. This approach is in accordance with the requirements of Article 9 of the OECD Model 
Tax Convention "...conditions are made or imposed amongst... two [associated] enterprises in 
their commercial or financial relations -which differ from those -which would have been made 
amongst unconnected parties, ..." (OECD, 2000:7). 
10 
The correct application of the separate entity approach in conjunction with the arm's length 
principle in effect allocates income and expenses amongst MNE members that commensurate with 
their relative economic contribution, as evidenced by reference to unconnected parties. In 
following a separate entity approach and applying the arm's length principle, a complex issue to be 
resolved is the determination of an arm's length transfer price amongst MNE members as it would 
have been amongst unconnected parties. 
One of the analyses undertaken in determining what would have been is to prepare a functional 
analysis. A functional analysis is a method of identifying and organising facts about an MNE's 
functions, assets and risks. It determines how functions, assets and risks are divided between the 
connected parties involved in the transaction under review. A functional analysis identifies the 
economically significant activities (functions performed, assets employed and risks assumed) that 
are undertaken by the member of a multinational and for which it should expect to be rewarded. 
1.1.2.2 Transfer pricing methodologies 
The determination of arm's length consideration can be based on a number of recognised transfer 
pricing methodologies. The use of transfer pricing methodologies and the determination of the 
arm's length consideration are dependent on the facts pertaining to each case. Various factors 
such as availability of data and applicability of the method under specific circumstances influence 
the selection of the most appropriate transfer pricing method. 
An analysis of the transfer pricing methods promulgated by the Organisation for Economic 
Cooperation and Development (OECD) guidelines as well as the methods acceptable to the 
Commissioner of the South African Revenue Service (SARS) and other methods the Inland 
Revenue Service, the tax administration in the United States are investigated. The OECD methods 
which are also the methods used by South Africa can be broadly characterised into two broad 
categories. Each of the broad categories has specific methods associated with it and is as follows: 
• Traditional transactional methods 
o Comparable uncontrolled price (CUP) 
o Cost plus (CP) 
o Resale price (RP) 
11 
• Transactional profit methods 
o Transactional net margin method (TNNM) 
o Profit split (PS) 
Other methods, predominantly used by the Inland Revenue Service (IRS) of the United States of 
America (US) promulgates are the comparable transaction method (CUT) which is comparable to 
the CUP and the comparable profit method (CPM) which is comparable to the TNMM the method 
used in this research. 
1.1.2.3 Comparability 
Comparability, as with the separate entity approach, is crucial in the determination of the arm's 
length consideration. Comparability in terms of Article 9 of the OECD Model Tax Convention 
requires "... [When] conditions are made or imposed amongst... two [associated] enterprises in 
their commercial or financial relations which differ from those which would have been made 
amongst unconnected parties..." (OECD, 2000:7). 
The principle of comparability is entrenched in South African practice (South Africa, 1999:9) 
which follows the international norm as expressed in the OECD Guidelines (OECD, 1995:1-7). 
Application of the arm's length principle is generally based on a comparison of the conditions in a 
controlled transaction with the conditions in transactions amongst unconnected parties. In order 
for such comparisons to be useful, the economically relevant characteristics of the situations being 
compared must be sufficiently comparable. To be comparable means that none of the differences 
(if any) amongst the situations being compared could materially affect the condition being 
examined in the methodology (e.g. price or margin), or that reasonably accurate adjustments can 
be made to eliminate the effect of any such differences. 
Differences amongst national economies, each with its own domestic market, regulatory or 
legislative environment exists and differences must be addressed in administering transfer pricing 
regulations. In South Africa, comparable information constraints necessitate the use of foreign 
comparables. Using foreign comparables challenge transfer pricing rules administration in South 
Africa insofar as material differences must and should be recognised and adjusted to accurately 
reflect the comparable differences in determining a result consistent with the arm's length 
principle. 
12 
1.1.2.4 International trends pertaining to transfer pricing 
International trends in transfer pricing, particularly detail pertaining to transactions and determined 
arm's length consideration is not publicly available nor is it published within the domain of the 
OECD. Authorities participate in the various working groups of the OECD and share experiences 
but such co-operation is restricted to generic and theoretical aspects of transfer pricing. 
Exchange of information pertaining to specific entities or taxpayers is accommodated in 
accordance with double taxation agreements (DTA's) and the use of such information is strictly 
used in accordance with the relevant articles governing it in the DTA's. This lack of coherent 
information on international trends in transfer pricing does not deter its importance. 
In surveys conducted by Ernst and Young (a leading auditing firm), multiple responses to specific 
questions in the questionnaire are allowed. This approach is in accordance with the concept of 
"collectively exhaustive" which aims to ensure the measurement of all factors, which could 
potentially influence the factors considered. In the context of this research, the incorporation and 
analysis of the Ernst & Young survey results allows transfer pricing trends to be identified which 
could assist management of MNE's and tax administrations in transfer pricing management. 
1.1.2.5 A pragmatic approach in transfer pricing 
Alternative approaches and methodologies are used in the determination of transactional prices of 
connected party dealings with varying degree of success. In South Africa, the biggest constraint in 
administering transfer pricing is the unavailability of South African comparables, which 
necessitates the use of foreign comparable information. Adjustment of financial information of 
comparables to enhance comparability can be made although its subjective nature could threaten 
objectivity in the determination of the arm's length consideration. 
In this research, a benchmark, which represents a fair proxy to country comparables differences, is 
put forward and incorporated as an alternative approach that can be used as support for the 
determination of an arm's length consideration. Having considered the abovementioned aspects 
underlying the transfer pricing environment in South Africa, it is imperative to follow a consistent 
approach in the determination of the arm's length consideration. 
This research aims to develop, describe and apply the comparability adjustment transfer pricing 
model (CATPM). The CATPM aims to provide greater clarity insofar as the determination of the 
13 
arm's length consideration despite constraints such as unavailable South African comparable 
information with inconsistent use of foreign comparable data that results in ambiguous, subjective 
conclusions on the arm's length nature of transactions. 
1.1.3 ZA Case 01 
For purpose of this research, a South African member of an MNE is evaluated in terms of South 
African transfer pricing regulations. The comparability adjustment transfer pricing model, which 
is developed, will be tested and applied to the case in addition to the conventional approach used 
in South Africa to date. 
Conclusions and inferences that could be made on the results obtained from the comparability 
adjustment transfer pricing model are proposed. The conclusions and inferences focus on 
providing a substantially enhanced objective approach to the determination of the arm's length 
consideration. 
Tangible goods account for the highest proportion of transfer pricing audits, although taxpayers 
are also concerned about services and financial transactions (Ernst & Young, 2003:1). This 
research follows a similar approach; the main focus is on tangible goods. 
1.2 Objectives of the research 
1.2.1 Primary objective 
The primary objective of this research is to develop and apply a comparability adjustment transfer 
pricing model (CATPM). 
1.2.2 Secondary objectives 
Through the development of a CATPM, the following secondary objectives will be pursued: 
• To also realize a CATPM which in turn aims to: 
o To apply the consequently developed CATPM to a practical case 
o Improve the comparability analysis by using ratio analysis. Ratios or the relevant 
profit level indicators provides measures of functions, assets and risks, to use the 
14 
information contained in financial statements and to guide the analysis of 
comparables; even in the absence of industry comparables. 
o Enhance comparability analysis by estimating weights that determine the 
quantitative impact of mutually exclusive and collectively exhaustive ("MECE") 
ratios on profitability. 
o Enhance the comparability analysis through providing an objective measure based 
on regression techniques to produce point estimates of the arm's length 
consideration relative to the inter-quartile range. 
• Provide objective clarity concerning the application of transfer pricing methodologies and 
their accompanying profit level indicators in the South African context. However, the 
results obtained from the research should provide a clear indication which profit level 
indicator is the most appropriate to use. 
• Limit ambiguity caused by vague guidelines with an objective CATPM to determine the 
arm's length consideration. 
• Use of an independent, market based economic indicator for a country risk adjustment in 
the subsequently developed model. A 2005 technical working group of the OECD, 
identified country risk premiums as a point for discussion under comparability (OECD, 
2005 (b): 6). It is the first time that the country risk appears as an agenda item after it was 
raised by South Africa as a consideration pertaining to comparability. 
• Sensitising and internalizing business managers and tax authorities of the importance and 
financial magnitude of transfer pricing. In essence, provide input to good corporate 
governance and stewardship, which is a key to contemporary business management. 
• Objective measurement and conceptualising of transfer pricing to business managers and 
tax authorities. 
• Identify additional research to the CATPM. 
15 
1.3 Scope of the research 
The research aims to put forward a transfer pricing model, which empirically highlights 
comparability adjustments in order to determine an objective, arm's length consideration for 
transactions amongst connected parties within the South African context. 
1.4 Research methodology 
1.4.1 Literature study 
In order to establish a sound theoretical background a comprehensive literature study was 
conducted focusing on: 
• Globalisation, its origins, trends, determinants, international tax and its implication on 
administering transfer pricing. 
• Current global transfer pricing trends and its implication on transfer pricing administration. 
• Transfer pricing guidelines and practice notes that provide guidance to the practical 
application of transfer pricing, from an administration as well as an advisory perspective. 
• Theory and practical application of financial statement analysis in order to guide the 
analysis required to determine the arm's length consideration for transactions amongst 
connected parties. 
• Author dominance is present with reference to the following publications: 
o The OECD Guidelines on Transfer Pricing is the internationally accepted 
guidelines by tax authorities of OECD member and non-member countries. It is an 
authoritive source on transfer pricing. 
o South Africa's Practice Note 7 as guidelines on transfer pricing in South Africa. 
Practice note 7 follows the OECD guidelines but make specific reference to 
situations pertinent to South African circumstances. 
o The National Association of Automobile Manufacturers of South Africa 
(NAAMSA) is the industry association representing the automobile manufacturers 
operating in South Africa. NAAMSA collects and publishes industry specific 
information. There is not an alternative source of information pertaining to the 
16 
automobile manufacturing sector. The empirical part of the research relied on 
information published by NAAMSA. 
1.4.2 Empirical field investigation 
1.4.2.1 Interviews 
Numerous interviews were conducted throughout the research process with the following 
interviews forming an integral part of the research methodology: 
• Structured interviews were conducted with various personnel at ZA Case 01 that are in 
accordance with the normal practical analysis of connected parties for the purposes of 
transfer pricing. A complete interview questionnaire is included in the research; refer to 
Appendix 5.2 for more details. In order to maintain confidentiality, the positions rather 
than the name of the interviewees are disclosed and they are as follows: 
o Directors of the Executive Committee of ZA Case 01 
o Procurement manager 
o Production manager 
o Dealer principle and the management committee of a specific flagship dealership 
• In addition to the structured interviews, unstructured interviews were conducted with 
various individuals at a number of relevant organisations and institutions which are as 
follows: 
o The OECD and in particular Bernhard Damsma based in Paris and John Neighbour 
based in London. 
o Inland Revenue, the United Kingdom's revenue service and in particular Ian Wood 
based in London. 
o Bureau van Dijk, the publisher of the Amadeus database, which is widely used in 
comparability analysis and Chris van der Walle, based in Brussels. 
o Ernst and Young's Global Transfer Pricing Practice and in particular the following 
individuals: 
17 
■ John Hobster, Global transfer pricing practice leader based in New York and 
London. 
■ Robert Miall, Senior Economist based in London. 
■ Nigel Dolman, Senior Transfer Pricing Analyst based in London. 
■ Sean Kruger, Partner Transfer Pricing in Southern Africa based in Johannesburg. 
1.4.2.2 Confidential classification 
In order to achieve the mentioned objectives and formulate empirical conclusions and 
recommendations that are based on practice rather than a hypothesised entity, it is essential to base 
the research on an actual transfer pricing case. The empirical part of the research focus on the 
evaluation of a South African member of an MNE which is not in a start-up phase and commands 
a significant market share in the domestic South African market, the so-called "ZA Case 01". In 
order to protect the identity of ZA Case 01 the research is classified as confidential based on the 
following grounds: 
• ZA Case 01 is not a listed company on the Johannesburg Securities Exchange (JSE), nor 
any other securities or stock exchange globally. The financial information pertaining to 
ZA Case 01 is not publicly available and is confidential. 
• The South African economy is relatively small with at most a handful of competitors in 
specific industries and sub-sectors of industry. This research focuses on a subsidiary of an 
MNE which is involved in the assembly, distribution and marketing of automotive 
products referred to as ZA Case 01. It would be relatively easy for anyone with knowledge 
of the automotive industry to identify ZA Case 01 and to gain access to the confidential 
and strategic information associated with ZA Case 01. 
• Disclosure of any information regarding a specific taxpayer to any other party is in 
contravention of Article 4, the secrecy provisions of the Income Tax Act. In the research, 
specific information, which is not imperative to transfer pricing, is not disclosed. This 
non-disclosure does not remove the confidentiality classification from the research. 
18 
1.4.2.3 ZA Case 01 
In the assessment process the connected party is evaluated in terms of the functions the specific 
connected party is performing, the assets it used in performing these functions and the risk 
involved in the performance thereof. The focus will be on a company, which primarily supplies 
vehicles to the South African Commercial Vehicle Market. In assessing the transfer pricing 
practices of the South African subsidiary of an MNE and establishing the arm's length 
consideration that is in accordance with the approach used by other tax jurisdictions the 
investigation will focus on the following in establishing the connected party dealings: 
• An overview of the MNE inclusive of the overall structure and nature of the business of the 
connected party that is the focus of the analysis. 
• The general market conditions in which the connected party operates including the current 
business environment. Market and business conditions evaluation focus on the current as 
well as predicted changes. The market conditions are analysed in terms of its potential and 
actual impact on prices and profitability. 
• Direct consideration of the transaction under review with consideration to: 
o the nature and terms of the transaction, 
o economic conditions and assets involved in the transaction and, 
o how the product or service that is the subject of the controlled transaction in 
question flows or are being transferred amongst the connected parties. 
• Actual contractual terms of the transaction that often provides evidence about the form in 
which the responsibilities, risks and benefits have been assigned amongst the MNE. 
• The functions undertaken by the relevant connected parties. 
• The relative contributions of the various functions performed by connected parties in the 
value chain and the overall reward for all these functions. The number of functions 
performed by a particular member of an MNE is not decisive in determining whether that 
member should derive the greater share of the profit. Profit attribution is based on the 
relative importance and risk associated with each business function rather than the number 
of functions that has been performed. 
19 
• Risk appraisal with reference to the free market, the assumption of increased risk 
compensated by an increase in the expected return. The risks assumed by the connected 
party are taken into account in the functional analysis. The CATPM is based on the 
relationship amongst risk and accounting profitability. 
A comparability analysis is undertaken to identify potentially comparable entities that constitutes 
the sample used for the determination of the arm's length consideration for ZA Case 01. The 
process followed in the analysis for the purpose of this research is two fold. 
• Firstly the analysis, referred to as current approach, focuses on the querying the Amadeus 
database and individual screening to ensure comparability. 
• Secondly, under the CATPM approach a similar querying process is followed to that of the 
current approach without any individual screening to determine comparable entities. 
1.5 Limitations of the research 
Transfer pricing encompass an extensive field of research. In order to achieve the objective of the 
research, not all concepts and issues relating to transfer pricing are undertaken. The following 
limitations of the research are highlighted: 
• Undisclosed company specific information will be used in the research and will not be 
disclosed as to enable any reader to identify the connected party being evaluated. As such, 
this is a classified study. 
• South African comparable information pertaining to publicly disclosed financial statements 
on an unconsolidated basis is not freely available. In the event that the need arises to make 
use of comparable information, foreign comparable companies from Bureau Van Dijk's 
Amadeus Database with information of approximately 1.2 million companies in Europe are 
used. 
• In the absence of provisions dealing with advance pricing arrangements (when companies 
engage the relevant tax authority on transfer pricing issues prior to entering into transfer 
pricing transactions that in effect give rise to a tax ruling) in the Act and PN 7, the research 
will not consider advance pricing arrangements. 
20 
• Although South African legislation concerning financial assistance as envisaged in PN 2 
exist, financial assistance will be incorporated into the specific aspects as mentioned in the 
problem statement. It will not be covered in a separate section. 
• The dynamics and trends underlying foreign direct investment (FDI) as a measure of 
globalisation is not discussed in any detail. The exclusion is based on the focus of the 
research being on the determination of the arm's length consideration and comparable 
adjustments to effect the arm's length consideration. Reference to FDI will be made 
insofar as it is essential to explain or contextualise transfer pricing. 
• Double taxation agreements (DTA's) form an integral part of international transfer pricing. 
Reference to DTA's are made as and when required. It is not dealt in specific detail. 
Reference to the arm's length requirement, as contemplated in the DTA's is included. 
Definitions, as defined in DTA's, which refer, to transfer pricing are included under the 
terminology of the research. 
• Transfer pricing involving intangible assets, royalties and cost contribution arrangements 
are not undertaken. 
• The potential impact of transfer pricing on competition and the inferences with competition 
legislation falls outside the scope of the research. 
• Transfer pricing involving natural persons, partnerships, trusts and close corporations falls 
outside the scope of this research. 
• The research period covers the time period 1996 through 2002 years of assessment for ZA 
Case 01 insofar as the transfer pricing analysis. 
1.6 Terminology of the research 
Terminology and definitions are based on the terminology and definitions as provided in the 
Income Tax Act 1962 (Act No. 56 of 1962) (the Act); Companies Act, 1973 (Act No. 61 of 1973) 
(the Companies Act); Organisation for Economic Co-operation and Development Transfer Pricing 
Guidelines for MNE's and tax administrators (OECD Guidelines); OECD Model Tax Convention 
on Income and on Capital (OECD Model Convention); PN 2: Income tax: Determination of 
taxable income where financial assistance has been granted by a non-resident of the Republic to a 
21 
resident of the Republic; and PN 7, Section 31 of the Income Tax Act, 1962: Determination of the 
taxable income of certain persons from international transactions: Transfer Pricing (PN 7). 
1.6.1 Ann's length principle 
The first and overriding principle is that transactions amongst connected parties are to be 
conducted at arm's length. The transaction should have the substantive financial characteristics of 
a transaction amongst independent parties, where each party will strive to get the utmost possible 
benefit from the transaction. 
1.6.2 Arm's length range 
A range of figures that are acceptable for establishing whether the conditions of a controlled 
transaction are at arm's length and that are derived from applying the same transfer pricing method 
either to multiple comparable data or from applying different transfer pricing methods. 
1.6.3 Business strategies 
Business strategies are relevant in determining comparability for transfer pricing purposes. 
Business strategies are a legitimate aspect of arm's length operations. The arm's length principle, 
therefore, acknowledges those strategies. Business strategies would take into account many 
aspects of an enterprise, such as innovation and new product development, degree of 
diversification, risk aversion and other factors that have bearing upon the daily conduct of 
business. 
1.6.4 Collectively exhaustive 
Collectively exhaustive means that everything applicable should be measured. 
1.6.5 Comparability 
Comparability is fundamental to the application of the arm's length principle. The preferred arm's 
length methods are based on the concept of comparing the prices/margins achieved by connected 
parties in their dealings to those achieved by independent entities for the same or similar dealings. 
In order for such comparisons to be useful, the economically relevant characteristics of the 
situations being compared must be highly comparable. To be comparable means that none of the 
differences (if any) amongst the situations being compared could materially affect the condition 
22 
being examined in the method (e.g. price or margin), or that reasonably accurate adjustments can 
be made to eliminate the effect of any such differences. If suitable adjustments cannot be made, 
then the dealings cannot be considered comparable. 
1.6.6 Comparability Adjustment Transfer Pricing Model (CATPM) 
The CATPM is a transfer pricing model founded on theoretical and empirical evidence that 
measure risk in order to quantify comparability adjustment(s) to comparable data in the 
determination of the arm's length consideration. 
1.6.7 Comparability analysis 
Comparability analysis comprises of a comparison amongst a controlled transaction with an 
uncontrolled transaction or transactions. Controlled and uncontrolled transactions are comparable 
if none of the differences amongst the transactions could materially affect the factor being 
examined in the methodology (e.g. price or margin), or if reasonably accurate adjustments can be 
made to eliminate the material effects of any such differences. 
1.6.8 Connected person (party) 
A "connected person" is defined in relation to each of the following categories of persons: 
In relation to a company: 
• its holding company, as defined in section 1 of the Companies Act, 1973 (Act No. 61 of 
1973); 
• its subsidiary, as defined in section 1 of the Companies Act; 
o the other company is a member thereof, and; 
o holds the majority of the voting rights therein; 
o has the right to appoint or remove directors holding a majority of the voting rights 
at meetings of the board; or 
o has the sole control of a majority of the voting rights therein, whether pursuant to 
an agreement with other members or otherwise; 
o it is a subsidiary of any company which is a subsidiary of that other company; or 
23 
o subsidiaries of that other company, or that other company and its subsidiaries, 
together hold the rights referred to above. 
A body corporate or other undertaking which would have been a subsidiary of a company, had the 
body corporate or other undertaking been a company for purposes of the Companies Act, is 
deemed to be a subsidiary of that other company. 
• any other company, where both such companies are subsidiaries (as defined) of the same 
holding company; 
• any person, other than a company as defined in section 1 of the Companies Act, who 
individually or jointly with any connected person in relation to such person, holds (directly 
or indirectly) at least 20 per cent of the company's equity share capital or voting rights; 
• any other company, if at least 20 per cent of the equity share capital of such company is 
held by such other company, and no shareholder holds the majority voting rights of such 
company; 
• any other company, if such other company is managed or controlled by -
(aa) any person (A) who or which is a connected person in relation to such company or 
(bb) any person who or which is a connected person in relation to A. 
For example, two companies will be connected parties in the event of one company being 
managed or controlled by a connected person in relation to the other company, as well as where 
the companies are managed or controlled by persons who are connected parties in relation to each 
other. 
In this research, transfer pricing relating to a natural person, trust, partnership and close 
corporation are not investigated. The definition of a connected person in relation to an individual, 
a trust, partnership and close corporation is thus excluded. 
1.6.9 Controlled (affected) transaction 
A transaction in terms of which the ownership or control relationship is able to influence the 
transfer price set. In relation to section 31, of the Income Tax Act, a controlled transaction will be 
any transaction amongst connected parties. 
24 
1.6.10 Economic circumstances 
Arm's length prices may vary across different markets, even for transactions involving the same 
product or service. To achieve comparability, it is important to ensure that the markets in which 
the parties operate are comparable. Any differences must either not have a material effect on 
price, or be differences for which appropriate adjustments can be made. For example, economic 
circumstances in the pharmaceutical industry in South Africa is substantially different to that in 
Europe with South African industry being exposed to stringent price regulations and price controls 
at a retail level. 
1.6.11 Elasticity 
An elastic demand supply curve indicates that consumers or producers are sensitive to changes in 
the price and that the accompanying change in the quantity is greater than the change in the price. 
1.6.12 Elasticity of demand 
Elasticity of demand can be defined, as the relative change in the quantity demand in relation to 
the relative change in the price, which caused the change in the quantity demand. 
25 
1.6.13 Financial ratio's 
The financial ratios (refer to 1.6.14 for explanation of acronyms) used in the research are as 
follows: 
Description Formula 
Tax leverage NP 
TLev = 
EBT Financial leverage vr , EBT FLev = 
EBIT 
Operating margin OM=EBIT 
Sales 
Total assets turnover TAT = Sales 
TA 
Asset structure AS~TA 
EBT 
Accounts receivable turnover Rec 
RecTO = 
Inv Inventory turnover ITQ _ Inventory 
Sales 
Cash position 
CP _ Sales 
CA 
Short term liquidity STLiq= — 
CL 
Liability structure LiabSt- CL 
Debt 
Long term solvency LTSol= Debt 
Capital 
Financial structure and risk management Capital 
Equity 
(Source: Brigham et al (1999: 86) and Libby et al (1998: 719) and own compilation) 
26 
1.6.14 Financial statement items 
Financial statement items covered in the research to ensure a consistent basis on which any 
subsequent analysis is as follows: 
Financial Statements Line Items Acronym 
Income Statement 
Sales (Turnover) TO 
Cost of goods sold COGS 
Gross Profit GP 
Operating expenses (Include selling, general and admin expenses, depreciating expenses often referred 
to as "SG&A") 
OPEX 
Earnings before interest and tax (also referred to as profit before interest and tax "PBIT") EBIT 
Interest expense Int 
Earnings before tax EBT 
Net Profit NP 
Balance Sheet 
Assets 
Cash and cash equivalents Cash 
Accounts receivables Rec 
Inventory Inv 
Other current assets OCA 
Current Assets CA 
Fixed assets (Net of depreciation) FA 
Property plant and equipment PPE 
Intangible assets IA 
Total Assets TA 
Liabilities 
Accrued expenses AE 
Accounts payable Pay 
Other Current liabilities OCL 
Current liabilities CL 
Long term debt Debt 
Equity eQ 
1.6.15 Financial transaction 
The definition of services, as contained in Section 31 of the Income Tax Act, includes financial 
transactions and would thus apply to non-arm's length interest, discounts and other payments for 
the use of money. 
1.6.16 Functional analysis 
A functional analysis is a practical way of evaluating functional comparability; it is a method of 
finding and organising facts about a business' functions, assets (including intangible property) and 
risks it assumes. It aims to determine how these (functions) are divided amongst the parties 
involved in the transaction under review. A functional analysis identifies the economically 
27 
significant activities (functions performed, assets employed and risks assumed) that are undertaken 
by the member of an MNE, and for which it should expect to be rewarded. This identifies the 
nature and characteristics of the connected party dealings that have to be priced. 
1.6.17 Globalisation 
Globalisation is the multiplicity of linkages and interconnections amongst countries, which make 
up the present world system. Globalisation describes the process by which events, decisions, and 
activities in one part of the world come to have significant consequences for individuals and 
communities in quite distant parts of the globe. 
Globalisation has two distinct dimension, firstly scope (or stretching) and secondly, intensity (or 
deepening). On one hand, globalisation defines a set of processes which embrace most of the 
globe or which operate worldwide, the spatial connotation. On the other hand, globalisation also 
implies intensification on the levels of interaction, interconnectedness or interdependence amongst 
countries which constitute the world community. 
1.6.18 Intangible property 
The term "intangible property" includes the rights to use industrial assets such as patents, trade 
marks, trade names, designs or models. PN 7 (South Africa, 1999:36) refers to Chapter VI of the 
OECD Guidelines, which deals specifically with intangible property. Chapter VI of the OECD 
Guidelines (OECD, 1995:VI-1) discusses special considerations that arise in seeking to establish 
whether the conditions made or imposed in transactions amongst associated enterprises involving 
intangible property reflect arm's length dealings. 
1.6.19 Juridical double taxation 
Juridical double taxation is the imposition of comparable taxes in two (or more) countries on the 
same taxpayer in respect of the same subject matter and for identical periods. 
1.6.20 Know-how 
Know-how is all the undivulged technical information, whether capable of being patented or not, 
that is necessary for the industrial reproduction of a product or process. This could be directly and 
under the same conditions; in as much as it is derived from experience, know-how represents that 
28 
a manufacturer cannot know from mere examination of the product and mere knowledge of the 
progress of technique (OECD, 2000:152). 
1.6.21 Managed or Controlled 
The concept of "managed or controlled" is used a number of times in the definition and the scope 
thereof is intended to be wider than the term "managed and controlled", as used in other sections 
of the Act. In order to determine the place where an entity is managed or controlled, regard will 
be had to the business activities of the entity and business activities of connected parties, as well as 
the degree of autonomy under which the entity operates. 
The South African Revenue Services (SARS) is of the view that the control of an entity is to be 
found at the meeting place of the persons who exercise authority over and control direction of the 
entity's business operations. Its directors generally control a company. However, situations may 
be encountered where the directors of a company's holding company or ultimate holding company 
effectively exercise control. The question of where the shareholders may reside or meet in an 
annual general meeting (in the case of a company) is therefore irrelevant. 
The place where directors and other persons performing the same functions (in the case of entities 
other than companies) usually exercise their functions and direct the affairs of the entity is an 
indication of where an entity is controlled. In most cases, this will be the place where the entity's 
head office is located. The place where an entity is managed is usually the place where the day-to­
day running of the business activities takes place. From the above it is evident that the place from 
which an entity is controlled is not necessarily the place from which it is managed. 
1.6.22 Marketing intangible 
An intangible attributable to marketing activities of the enterprise, which advance the commercial 
exploitation of a product or service and/or has an important promotional value for the product 
concerned. Marketing intangibles as opposed to commercial intangibles, on the other hand is a 
special type of commercial intangible with a somewhat different nature. It includes trademarks 
and trade names that aid in the commercial exploitation of a product or service, customer lists, 
distribution channels and unique names, symbols or pictures that have an important promotional 
value for the product or services concerned. 
29 
Some marketing intangibles such as trademarks might be protected by law in the country 
concerned and used only with the owner's permission for the relevant product or services. The 
value of such intangible depends on a number of factors including the reputation and credibility of 
the trade name or trade mark fostered by the quality of goods and services provided under the 
name in the past, the degree of quality control, ongoing research and development, distribution and 
availability of goods and services being marketed (OECD, 1995:VI-2). 
Intellectual property such as know-how and trade secrets can be trade intangibles or marketing 
intangibles. Know-how and trade secrets are proprietary information or knowledge that assist or 
improves a commercial activity, but that is not registered for protection similar to a patent or 
trademark. 
1.6.23 Multinational Enterprises (MNE's) 
PN 7 (South Africa, 1999: 4) refers to a multinational and the OECD Guidelines (OECD, 1995: G-
6) refers to an MNE with the term used to refer to any group of connected parties with members or 
business establishments in two or more countries. The term "members" refers to constituent parts 
(including natural persons) of that MNE, each having a separate legal existence. 
Within the context of this research no distinction is made amongst the multinational, global, 
international and transnational enterprise (a term used in UNCTAD literature, transnational 
corporations (TNC's) comprise parent enterprises and their foreign affiliates with a parent 
enterprise being defined as one that controls assets of another entity or entities in a country or 
countries other than its home country, usually by owning a capital stake with an equity capital 
stake of at least 10% which is normally considered as a threshold for the control of assets in this 
context.) (UNCTAD, 2002:5). 
1.6.24 Mutually exclusive 
Mutually exclusive means that the same aspect should not be measured twice. 
1.6.25 Permanent Establishment 
Article 5 of the OECD "Model Tax Convention on Income and on Capital" (OECD, 2000:26) 
provides a definition of a Permanent Establishment (PE). 
30 
"Paragraph 1 For the purposes of this Convention, the term "permanent establishment" means a 
fixed place of business through which the business of an enterprise is wholly or 
partly carried on. 
Paragraph 2 The term "permanent establishment" includes especially: 
a) a place of management; 
b) a branch; 
c) an office; 
d) a factory; 
e) a workshop, and 
f) a mine, an oil or gas well, a quarry or any other place of extraction of natural 
resources 
Paragraph 3 A building site or construction or installation project constitutes a permanent 
establishment only if it lasts more than twelve months. 
Paragraph 4 Notwithstanding the preceding provisions of this Article, the term "permanent 
establishment" shall be deemed not to include: 
a) the use of facilities solely for the purpose of storage, display or delivery of 
goods or merchandise belonging to the enterprise; 
b) the maintenance of a stock of goods or merchandise belonging to the 
enterprise solely for the purpose of storage, display or delivery; 
c) the maintenance of a stock of goods or merchandise belonging to the 
enterprise solely for processing by another enterprise; 
d) the maintenance of a fixed place of business solely for the purpose of 
purchasing goods or merchandise or of collecting information, for the 
enterprise; 
e) the maintenance of a fixed place of business solely for carrying on, for the 
enterprise, any other activity of a preparatory or auxiliary character; 
f) the maintenance of a fixed place of business solely for any combination of 
activities mentioned in subparagraphs (a) to (e), if the overall activity of the 
fixed place of business resulting from this combination is of a preparatory or 
auxiliary character. 
Paragraph 5 Notwithstanding the provisions of paragraphs 1 and 2, where a person - other than an 
agent of an independent status to whom paragraph 6 applies - is acting on behalf of 
31 
an enterprise and has, and habitually exercises, in a Contracting State an authority 
to conclude contracts in the name of the enterprise, that enterprise shall be deemed 
to have a permanent establishment in that State in respect of any activities which 
that person undertakes for the enterprise, unless the activities of such person are 
limited to those mentioned in paragraph 4 which, if exercised through a fixed place 
of business, would not make this fixed place of business a permanent establishment 
under the provisions of that paragraph. 
Paragraph 6 An enterprise shall not be deemed to have a permanent establishment in a 
Contracting State merely because it carries on business in that State through a 
broker, general commission agent or any other agent of an independent status, if 
such persons are acting in the ordinary course of their business. 
Paragraph 7 The fact that a company which is a resident of a Contracting State controls or is 
controlled by a company which is a resident of the other Contracting State, or which 
carries on business in that other State (whether through a permanent establishment 
or otherwise), shall not of itself constitute either company a permanent 
establishment of the other. " 
1.6.26 Residence 
Article 3 of the OECD Model Tax Convention on Income and on Capital (OECD, 2000:23) 
provides a definition of residence. 
"For the purposes of this Convention, the term "resident of a Contracting State" means any person 
who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place 
of management or any other criterion of a similar nature, and also includes that State and any 
political subdivision or local authority thereof. This term, however, does not include any person 
who is liable to tax in that State in respect only of income from sources in that State or capital 
situated therein. (1) 
Where by reason of the provisions of paragraph 1 an individual is a resident of both Contracting 
States, then his status shall be determined as follows (2): 
a) he shall be deemed to be a resident only of the State in which he has a permanent home 
available to him; if he has a permanent home available to him in both States, he shall be deemed to 
32 
be a resident only of the State with which his personal and economic relations are closer (centre of 
vital interests); 
b) if the State in which he has his centre of vital interests cannot be determined, or if he has 
not a permanent home available to him in either State, he shall be deemed to be a resident only of 
the State in which he has an habitual abode; 
c) if he has a habitual abode in both States or in neither of them, he shall be deemed to be a 
resident only of the State of which he is a national; 
d) if he is a national of both States or of neither of them, the competent authorities of the 
Contracting States shall settle the question by mutual agreement. 
Where by reason of the provisions of paragraph 1 a person other than an individual is a resident of 
both Contracting States, then it shall be deemed to be a resident only of the State in which its place 
of effective management is situated. (3)" 
1.6.27 Royalty 
Royalty (South Africa 2002:35) is defined as any amount received by or accrued to any person as 
consideration for the use of, or the right to use, any copyright of literacy, artistic or scientific work 
(including cinematograph films and films, tapes or discs for radio or television broadcasting), any 
patent, trade mark, design or model, plan, secret formula or process, or any other property or right 
of a similar nature, or for information concerning industrial, commercial or scientific experience 
(refer also to section 9 (1) (b), (bA), section 9C (1) (c) and section 35 of the Act). 
The term royalties as defined in the OECD Model (OECD, 2000:33) under Article 12 means 
payments of any kind received as a consideration for the use of, or the right to use, any copyright 
of literary, artistic or scientific work including cinematograph films, any patent, trade mark, design 
or model, plan, secret formula or process, or for information concerning industrial, commercial or 
scientific experience. 
1.6.28 Safe harbour 
Safe harbour, in the context of the arm's length principle, is defined by the OECD Guidelines 
(OECD, 1995:TV-32) as "...providing circumstances in which taxpayers could follow a simple set 
33 
of rules under which transfer prices would be automatically accepted by the national tax 
administration. Such provisions would be referred to as a "safe harbour" or "safe haven". A safe 
harbour is a statutory provision that applies to a given category of taxpayers and that relieves 
eligible taxpayers from certain obligations otherwise imposed by the tax code by substituting 
exceptional, usually simpler obligations. 
In the specific instance of transfer pricing, the administrative requirements of a safe harbour varies 
from total relief of targeted taxpayers from the obligation to conform with a country's transfer 
pricing legislation and regulations to the obligation to comply with various procedural rules as a 
condition for qualifying for the safe harbour. These rules could require taxpayers to establish 
transfer prices in a specific way, i.e. by applying a simplified transfer pricing method provided by 
the tax administration, or to satisfy specific information reporting and record maintenance 
provisions with regard to controlled transactions. 
1.6.29 Section 31 of the Income Tax Act No. 58 of 1962 
The particular section of the Income Tax Act No. 58 of 1962 (the Act) is as follows: 
South Africa (2002:236) Section 31. "Determination of taxable income of certain persons in 
respect of international transactions. 
(1) For the purposes of this section— 
"goods" includes any corporeal movable thing, fixed property and any real right in any such thing 
or fixed property; 
"international agreement" means a transaction, operation or scheme entered into amongst 
(a) (i) a resident; and 
(ii) any other person who is not a resident; or 
(b) (i) a person who is not a resident; and 
(ii) any other person who is not a resident, 
for the supply of goods or services to or by a permanent establishment of either of such persons in 
the Republic; or 
(c) (i) a person who is a resident; and 
(ii) any other person who is a resident, 
34 
for the supply of goods or services to or by a permanent establishment of either of such persons 
outside the Republic; or 
(d) (i) a person who is a resident; and 
(ii) any other person who is a resident, 
where either of such persons is as a result of the application of the provisions of any agreement 
entered into by the Republic for the prevention of double taxation, not subject to tax in the 
Republic; and 
[Definition of "international agreement" substituted by s. 37 (1) of Act No. 30 of 1998, amended 
by s. 31 (1) of Act No. 53 of 1999 and substituted by s. 37 (a) of Act No. 59 of 2000.] 
Wording of Sections 
"permanent establishment" 
[Definition of "permanent establishment" inserted by s. 37 (b) of Act No. 59 of 2000 and deleted 
bys . 16 of Act No. 5 of 2001.] 
Wording of Sections 
"services" includes anything done or to be done, including, without limiting the generality of the 
foregoing— 
(a) the granting, assignment, cession or surrender of any right, benefit or privilege; 
(b) the making available of any facility or advantage; 
(c) the granting of financial assistance, including a loan, advance or debt, and the provision of 
any security or guarantee; 
(d) the performance of any work; 
(e) an agreement of insurance; or 
(f) the conferring of rights to incorporeal property. 
(2) Where any goods or services are supplied or acquired in terms of an international agreement 
and— 
(a) the acquirer is a connected person in relation to the supplier; and 
(b) the goods or services are supplied or acquired at a price which is either— 
(i) less than the price which such goods or services might have been expected to fetch 
if the parties to the transaction had been independent persons dealing at arm's 
length (such price being the arm's length price); or 
(ii) greater than the arm's length price, 
35 
then, for the purposes of this Act in relation to either the acquirer or supplier, the Commissioner 
may, in the determination of the taxable income of either the acquirer or supplier, adjust the 
consideration in respect of the transaction to reflect an arm's length price for the goods or services. 
(3) (a) Where any person who is not a resident (hereinafter referred to as the investor) has granted 
financial assistance contemplated in paragraph (c) of the definition of "services" in 
subsection (1), whether directly or indirectly, to— 
(i) any connected person in relation to the investor who is a resident; or 
[Sub-para, (i) substituted by s. 37 (c) of Act No. 59 of 2000.] 
Wording of Sections 
(ii) any other person (in whom he has a direct or indirect interest) other than a natural person, 
which is a resident (hereinafter referred to as the recipient) and, by virtue of such interest, 
is entitled to participate in not less than 25 per cent of the dividends, profits or capital of 
the recipient, or is entitled, directly or indirectly, to exercise not less than 25 per cent of the 
votes of the recipient, 
[Sub-para, (ii) substituted by s. 37 (c) of Act No. 59 of 2000.] 
Wording of Sections 
and the Commissioner is, having regard to the circumstances of the case, of the opinion that the 
value of the aggregate of all such financial assistance is excessive in relation to the fixed capital 
(being share capital, share premium, accumulated profits, whether of a capital nature or not, or any 
other permanent owners' capital, other than permanent capital in the form of financial assistance 
as so contemplated) of such connected person or recipient, any interest, finance charge or other 
consideration payable for or in relation to or in respect of the financial assistance shall, to the 
extent to which it relates to the amount which is excessive as contemplated in this paragraph, be 
disallowed as a deduction for the purposes of this Act. 
[Para, (a) amended by s. 37 (c) of Act No. 59 of 2000.] 
Wording of Sections 
(b) For the purposes of paragraph (a), financial assistance granted indirectly shall be deemed to 
include any financial assistance granted by any third person who is not a connected person in 
relation to the investor, a connected person contemplated in paragraph (a) or the recipient, where 
such financial assistance has been granted by arrangement, directly or indirectly, with the investor 
and on the strength of any financial assistance granted, directly or indirectly, by the investor or any 
connected person in relation to the investor, to such third person. 
36 
[S. 31 substituted by s. 23 (1) of Act No. 21 of 1995.]" 
1.6.30 Trade intangible 
Trade intangible is a commercial intangible other than a marketing intangible. 
1.6.31 Tax treaties 
Article 7 of the OECD Model Tax Convention on Income and on Capital (OECD, 2000:28) 
provides inter alia for the attribution of profits to a permanent establishment of an enterprise. 
Article 9 (OECD, 2000:30) stipulates that the arm's length principle must be applied to 
commercial and financial relations amongst associated companies residing in the contracting 
states. These principles are embodied in each of South Africa's tax treaties. Tax treaties cannot 
impose tax liability; they merely allocate existing tax liabilities amongst countries. 
1.6.32 Transfer prices 
Transfer prices are the prices at which an entity transfers goods and services to connected parties. 
1.6.33 Transfer pricing 
The term transfer pricing describes the process by which entities set the prices at which they 
transfer goods or services amongst each other. 
1.6.34 Tested party 
The tested party is the member of the MNE who is the subject of the analysis for which the arm's 
length consideration is determined. 
1.6.35 Uncontrolled transaction 
An uncontrolled transaction is a transaction, which is concluded at arm's length amongst 
enterprises that are not, connected parties in relation to each other. This could, for example, 
include transactions at arm"s length amongst a member of an MNE and an unconnected person. 
Uncontrolled transactions form the benchmark against which an MNE's transfer pricing is 
appraised in determining whether its prices are arm's length. 
37 
1.7 Layout of the research 
Chapter Two investigates globalisation within the context of transfer pricing. The chapter 
commences with globalisation, its origin and current discernible trends, explores the openness of 
the South African economy. The progressive evolution of the MNE are explored insofar as 
international production and its policies and practices of income distribution with the 
accompanying challenge of tax exposure for MNE's and tax collection for administrations, in 
particular transfer pricing. 
International tax is explored with reference to FDI flows within the MNE. Examples are used to 
illustrate the various concepts involved in international tax and transfer pricing. In order to 
explain the various concepts reference to the country of origin will be referred to as "Home" and 
the recipient country as "Foreign". 
In Chapter Three the focus moves from globalisation and the MNE towards the pricing of the 
consequent international transactions. Regulations, international standards, transfer pricing 
methodologies are investigated in detail. The South African regulations and legislation is 
incorporated into the chapter to provide a clear understanding of the regulatory and legislative 
requirements of South Africa within the bigger global reference. 
In Chapter Four a comparability adjustment transfer pricing model is developed. Adjustments to 
potentially comparable data are investigated in order to enhance comparability objectively in 
accordance with the arm's length principle, encapsulated by the comparability adjustment transfer 
pricing model (CATPM). PN 7 (South Africa, 1999:10) as well as the OECD Guidelines (OECD, 
1995:1-9) promulgates the use of adjustments in order to obtain a result that is consistent with the 
arm's length principle. 
Difficulties exist in the determination of an appropriate adjustment that takes cognisance of 
economic conditions in the various markets. The CATPM recognises factors that influences 
profitability and by virtue of multiple regression analysis estimate objectively "what would have 
been" in accordance with paragraph 1 of Article 9 of the OECD Model Tax Convention. 
Chapter Five, encompass the evaluation and determination of the arms' length consideration of a 
South African member of an MNE, ZA Case 01. The investigation follows the South African 
38 
transfer pricing rules with reference to the OECD Guidelines. The CATPM is applied to ZA Case 
01 in conjunction to the current approach used in South Africa. 
The comparative analysis part of the research makes use of international comparables published by 
Bureau Van Dijk's Amadeus Database with information of approximately 1.2 million companies 
in Europe. The evaluation of ZA Case 01 are based on the data so obtained and the consideration 
consistent with the arm's length principle so determined, applied and tested to the actual financial 
and commercial information of ZA Case 01. The arm's length consideration and a conclusion on 
the nature of ZA Case 01 connected party dealings are drawn. 
In Chapter Six the results of the CATPM are interpreted and recommendations concerning the 
implementation of the CATPM in the administration of transfer pricing in South Africa are made 
that could potentially influence current best practices. Recommendations for further research are 
explored. 
1.8 Summary 
The formulation of "what would have been" contained paragraph 1 of Article 9 of the OECD 
Model Tax Convention, the comparative benchmark, could be subjective and ambiguous. 
Ambiguity is acknowledged with reference to transfer pricing being regarded as a non-exact 
science and "requires judgment". 
The OECD guidelines clarify ambiguity in terms of the transfer price may have to be estimated 
within a range of acceptable figures with the assistance of transfer pricing methodologies with the 
choice of methodology for establishing arm's length transfer price not often be unambiguously 
clear. This research aims to clarify some of the uncertainty surrounding the ambiguity 
surrounding the "what would have been" hypothesis, which forms the basis of the arm's length 
principle. 
In South Africa, the biggest constraint in administering transfer pricing is the unavailability of 
South African comparables, which necessitates the use of foreign comparable information. 
Alternative approaches and methodologies are used in the determination of transactional prices of 
connected party dealings. Working capital adjustments that are based on adjustments to financial 
statements of comparables to enhance comparability serve as an example. 
39 
This research aims to provide greater clarity on "what would have been" as envisaged by the arm's 
length principle. The CATPM makes use of the comparables determined in accordance with 
comparability requirements, identifying factors (determined from the financial statements of 
comparables) that influences profitability and by virtue of a multi regression analysis model 
estimate objectively "what would have been" in accordance with paragraph 1 of Article 9 of the 
OECD Model Tax Convention. The CATPM provides an approach, which limits subjectivity and 
the non-exact nature of transfer pricing through multiple regression analysis, and provides a 
consistent approach in the determination of the arm's length consideration. A multi regression 
model that estimates the arm's length consideration based on the factors (that influences 
profitability), as determined by the comparables is clearly a substantial enhancement in the 
objective determination of a transfer price. 
The consistent, objective measures of the approach provide considerable potential use for 
managers of MNE's and tax administrations alike. Uncertainty concerning the interpretation and 
the judgment of the facts, which affects the arm's length principle, is greatly reduced. The 
determination of the arm's length consideration is based on the factors that influence profitability. 
These factors are established through multiple regression. The arm's length range so determined 
will be based on the same factors, objectively determined, irrespective if the management of the 
MNE or the tax authority executes the CATPM model. 
40 
Chapter 2 Transfer pricing in a globalising world 
2.1 Introduction 
Transfer pricing involves a process by which entities set the prices at which they transfer goods or 
services amongst each other. Conversely, a transfer price is the price at which an entity transfers, 
buys or sell goods or services. Within an MNE context, transfer prices have a direct bearing on 
the proportional profit the MNE derives in each country in which it operates. 
If an excessive consideration is paid for the transfer of goods or services between the members of 
an MNE, the profit calculated for each of those members will be inconsistent with their relative 
economic contribution to the transfer (transaction.) For example, when a member of the MNE 
receives an excessive consideration for the selling of goods or services, profit is inflated (for the 
selling member) whilst the converse is true for the member who pays the consideration. This 
distortion impacts on profit calculations for members of the MNE within the geographical market 
they operate. In addition to the profit so recognised by the MNE, the recognised profit impacts on 
the tax revenues of the tax jurisdictions in which the MNE operate. 
MNE's operate in an increasing globalising world. Deprez (2003:387) and Dunning (2001:207) 
views globalisation as a significant increase in economic interaction amongst different national 
economies resulting in a qualitative repositioning of relationships amongst various countries. The 
economic interaction is observable as MNE activity. UNCTAD (2002:xv) shares this view, 
indicating that a trend of interconnectedness of enterprises is apparent. Globally 64 000 MNE's 
control 870 000 foreign affiliates (UNCTAD, 2002:xv). 
Against this background of economic interaction and the interconnectedness of enterprises, 
transfer pricing is becoming increasingly important, for managers of MNE's and tax 
administrations alike. The importance of transfer pricing is confirmed by Ernst and Young 
(2005:5) who reported that since 1995, transfer pricing remains the prominent international tax 
issue for MNE's. The 2003 research reiterated the importance of transfer pricing stating that 
eighty-six per cent of parent companies and ninety-three per cent of subsidiaries identified 
transfer pricing as the most important international tax issue on the agenda (Ernst and Young, 
2003:7). 
41 
2.2 The context of globalisation 
Dunning (2002:207) reiterates that consumers and competitors pressurise enterprises to perpetually 
introduce new products, enhance the quality, and reduce relative prices of goods and services 
thereby providing impetus to globalisation. This observation of Dunning effectively amounts to 
demand pull caused by external forces. Storm and Naastepad (2001:2) support Dunning's view of 
customers and competitors' demand-pull. Their perception is that perpetual innovation aimed at 
minimising escalating cost of research and development, shortening of product life cycles and 
searching for wider markets are an essential response to the external pressure. 
The views and perceptions on globalisation, expressed by Dunning, Storm and Naastepad are 
significant in terms of transfer pricing. In the determination of transfer prices by MNE's 
cognisance of shortened product life cycles, new product introduction, downward pressure on 
prices and cost that implicitly affect profits, must be considered. 
The convolution of transfer pricing is augmented by market supporting policies promulgated by 
national governments through the growth of market led regional integration. Tax competition 
(refer to section 2.4.2 for more detail), is a widely used instrument by national governments to 
achieve market growth. The lowering of trade barriers such as tariffs as well as tax incentives are 
examples of what Dunning identified as obstacles (2001:208). With globalisation gaining 
momentum and still growing, the transfer pricing challenge remains a prominent issue and 
increases in importance (Ernst & Young, 2001:5, and 2003:7). 
Storm and Naastepad (2001:2) views the context of globalisation as the removal of barriers that 
inhibit international trade, investment and finance and identify two fronts on which it occurs: 
• Firstly, the technological revolution in transport, communication and information 
technology and the reduced cost of international transactions makes participation in 
international trade easier. 
• Secondly, globalisation is possible by accelerated trade liberalisation, substantial foreign 
direct investment (FDI) and foreign capital flows amongst countries. Foreign direct 
investment (FDI) global inflows into recipient countries increased from US$ 59 billion in 
1982 to US$ 651 billion in 2002 at current prices with the annual growth rate 40.2 per cent 
in FDI inflows from 1996 to 2000 (UNCTAD, 2003:2). 
42 
These aforementioned globalisation views, referred to as removal of barriers, expressed by 
Dunning, Storm and Naastepad confers with the views of Deprez (2003:369), Dunning 
(2001:208), Dunning (2002:378) and Rakshit (2001:157). The integration is facilitated by 
technology enhancement and trade liberalisation, which occurs globally. This research is 
concerned with trade amongst members of the same entity, which operates globally, and in 
particular, the prices of such trade, commonly referred to as transfer pricing. Globalisation can be 
seen as the catalyst with the MNE as the architect of transfer pricing, hence, this chapter follows a 
similar approach. 
Perez (1998:20) confirms the importance of technology, attributes technology as a major driving 
force in globalisation, and expands this view by drawing a continuum regarding technology and 
the MNE as mutually dependent. This view of Perez is corroborated by a survey conducted 
amongst managers of MNE's who perceives transactions involving intangibles and technology 
cost sharing agreements are more susceptible for transfer pricing audits in 2003 than in 2001 
(Ernst & Young, 2001:5 and 2003:7). 
Globalisation has two distinct dimensions; firstly scope (or stretching) and secondly, intensity (or 
deepening). On one hand, globalisation defines a set of processes which embrace most of the 
globe or which operate worldwide, the spatial connotation. On the other hand, globalisation also 
implies intensification on the levels of interaction, interconnectedness or interdependence amongst 
countries, which constitute the world community (Dunning, 2002:378). 
Globalisation comprises structural transformation that affects enterprises and countries giving rise 
to new relationships and interdependencies. Globalisation creates a multiplicity of linkages and 
interconnections amongst countries and societies, which make up the present world system 
(Dunning, 2001:207 and 2002:83). 
The multiplicity of linkages and interconnections is aligned to the spatial perspective, linking 
globalisation with the MNE insofar as it relates to an integrated production network being spread 
over various geographic locations, a form of economic integration stretching national boundaries. 
Transfer pricing concurs with this view, MNE's are impacted insofar as securing production 
factors (raw material, labour, capital and entrepreneurship) and markets to secure sustainable 
profitability. Countries, in which MNE's operates, are being affected by their ability to provide 
43 
production factors, secure market related payment as well as protecting their respective tax base 
through transfer pricing. 
The impact the 9/11 terrorist attacks on the World Trade Centre had on the global economy 
emphases another aspect of globalisation. Globalisation describes the process by which events, 
decisions, and activities in one part of the world come to have significant consequences for 
individuals and communities in quite distant parts of the globe. Divergence rather than 
convergence is observable if the massive increase in inequalities amongst nations is taken into 
account in the era of modern economic growth, which does not inspire confidence (Rao, 2001:50). 
2.2.1 South Africa's economic integration 
In defining globalisation, it is apparent that the phenomenon is discernable as structural 
transformation affecting enterprises (such as the MNE) and countries, giving rise to new 
relationships and inter dependencies. This economic integration amongst enterprises, which 
stretches across national boundaries, gives rise to multinational value creating activities resulting 
in the MNE earning economic rent in multiple countries, a form of cross-border economic 
integration. 
The measurement of economic rent or return, within national parameters because of economic 
integration, and the subsequent tax consequence provides multinational and national challenges, 
which are addressed through transfer pricing regulations. Evidence of such economic integration 
exists and South Africa, post-1994 and democratisation became part of the phenomenon. 
South Africa experienced a noticeable increase in economic integration since 1994. In order to 
illustrate the concepts concerning globalisation, an empirical analysis within the domain of 
international tax and transfer pricing is imperative. The empirical analysis is two-fold. Firstly, a 
measure of openness of the South African economy is undertaken and secondly, branch payments 
and receipts are used as an indicator of connected party dealings. 
2.2.1.1 Openness of the South African Economy 
Openness of an economy can broadly be defined as the relation of exports and imports to gross 
domestic product (GDP) of the economy. It provides a measure of exposure to international trade 
and business trends. From an international tax and transfer pricing perspective, it is indicative of 
44 
the level of international interaction of the economy with a significant number of participants in 
the international interaction being driven by MNE's and connected party dealings. 
Ordinarily, one would expect that a measure of openness would be directly indicative of the 
prevalence of international trade as well as the volume and value of potentially connected party 
dealings. It would also indicate the probability of multinational transactional activity in line with 
the underlying trend as illustrated in Figure 1. 
Figure 1: Openness of South African Economy  
(Source: Own compilation from SARB Quarterly Bulletins) 
From the illustration, it is apparent that since South Africa's re-entering the global marketplace, 
the economy opened up considerably. Openness peaked at 68 per cent of GDP during the first 
quarter of 2003 and declined since then, predominantly due to the relative strength of the domestic 
currency compared to the US$. However, if the trend of the data is taken into consideration, it is 
apparent that international trade integration can be expected to continue which in turn would 
require additional resources to administer international tax and transfer pricing regulations in order 
to prevent the erosion of the tax base. 
45 
2.2.1.2 South African branches of foreign entities 
A further measure of the magnitude of international transactions, which are intricately linked to 
the provisions of international tax and transfer pricing legislation are the prevalence and trends 
observable with regard to branch profits. Although branches are not considered within the ambit 
of Section 31 of the Act, nor a focus of this research, the arm's length principle is a prerequisite 
under the Double Taxation Agreements. Within this context, the arm's length nature of dealings 
amongst branches and their respective Head Quarters are administered. 
Figure 2: Branch Profits  
1000 ■ 1 
800 - ■ 
.1 
= 600 - 1 1 
« w 400 - 1 ■ 1/ '1 \ 
200 - ■-Y J M - ^ - ^ 1 1 « 
0 I T T 1 - ■ w 'I 
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 
^ ^ H Branch profit payments 232 466 414 289 55 111 924 1117 786 221 
—4—Branch profit receipts 162 220 136 131 252 170 111 158 608 227 
Year 
(Source: Own compilation from SARB Quarterly Bulletins) 
Figure 2 is indicative of the magnitude of branch profit receipts and payments of South African 
branches to their respective foreign Head Quartered companies. The observed volatility and 
magnitude of these transactions makes it imperative to evaluate these receipts and payments in 
respect of the arm's length principle. In the absence thereof, it is not implausible that the tax base 
could emigrate with relative ease. The administration of the arm's length principle with respect to 
branches are not dealt with in this research, however, it has illustrative value within the context of 
this research. 
46 
A foreign Head Quartered company could set up a business enterprise, with relative ease as a 
branch in another country if compared to the legislative requirements to set up a foreign 
subsidiary. Branches of foreign Head Quartered companies, is predominantly financial services 
entities, which provides access to foreign capital and related services for domestic firms within the 
country where it is resident. 
In Appendix 1 a detailed list of branches of foreign Head Quartered, companies are provided. In 
2005, there were 79 branches of foreign Head Quartered companies providing financial and 
general services to companies in South Africa. The prevalence of branches in the other sectors of 
the economy is not as profound as in financial services and general services sectors due to factors 
such as regulatory requirements. Regulatory requirements ranges from registration as a taxpayer, 
obtaining a license i.e. insurance, to registration by the medicines control council if you are a 
pharmaceutical company. 
2.2.2 Phases of globalisation 
Globalisation is dynamic with capital and production becoming a driving force towards economic 
integration notwithstanding the current traditional boundaries. Globalisation encompasses much 
more than the lowering of tariffs and the elimination of non-tariff barriers (Deprez, 2003:369, 
Dunning, 2002:378 and Rakshit, 2001:157). 
This view is echoed by Storm and Naastepad (2001:2) who are of the opinion that globalisation 
was made possible by rapid trade liberalisation as well as technological revolution. Globalisation 
is a process of change with a definitive starting point and moving on a continuum of irrevocable 
change, with change clearly discernable into phases. The phases have unique characteristics 
attributable to it hence, classification is possible. Deprez (2003:367-373) stipulates that 
globalisation encompass three, distinct phases: 
• In the first phase, the focus is on breaking down of traditional trade barriers, 
• in the second phase the focus shifts towards deregulation and privatisation and, 
• in the third phase, international coordination, harmonisation and standardisation become 
key issues. 
47 
Transfer pricing, can be positioned within each of these phases with MNE's making use of the 
opportunities presented within each one of the discernable phases. 
2.2.2.1 Phase 1: Breaking down of traditional trade barriers 
During the first phase of globalisation, traditional trade barriers according to Deprez (2003:371), 
Dunning (2002:44), Lindert (1991:279) and Root (1978: 134-143) such as tariffs, quotas, and 
non-tariff barriers such as import licences, product standards and bureaucratic red tape are 
reduced and the aim is final abolishment. The General Agreement on Tariff and Trade (GATT) 
established in 1947 was initially devoted to the promotion of freer trade through multilateral trade 
negations in the trade of goods (Salvatore, 1987:228). According to Salvatore (1987:228) and 
Bennett (1999:13), GATT was based on three basic principles: 
• firstly, on non-discrimination which accepts the most favoured nation principle 
• secondly, on elimination of non-tariff barriers with the exception of agriculture products 
and for nations experiencing balance of payments difficulties 
• thirdly, it was geared towards consultation amongst nations in solving trade disputes within 
the GATT framework, being replaced by the World Trade Organisation (WTO) 
An attempt is made to settle disputes through bilateral talks and if the dispute cannot be settled, a 
working party is convened to investigate the matter and make recommendations accordingly. 
Should an offending country ignore the recommendations of the working party, the aggrieved 
country is permitted to retaliate (Bennett, 1999: 13). 
Using the European integration as an example, with the Internal Market Program (IMP) being 
initiated by the European Commission in Brussels in 1985, the intention was the removal of all the 
remaining non-tariff barriers to trade in goods, services and assets amongst the member countries 
by the mid nineties. Dunning (2002:252) estimates that amongst 1985 and 1990 12-member states 
had 319 directives, which intended to remove or drastically reduce trade barriers. The World 
Investment Report sustains the view that since the dismantling of trade barriers has gained 
momentum, it allowed MNE's to pursue integrated international production strategies resulting in 
a portfolio of locational, or geographical dispersed assets, which provide diversification 
opportunities during economic turmoil (UNCTAD, 2003:27). 
48 
2.2.2.2 Phase 2: Privatisation and deregulation 
With the advent of reducing trade barriers and non-tariff barriers, classified as phase one of 
globalisation, it is expected that sequential domestic economic adjustment needs to take place to 
give effect to these changes. During the second phase of globalisation, (Deprez 2003:372) the 
restructuring of the domestic economy is characterised by deregulation and privatisation. 
2.2.2.2.1 Privatisation 
Privatisation by nature is not sustainable due to a relative small, finite amount of centrally 
controlled companies that can be privatised, and the FDI attracted in the event of privatisation is 
volatile (Adelman and Nak, 2001: 90). In South Africa, the steel producer ISCOR, synthetic fuel 
producer SASOL and Telkom, the fixed line telephone services provider were privatised. 
Privatisation can result in increased transfer pricing risk. The privatisation of ISCOR in the South 
African economy is a case in point. The initial beneficiaries of the Iscor privatisation were 
employees, the general South African population and institutional investors. Unfortunately, 
shareholding tends to change, and in the Iscor example, Mitral Steel, bought out minorities, adding 
Iscor to its list of acquisitions. Iscor is an integral part of the Mittal Group with its influence 
stretching far beyond the national boundaries of South Africa, which give rise to transfer pricing 
risk. Transactions, which were not previously recorded (before Iscor became part of Mittal), are 
becoming part of the MNE's transactions. Management services are provided from India and 
London and supply agreements between members of the MNE, essentially Mittal Group 
companies replaced previous 3rd party supply agreements. 
Privatisation can cause economic mayhem. Korea is a prime example. During the sixties and 
seventies, banks in Korea were under strict, centralised, government control with some specialised 
government owned banks. Privatisation in Korea started in the early eighties albeit under strict 
central control concerning lending. Banks were mandated by the Korean government to provide 
solvency to the corporate sector and support social incentives. Encouragement was extended to 
grant loans to aspiring homeowners (social policy) and instructed banks not to call on corporate 
loans in 1992 and 1997. 
The expected moratorium on the calling of corporate loans lead to an unsustainable situation, 
banks were left with a very risky portfolio of loans with little, if any screening of projects and 
49 
credit-worthiness of borrowers. When the banks were privatised, the balance sheets of the banks 
were not purged of dubious assets, the legacy of dubious and questionable loans albeit that the 
banks enjoyed in essence insurance from insolvency from the central government increased the 
risk of failure (Adelman and Nak, 2001:91-93). 
Historically, the Korean environment was centrally controlled and protected. With liberalisation 
and the consequential opening up of the Korean economy, the institutional Korean problems were 
compounded by deficiencies of the international financial system with vast quantities of money 
being transferred; resulting in the implosion of the Korean system (Adelman and Nak, 2001:93). 
Similarities between privatisation in Korea and Eastern Europe exist. Bennett identified the 
following difficulties experienced with privatisation in East Europe (1999:65): 
• Many enterprises fail immediately upon their entry to the free market, leaving investors 
with worthless investments. 
• Price reductions and special inducements needed to unload certain enterprises might be 
very costly to the national authorities, which could in turn render the venture 
uneconomical. 
• Administrative systems established to organise privatisation are more often than not 
bureaucratic and inefficient themselves. 
• Privatisation is an enormous task with little prospect over the short term if a long-term 
approach is not followed. 
• Financial infrastructure to facilitate and assist in privatisation did not exist which 
compounds the problems experienced in privatisation. 
• Privatisation enjoys a high profile and creates unrealistic expectations. 
• A considerable amount of East European industries is worthless; however, parts of it show 
promise and potential and it is arguable that these potential parts were sold off at a big 
discount. 
2.2.2.2.2 Deregulation 
Deregulation within a global perspective can be observed with the conclusion of the Uruguay 
Round in December 1993 and the establishment of the World Trade Organisation (WTO). On the 
50 
back of the conclusion of the Uruguay Round and the establishment of the WTO, deregulation, 
and a distinct phase of globalisation took effect. Tariffs were to be lowered by 40 per cent by 
2000 with the US and the EU to lower tariffs on their products to one another by 50 per cent with 
immediate effect. GATT was restructured and the WTO emerged with increased powers. 
The new dispensation included new measures to deal with the protection of intellectual property, 
prohibition of trade in counterfeit goods, reform of national agricultural subsidies and trade in 
services. The Uruguay settlement concerning intellectual property provides for the fist time for 
the following (Bennett, 1991:14): 
• Patent protection for 20 years 
• Limitations on the use of compulsory licensing for patented products 
• Copyright protection for at least 50 years from the creator's death 
• All countries to introduce legislation to prevent the unauthorised disclosure of trade secrets 
• Provision of equal treatment for domestic and foreign intellectual property holders 
The inferences to intellectual property transactions within the MNE, is indicative of its 
importance. A chapter in the OECD Guidelines deals exclusively with transactions involving 
intangible property (OECD,1995:VT-l-VI-15). Therefore, with transfer pricing being the focus of 
the research and within the current text, the focus is on deregulation, (as a distinct part of the 
second phase of globalisation), and the Uruguay Round, where intangible property was first 
addressed. 
The phasing in of the agreement was asymmetrical with developing countries having five years 
and least developed countries ten years respectively. The World Investment Report states that post 
the Uruguay Round the average tariff rate cut across all products is 4 per cent for industrial 
countries whilst for developing countries it is at 25 per cent (UNCTAD, 2003:31). 
Tariffs and the reduction thereof provide further incentives for MNE's to transfer price. With an 
observed divergence amongst tariffs and corporate tax rate, the overall tax rate of an MNE can be 
artificially lowered. MNE's can by virtue of increasing the price of product bought from related 
parties, beyond the arm's length standard, end up increasing customs exposure but leverage the 
customs exposure off against corporate tax. 
51 
For example, a company imports a product with a tariff of 5 per cent. The imported product's 
price can easily be increased by 5 or even 10 per cent, effectively paying 5 per cent on the 
increased value instead of possibly 30 per cent corporate tax on the profit it would have made on 
the original (arm's length) price. The cost of the product is artificially increased with the retail 
price of the product being a constant; the resultant profit is lowered by at least the customs duty 
and the artificially increased portion of the price. By virtue of increasing the imported product's 
price, it is clear that profitability for the MNE and taxation can be lowered substantially in the 
specific country. 
2.2.2.3 Phase 3: International coordination, harmonisation and standardisation 
The removal, sometimes-asymmetrical removal of trade barriers between developed and least 
developed nations poses challenges of coordination and harmonisation. The removal of trade 
barriers, as envisaged by the Uruguay Round of the WTO and the consequent Doha Round, in the 
context of developed, developing and least developed nations, and the onset of privatisation and 
deregulation, some measure of global order organisation are needed to provide stability. 
The desire of developed, developing and least developed nations exists to impose order (Deprez, 
2003:372). This desire to impose order is a result of a general dissatisfaction with the market 
outcomes that are primarily a result of highly deregulated, privatised and an uncoordinated 
international market system. Dunning (2002:50) confers with the views of Deprez (2003:372) and 
illustrated in Figure 3, the types of inadequacies of the contemporary markets and institutions 
inclusive of the moral behaviour underpinning these and should be addressed for globalisation to 
succeed in the future. Market, institutional and moral failure is counter-productive to global 
capitalism and globalisation. 
Market failure is, according to Dunning (2002: 50), primarily driven by structural and endemic 
failures. According to the research undertaken by Dunning in seven countries, which is tabulated 
in Table 1, moral failure in five of the seven countries studied contributed to failures of global 
capitalism. Structural failures, discernable by inappropriate macro economic policies, overvalued 
or tied (pegged) currency as well as the presence of a strong black market contributed to market 
failure of global capitalism. 
52 
On the other hand, institutional failure is driven by various inadequacies. An inadequate 
regulatory and supervisory system was evident in all seven countries in which global capitalism 
failed. The lack of transparency and inadequate accounting standards (which is critical for 
transfer pricing transaction recognition) occurred in six of the seven countries whilst an 
inappropriate financial system let to the demise and failure of global capitalism in four of the 
seven countries. 
Figure 3: Three perceived ways in which global capitalism might fail  
(Source: Dunning 2002:50) 
Moral failure, especially nepotism, or Dunning's reference of crony or Mafia capitalism as well as 
the prevalence of bribery and corruption in five of the seven countries led to global capitalism 
failure. Dunning (2002: 51) list in Table 1 the three failure modes, discussed in the previous 
section, which were highlighted by the Asian financial crises and is evidenced by research in seven 
countries. 
53 
Market, institutional and moral failure cannot be singled out as the factor contributed to the 
actual "failure" of global capitalism. Some factors, such as inadequate regulatory/supervisory 
system are ever-present whilst others cannot be disregarded. Dunning stipulates that there seems 
to be a multiplicity of interconnected deficiencies when combined, results in failure and should be 
addressed (Dunning, 2002:50). 
Table 1: Failures of global capitalism in seven countries 
Japan Korea Indonesia Thailand Hong Kong Malaysia Russia 
Market Failure 
Moral failure X X X X X 
Inappropriate macro 
economic policies X X X X X 
Excessive speculation X X 
Overvalued currency / Tied 
exchange rates X 
Bad timing of short-term 
debt X X 
Presence of strong black 
market X X 
Contagion (contamination) 
effect X X 
Institutional Failure 
Inadequate 
regulatory/supervisory 
system X X X X X X X 
Inadequate banking system X X X X 
Inadequate legal and other 
infrastructure X X X 
Inappropriate financial 
system X X X X 
Inadequate protection of 
property rights X 
Lack of transparency / 
inadequate accounting 
standards X X X X X X 
Moral Failure 
Crony/ Mafia capitalism X X X X X 
Bribery and corruption X X X X X 
Lack of trust / social 
responsibility X X X 
Excessive greed of investors 
/ institutions X X X 
(Source: Dunning 2002:5J) 
The general strive towards order is not only limited to the abovementioned examples of failures. 
Deprez (2003:372) also identifies issues such as global warming (Kyoto protocol aimed at 
emission control) to take care of global issues that cannot be addressed only by the private 
markets. MNE's are not exporters of pollution due to their relocation activities of production to 
54 
areas with less stringent emission controls with some often set, rather than follow environmentally 
friendly operations. 
These relocation activities of production to countries with less stringent emission controls occur 
within the MNE, hence transfer pricing would become increasingly important in securing the 
national tax base in all the jurisdictions affected by such relocation activities. Relocation activities 
do not necessarily have to be in physical closure of facilities, it occurs as functional relocation as 
illustrated by distribution (refer to Table 7) and manufacturing structures (refer to Table 8 and 
Table 11) MNE's employ globally. 
2.3 Multinational Enterprise 
In order to clarify the term MNE, a description was previously provided in section 1.6.23. 
However, in order to clarify the concept, for the purpose of this discussion, an MNE is an 
enterprise that controls and manages production located in at least two countries. The MNE is a 
key driver of globalisation and it provides the engine for FDI flows to and from developed and 
developing economies globally. The MNE's influence stretches beyond FDI flows; it is also a 
globalisation driver insofar as trade amongst members of MNE's. 
2.3.1 Current environment 
Merger and acquisition represents one of the strategies an MNE might follow in the establishment, 
expansion or contraction of the MNE. By virtue of tracking the merger and acquisition activity 
over time, a general trend is expected to emerge, albeit that over the short term, volatility is 
expected due to economic up and downturns. Various factors, such as global economic growth, 
interest rates, and consumer demand etc. are expected to have an impact on the absolute level of 
the merger and acquisition activity. However, over time its illustrative trend is noteworthy, as 
depicted in Figure 4. 
55 
Figure 4: Cross border merger and acquisition with values over US$ 1 billion 
180 -
160 -
140 -
(0 
g 120-
■a 
■s 1 0 ° -
a> 80 -
Si 
| 60 -
2 40-
20 - r-T n f l 
- 70 
-60 
B 
- 50 O 
o 
- 4 0 *a c 
-30 ? 
a> 
a. 
- 20 
- 10 
- 0 
^ 
«87 1988 •989 1990 ■991 1992 •893 ■994 1995 B96 1997 1998 •899 2000 2001 2002 
i i No. of deals 14 22 26 33 7 t ) 14 24 36 43 64 86 114 175 113 81 
— • — - P e r c e n t of total 40.3 425 42.4 404 2 5 2 26.8 28.3 40.1 43.1 414 42.4 62 68.1 75.7 63.7 58.1 
Year 
(Source: UNCTAD 2003:17) 
In analysing and representing the data on a chart (Figure 4), it is obvious that merger and 
acquisition activity is on the increase, which is indicative of the prevalence of the MNE. The 
relative volatility observed in merger and acquisition activity as well as FDI flows, is expected in 
light of the up and downswings of the global economy. However, the World Investment Report 
cites volatility as being caused by the following microeconomic factors (UNCTAD, 2003:17-18): 
• Decline in reinvested earnings because of the repayment of intra company loans 
• Lower corporate profits combined with the MNE's ability or willingness to finance FDI 
through intra company loans in conjunction with a slowdown in corporate restructuring 
contributed to the downturn 
Downward pressure on MNE's corporate profits increases the risk of transfer pricing. Transfer 
pricing risk in this instance refers to the risk of revenue authorities querying profitability followed 
by a transfer pricing investigation. Under conditions of declining profitability in conjunction with 
the use of intra company loans (from capital-endowed parts of the MNE to parts of the MNE that 
is a net capital consumer) the MNE internally receive interest payments in certain areas whereas 
other areas are paying interest. 
56 
MNE's manage their taxation expense as they would any other expense, hence it does not make 
commercial sense to pay tax in certain locations whilst in other locations the MNE is in a tax loss 
position. It would be more prudent to lower the taxes paid in profitable areas (through interest 
payments to other parts of the MNE) and receive payment in areas where the MNE has an assessed 
tax loss. The overall tax positions will reflect a significant lower taxation expense. 
Volatility in merger and acquisition statistics can be seen from an investment perspective, a form 
of acquiring and merging of business enterprises into a bigger MNE or alternatively, a 
consolidation of businesses within the MNE or a move away from non-core operations. A decline 
in the merger and acquisition activities is indicative of disinvestment. Now, there is not any 
published information on divestment after merger by South African MNE's. The reality of 
disinvestment is tabled in Table 2, which illustrates the changes in the number of foreign affiliates 
and host countries of selected cases (UNCTAD, 2003:18). 
Table 2: Disinvestment after Merger 
Merger Case 
(Partner names) 
Merger Year No. of foreign affiliates and host 
countries at the time of the merger 
2002 (No. of 
foreign affiliates) 
Vivendi Universal 
(Vi vendi-S eagram) 
2000 
52 host countries 
904 foreign affiliates 
50 host countries 
704 
BHP Billiton 
(BHP-Billiton) 
2001 ■ 
30 host countries 
184 foreign affiliates 
20 host countries 
60 
Unilever 
(Unilever - Bestfoods) 
2000 
50 host countries 
275 foreign affiliates 
44 host countries 
242 
Nestle 
(Nestle-Ralston 
Purina) 
2001 
63 host countries 
428 foreign affiliates 
86 host countries 
398 
(Source: UNCTAD 2003:17) 
Disinvestment, the inverse of investment is clear from the statistics as tabled in Table 2. A 
substantial number of subsidiaries of MNE's, spanning a wide number of countries were closed 
down, which is indicative of the observed volatility. Within merger and acquisition activity, there 
seems to be periods of investment (rise in merger and acquisition activity) that is followed by a 
period of consolidation (static and decrease in merger and acquisition activity). Merger and 
acquisition activity is at best an indication of the underlying trend of globalisation insofar as the 
MNE. Merger and acquisition activity is not explanatory of the MNE hence further analysis is 
required. 
In an attempt to analyse the MNE, the analysis' point of departure are based on the basic 
fundamental issue of economics, as it would apply to any enterprise, i.e., scarcity (of production 
57 
factors such as capital, labour, raw material and entrepreneurship) within a national and global 
perspective. Scarcity in its simplest form is that the available resources and means are insufficient 
to fulfil all needs, i.e., unequal factor endowments. 
2.3.2 Unequal Country Endowments 
This imbalance or disequilibrium amongst resources and needs is due to the unlimited nature of 
needs, which continues to expand in contrast to natural resources, which are finite and scarce. The 
economic reality and challenge is to satisfy unlimited demands (needs) with limited, scarce 
resources. Demand as well as scarce resources is not restricted to specific countries or regions, it 
is globally spread because of the unequal endowment between countries. Limited resources are 
available and utilised in the provision of goods and services, on a national or global basis which as 
discernable as the following production factors (Smit, et at: 2002:6). 
• Natural resources such as minerals 
• Labour which includes physical and mental effort for reward 
• Capital inclusive of assets used for the production of goods and services 
• Entrepreneurs who recognises opportunities and economic demand (needs) and combines 
the production factors in order to fulfil the demand (needs) 
An adjunct to the abovementioned resources, Dunning draws reference to competitive strategies 
MNE's follow to obtain a competitive advantage (Dunning, 2002:235). Competitive advantage is 
achieved through natural resource seeking, market seeking, efficiency seeking and strategic asset 
seeking (refer to Table 4 for more details) activities that results in value creation in access of the 
cost involved in securing it (Porter, 2004:4). 
In order to achieve the objective of meeting demand, the allocation, production and distribution 
process requires consideration. In essence, scarcity involves the allocation of scarce resources, the 
production process utilising these resources and the distribution of these goods and services. 
Expanding on this approach, the MNE is the enabler through which scarce resources are allocated, 
utilised in production and distributed to fulfil demand on a multinational scale, globally. Dunning 
(2002:341) confers the abovementioned view and draws the attention to two commonly held albeit 
it divergent views of MNE's: 
58 
• Firstly, by virtue of their advantageous access to human and financial resources combined 
with the ability to limit geographic constraints by moving these resources across national 
boundaries and industries, which contributes to structural modernisation and 
transformation of the economies they came into contact with. 
• Secondly, MNE's' resource allocation decisions, based on a global perspective might be 
counter productive and even detrimental to the long term health of the economies in which 
they operate. 
AN MNE does secure access to resources through FDI. The FDI of the MNE have two distinct 
strategic dimensions (Dunning, 2002:222). Initially the FDI is geared towards obtaining access to 
natural resources and markets. Subsequent to obtaining access to natural resources and markets 
FDI changes focus aimed at achieving efficiencies and securing strategic assets. FDI of MNE's is 
not a once-off occurrence, it has an initial and sequential component that can be best illustrated as 
tabled in Table 3. 
Table 3: Four main types of FDI 
Initial FDI Sequential FDI 
1. Resource seeking (Natural) 
(a). Physical resources 
(b). Human resources 
3. Efficiency seeking (Rationalisation of production to exploit economies of 
scope and specialisation) 
(a). Across value chains (product specialisation) 
(b). Along value chains (process specialisation) 
2. Market seeking 
(a). Domestic markets 
(b). Adjacent market (regional) 
4. Strategic- (created-) asset-seeking (To advance regional or global strategy) 
(a). Technology 
(b). Organisational capabilities 
(c). Markets 
(Source: Dunning 2002:233 and own compilation) 
The initial FDI as well as the sequential FDI poses challenges for transfer pricing. The challenges 
can be summarized as follows: 
• Resource seeking FDI focus is on access and allocation of the scarce natural resources 
spanning geographical boundaries. Transfer pricing is concerned with the supply 
agreements between natural resource MNE's. 
• Market seeking FDI, on the other hand is primarily involved in establishing and securing 
demand within the domestic and adjacent market in order to fulfil demand (need) for goods 
and services. Resource and market seeking FDI of MNE's converge through establishment 
59 
of specialised global marketing organisations. These global marketing organisations poses 
substantial transfer pricing challenges with their purchases of natural resources from 
affiliates globally, servicing their global customers from a single location. MNE's with 
substantial interest in the natural resource market such as Rio Tinto, Billiton, Total, and 
SASOL etc. are some examples. 
• Efficiency seeking FDI is part of the broader sequential classification, which aims to 
achieve increasing efficiency of regional and global activities by MNE's through 
integration of assets, production, and markets. Often, sequential and first time investment 
are in form and substance strategic asset seeking investment with the main purpose to 
acquire resources and capabilities to augment competitiveness and core competencies on a 
regional and global scale (Dunning, 2002:233). 
o Efficiency seeking FDI poses significant transfer pricing, and in particular 
comparability challenges. Efficiency gains from economies of scale and 
integration (benefits from being part of a bigger group) are recognised by the 
OECD Guidelines (OECD, 1995:1-4,111-3 and VII-5). 
o Comparability and in particular the determination of the arm's length consideration 
could theoretically be influenced by efficiency gains the MNE obtains. The OECD 
Guidelines as well as PN 7 recognises that benefits a member of an MNE obtains 
through being part of an integrated group does not necessarily feature in 
independent dealings (OECD, 1995:VIII-4 and South Africa, 1999:21-22). 
• Strategic asset seeking FDI aims to advance the regional and global strategy of the MNE 
through leverage from technology, organisational and market positioning. This strategic 
asset seeking FDI results in new finance capital and the creation of complimentary assets in 
the regions or countries the MNE operates. 
The contribution of the natural resource seeking, market seeking, efficiency seeking and strategic 
asset seeking behaviour of MNE's and the competitive advantage opportunities is highlighted in 
Table 4. Obtaining access to natural resources and markets as well as reaping the benefits from 
efficiency gains and ownership or control of strategic assets is an objective of the MNE to secure a 
competitive advantage. 
60 
Table 4: MNE's competitive advantage opportunities 
Natural 
resource 
seeking 
Provides for complimentary assets (Management, technology and organisational competence) 
Provides access to foreign markets 
Raises standard of product quality 
Could foster clusters of resource based related activities 
Market 
seeking 
Provides for complimentary assets 
Foster backward supply linkages and clusters of specialised labour markets 
Raises standard of product quality as well as consumers' expectations of domestic competitors 
Stimulates local entrepreneurship and domestic competition 
Efficiency 
seeking 
Improves international division of labour and cross border networking 
Provides access to foreign markets and sources of supply 
Foster backward supply linkages and clusters of specialised labour markets 
Raises standard of product quality 
Stimulates local entrepreneurship and domestic competition 
Assists in structural adjustment 
Strategic 
asset 
seeking 
Provides new finance capital and complimentary assets 
Provides access to foreign markets 
Stimulates local entrepreneurship and domestic competition 
Improves international division of labour and cross border networking 
(Source: Dunning 2002:235) 
The diversification benefit is not illustrated but it is noteworthy that the benefit for MNE's in 
having natural resources and markets in different geographic markets spread globally provides 
opportunities to limit the potential detrimental effect economic up and downswings in one country 
compared to that of another. The upswing in one country can effectively offset the downswing 
observed in another which limits the overall impact on the MNE. 
2.3.3 International production 
During the 1970s and 1980s, the world was exposed to new, emerging industrialising countries 
(predominantly from the East), a series of technological breakthroughs in the information 
technology and communications industries. The emergence of industrialised economies combined 
with technological advancement in information technology and communication had and continues 
to have a profound impact on economic activity and resources allocation, amongst and within 
countries. 
61 
Global economic growth declined during the 1970s and 1980s and a swing towards neo-liberal 
policies of governments has had a different impact on countries. The impact depended primarily 
on the level of development and economic structure of the countries and their government's ability 
to adjust (Dunning, 2002:340). 
Tolentino (2000: ix) and Cantwell (2000: 11) reports four frameworks which provides insight to 
the major theories of international production which are: 
• A Microeconomic approach that examines the international growth of individual 
enterprises or MNE's 
• A Mesoeconomic approach that considers the interaction amongst enterprises at an 
industry level 
• A Macroeconomic approach, which studies broad national and international trends 
• An Eclectic paradigm, which is not an alternative analytical framework but rather as an 
incorporation of various elements of all the other approaches 
A common issue identified by the various economic schools of thought is that attention should be 
given to the dynamic aspects of international production. Theoretical divergence is expected 
within the ambit of international production, however, the eclectic paradigm is not merely a 
paradigm contributable to a diversity of ideological standpoints but is has a wider implication due 
to the following (Cantwell, 2000: 11): 
• International production could be resource based, import substituting, export driven or it 
could be a drive towards global integration with each of the abovementioned raising 
specific considerations, which have a different affect on home and host countries. 
• Related to international production, the theories address issues and raises questions with 
respect to the theories of international capital movements, international trade, location, 
industrial organisation, innovation as well as the enterprise at large. Theories of the 
enterprise will concern itself with the MNE, whilst the theory of international financial 
flows would be primarily concerned in FDI 
• An analyses of international production can be undertaken at three levels, 
62 
o The first being the macroeconomic level where the analysis are based on broad 
national and international trends. The theories relied on theories of trade, location 
insofar as FDI is concerned, balance of payments and exchange rates. 
o Secondly, the mesoeconomic level which considers the interaction amongst 
enterprises at an industry level. These theories are inclined towards industrial 
economics, game theory and the theory of innovation and comparative corporate 
trajectories or strategies. 
o Thirdly, the microeconomic level, which is concerned with the international 
growth of individual enterprises and the theory of the individual enterprise. 
The emphasis of this theoretical review cannot be all inclusive, special emphasis is on the theories 
of international production which best explains the MNE in its drive to provide goods and services 
from limited resources to fulfil unlimited demands. The inference of the interaction within the 
MNE to fulfil the economic objective in relation to scarcity is of critical importance in terms of 
transfer pricing. 
Transfer pricing imposes a hypothetical market in the determination of the arm's length 
consideration, hence reference to the market approach to international production is followed. 
Alternative approaches to study the MNE are possible. Transaction internalisation with reliance 
on the transactional cost approach to economic organisation is such an alternative. Dunning 
(2002:377) reiterates this approach by highlighting the role of transaction cost in determining the 
organisation, the MNE, in terms of economic activity. Cantwell (2000:11) views the MNE in 
relation to markets, which are applied to international production, effectively emphasising 
transactional efficiency. 
Each one of the approaches has value in analysing the MNE as a key driver of globalisation and 
transfer pricing as the pricing mechanism. However, transfer pricing is based on the hypothetical 
market being imposed on transactions amongst connected parties. The market is the environment 
in which transactions are concluded. In order to achieve the research's objective insofar as 
transfer pricing, the market approach is the focus of analysing the MNE. 
63 
2.3.3.1 Market power approach 
Cantwell (2000:12) and Dunning (2002:404) elucidates the theory of international production 
separate from the theory of international trade and capital movements. The orthodox theory of 
international trade and capital movement does not explain the foreign operations of MNE's, 
especially the two-way flows of FDI nor the flows amongst countries with similar factor 
endowments (Cantwell, 2000:12) 
The market failure paradigm was internationalised (refer to Figure 3 and Table 1 for more detail). 
Economically advanced and developed countries with capital abundance and labour scarcity have 
low profit or interest rates but high wage rates prior to international transactions. Exports to less 
developed, labour abundant countries comprise of products dependent on capital-intensive 
production methods. Capital are also exported in the form of direct FDI to developing countries, 
capital flows from low return to high returns based on scarcity (Cantwell, 2000:13). 
Traditional classical approaches came to the same conclusion that due to under-consumption of 
capital in the countries with low interest, the capital can produce higher rates of return in 
developing countries with different resource endowments to provide a higher return (interest rate). 
In the home country, the return (interest rate) is under downward pressure due to competition, as 
envisaged by Adam Smith, with developing countries absorbing the surplus capital at a higher 
return (interest rate). 
Marxist proponents attributes this downwards pressure on returns to either a rise in the capital 
output ratio (organic composition of capital) or a fall in the share of profits in income (the rate of 
exploitation) (Cantwell, 2000:14). The conclusion is that there will be investment opportunities in 
developing and least developed countries (LDC) with a low capital output ratio or countries, which 
allow exploitation of a disorganised labour force. 
2.3.3.1.1 Central themes of the market power approach 
Cantwell (2000:14) elucidates that the conventional explanation of international production focus 
on the macroeconomic level failing to explain cross-investment amongst developed countries 
without any reference to cross-investment amongst industries of any substance. Cantwell 
(2000:15) responds to the conventional explanation of international production with the theory of 
64 
the enterprise within its industry in an attempt to establish the determinants of intemalisation. The 
main ideas surrounding the determination of intemalisation of the MNE are as follows: 
• In the early stages of growth, MNE's increase their share of the domestic markets through 
merger and acquisition and capital extension with an increase in profits due to increased 
industrial concentration and market power. 
• Market expansion within the domestic market is finite; hence, profits from the domestic 
market under a high degree of monopolistic behaviour are invested in foreign markets in 
foreign enterprises. This will be leading to a similar process of assimilation and increased 
industrial concentration in the foreign market. 
• Adam Smith's notion that enterprises (similarly MNE's) would seek collusive agreements 
in order to sustain profits is not in line with the market power approach. Adam Smith sees 
competition amongst MNE's as a spur to increased levels in investment and technological 
change whereas under the market power approach investment is not seen as so much an 
independent response to competition but rather as a means of extending and expanding 
collusive networks. 
• Common belief is that MNE's invest in foreign operations to reduce competition and 
increase barriers of entry in their respective industries. Increasing their monopolistic 
power might be counterproductive since efficiency in foreign operations could decrease 
over the long term. 
• The market power approach is at odds with the alternative theory, which postulates that the 
centrifugal objective of the MNE is to increase its international effectiveness by virtue of 
enhanced profits. 
At best, it is ambiguous to contemplate that an MNE by virtue of increasing productivity in foreign 
operations and enhanced efficiency through the coordination of different types of plant and 
technology in the foreign operations would equate to increased profitability in international 
industries. Increased efficiency within the MNE's might increase competition amongst them, 
complicating the perception and measurement of profitability, which could be a setoff against 
efficiency, gains, which is difficult to quantify in transfer pricing. 
65 
The market power approach can be associated with industrial organisation insofar as the 
argument that a more concentrated market structure points towards a greater degree of collusion 
amongst connected parties (the area Transfer Pricing is concerned with) and a higher rate of 
profit. The market power approach contemplates the conduct of MNE's to market structure rather 
than vice versa. MNE's are seen as establishing a position of power in their domestic economy 
and in their respective international industries. Internationalisation is also triggered by a decline or 
stagnation in the domestic market. 
Arguments can be raised that the market power approach is irrelevant due to increased 
globalisation. The MNE has a diversity of potential global sources of supply. These sources of 
supply erode the traditional position of market dominance in the domestic economy. In effect, the 
argument is based on the premise that profits derived from market power approach will over the 
long term diminish with sustainability dependent on the MNE's ability to create an international 
network of innovation situated in locational dispersed centres of differentiated new technology. 
The counter argument can be based on the fact that currently globalisation is associated with the 
increasing influence of finance capital, which is reminiscent of the categorisation of imperialist 
capitalism (Cantwell, 2000:17). Deregulation of financial markets and the increasing economic 
weight of leading financial institutions brought about renewed pressure for profits from market 
power through perpetual re-contracting and redistribution of income. The critical issue is if these 
pressures could result in sustainable profit over a long period of time in the current paradigm 
where it is becoming increasingly difficult to establish and hold market power (Cantwell, 
2000:17). 
The difficulty in establishing and holding of market power is not removed from having access to 
the resources, assets in particular that give rise to the market power. MNE's retain control over 
the network of assets due to the "internationalisation advantages" of doing so Cantwell (2000:20). 
2.3.3.2 Complimentary Assets 
Internationalisation advantages arose from the increased ease with which an MNE is able to realise 
return on its assets, albeit distinctive in the narrow definition and classification of assets, such as 
technology (Cantwell, 2000:20). This realisation is not limited to technology-based assets, it is 
66 
also applicable to the return realised directly attributable to the coordination of complimentary 
assets, naturally subject to the costs of managing these complex asset network. 
Cantwell (2000:20) alludes to the advantage derived by virtue of employing a common 
governance of a network of complimentary assets located in different countries. This encapsulates 
intemalisation through the coordination and use of complimentary assets, similar to the 
transactional benefits Dunning refers to (Dunning, 2000:125). 
2.3.4 Transfer pricing implication of the market power approach 
An advantage obtained from coordination within the MNE and not necessarily through market 
coordination, is indicative of the so-called transactional market failure (Cantwell 2000:20). 
Cantwell (2000:20) cite the following three reasons, which have particular significance to transfer 
pricing, that transactional market failure are can be attributable to: 
• In the event of the presence of externalities (such as counter trade agreements), benefits 
external to the transactions concerned could possibly not being recognised by the relevant 
parties dealing at arm's length. 
• This role of externalities is of particular importance within the context of transfer pricing. 
Connected parties' dealings, which for transfer pricing purposes implicitly implies amongst 
connected parties, would fail to recognise these external benefits in determining the arm's 
length standard. This is due to the preposition that the arm's length consideration is based 
on the dealings comparable to that of unconnected parties. Hence, failure to recognise the 
benefit derived from coordination of complimentary assets within the MNE cannot be 
established if the comparative benchmark is based on independent enterprise dealings. 
• Risk and uncertainty plays a significant role in cross border transactions. Entry into new 
markets and access to resources from previously external sources (from the perspective of 
the MNE) give rise to uncertainty and consequent risk. 
o Comparability used to determine the arm's length consideration in transfer pricing 
is based on functions performed, assets used and risk assumed. 
o Risk assumed in this context is not necessarily all encompassing of cross border 
transactions; comparability is primarily based on functionality. 
67 
o Cross border transaction; prevalence is not easily established and is not a 
prerequisite in the determination of the arm's length consideration. 
o In order to recognise the differences in risk, in the South African market, a risk 
premium is considered appropriate. The risk premium is based on the differences 
between the comparable government bond yields. In section 5.4.5.2 the use of the 
bond yield as risk premium is discussed in detail. 
2.3.5 The Transfer pricing challenge to classic theory 
The previous sections created awareness that globalisation by nature, and in practice are 
responsible for significant expansion in the exchange of goods, services and capital flow across 
national boundaries. The theory of international trade as promulgated by David Ricardo's 
comparative advantage (Lindert, 1991: 24) fails to explain the dynamics of transfer pricing as a 
form of international trade. The normative conclusion that gains of trade is comparative insofar 
being relative and not absolute does not explain the advantages obtained from intra-firm trade and 
in essence the proceeds from such trade. 
The MNE trade within itself, within national and international boundaries and in so doing create 
"markets". These markets, does not exist in the broader sense, i.e., willing buyer and seller with 
both parties striving to optimise their benefits from the trade. In MNE's, the objective could be to 
achieve the greatest level of benefit from the total value chain, often spanning multinational 
boundaries, not necessarily from each transfer amongst member organisations. 
In some instances, especially the transfer of intermediate or semi-finished goods amongst 
connected parties, no comparative market exists (South Africa, 1999:17-18). Transfers only take 
place within the group and as such, international trade according to the classical theories fails to 
explain the MNE where the one party of the MNE has a comparative advantage or even an 
absolute advantage over the other, hence the prevalence of international trade. 
Objectives for intra-firm (market) and inter-firm (MNE) are different where inter-firm's objectives 
are to realise profit where the transaction occurs. Inter-firm profit realisation is closer linked to 
maximisation of the benefit over the complete value chain. Within the ambit of the MNE, taxation 
insofar as profit recognition, taxable loss set-offs amongst loss making and profitable enterprises 
to affect a neutral position, and debt structures with interest payments can be some of the 
68 
considerations international tax planning, of which transfer pricing is one aspect. A specific 
transfer pricing inference is when arbitrary allocation of cost occurs in a high tax jurisdiction 
rather than where the expenses have been incurred. 
Transfer pricing is the focus of the research. However, transfer pricing is also one aspect of 
international tax, hence a contextual analysis of the pertinent international tax issues provides 
greater insight to transfer pricing. 
2.4 International taxation 
Moving beyond the substantial issues of progress, economic growth and the role globalisation and 
the role the MNE plays in the world economy, taxation and its implications seems to be a matter of 
accounting and financial consolidation. Such apathy is misplaced and the importance of the 
taxation of corporate profits within the jurisdiction in which the MNE realises such income, 
demands attention to detail for managers of MNE's and tax authorities alike. 
In this section, the normative effect of corporate taxes on MNE's are considered. The welfare of 
the host country (country receiving FDI, or from which the particular member of the MNE 
operates) is incorporated within the context of international tax. 
2.4.1 The Global context 
All countries levy taxes on the net income of enterprises (includes MNE's, branches, close 
corporations etc.) at marginal rates. Traditionally tax is seen as a levy on pure economic rent or 
surplus that has no or very little impact on savings or output decisions (Caves, 1999:189). 
Caves (1999:189) alludes to the practical aspect of taxation, it is seen as the "sum of the 
opportunity cost of equity capital plus any rents or windfalls accruing to suppliers of capital." 
Following this approach, taxation cause a divergence from the net return received by investors and 
the before tax earnings of the investment invested by the MNE. The tax impact on investors and 
conversely the consumers of goods or services depends on elasticity (refer to 1.6.11). In the event 
that the supply of capital was perfectly elastic (invest in non-tax forms or increase consumption 
when tax reduces the net return to equity capital), the tax burden would entirely fall on the 
consumers of the MNE's goods and services (Caves, 1999:189). 
69 
This research refers to FDI flows within the MNE. Examples are used to illustrate the various 
concepts involved in international tax and transfer pricing. In order to explain the various 
concepts reference to the country of origin will be referred to as "Home" and the recipient country 
as "Foreign". 
Moving from the premise of foreign investment, "Home" investors have a choice, either to invest 
domestically or abroad with "Foreign" users of capital acquiring capital from domestic or sources 
from abroad. Concepts of tax-neutrality emerges which serves the purpose of identifying the 
effect of taxes on capital location. 
Capital-export neutrality refers to the choice that "Home's" MNE make amongst investment in 
domestic activities and investing abroad. All-inclusive relevant taxes taken into consideration are 
considered neutral if domestic and international investments earn the same pre-tax rates of return, 
which also yield the MNE the same returns after tax. 
Capital-import neutrality addresses the competition amongst "Foreign's" domestic investors and 
the MNE to supply capital that produces goods in "Foreign". The tax system is neutral if equal 
before tax returns are realised by the MNE and competing suppliers of capital, which translates 
into equal after tax returns. Neutral tax systems ensures and promotes efficient use of resources 
and might be considered just (Caves, 1999: 190). Import neutrality places competing domestic 
MNE's and foreign subsidiaries on an equal footing to the extent that "Foreign's" buying decision 
is based on the most competitive source not being distorted by taxes. 
2.4.1.1 Multiple tax authorities 
Neutrality is primarily based on who is paying what tax, not where such tax is being paid. The 
dynamics of tax neutrality and transfer pricing is best understood by making use of "Foreign" and 
"Home", terms used for illustration purposes. 
In the event that "Home" does not impose corporate tax whilst "Foreign" imposes 40 per cent tax 
on resident capital, domestic or foreign. Capital-import neutrality exists in "Foreign" but capital-
export neutrality does not exist in "Home" as the MNE would divert their funds towards untaxed 
domestic investment projects rather than pay the 40 per cent corporate tax in "Foreign". 
An alternative scenario can also prevail: In the event that "Foreign's" tax authority does not levy a 
tax but "Home" levies a tax of 50 per cent on all profits earned by "Home's" residents irrespective 
70 
if their capital is placed abroad or domestic. Capital-export neutrality prevails but certainly not 
capital-import neutrality. From the example it is clear that taxes are to be paid, the dilemma is 
which tax jurisdiction get which taxing right to the profits in question and what allowance the 
other jurisdiction makes for the taxes being paid in the other jurisdiction. In the example, "Home" 
is having the opportunity (right) to tax and can possibly decide on the following policies (Caves, 
1999:91): 
• Exemption. "Home" can exempt further taxation of income of the MNE, which has been 
taxed abroad, often referred to preventing double taxation of the same economic profit in 
multiple jurisdictions. In the example, the tax rates amongst the two jurisdictions differ; 
capital-import neutrality prevails although capital-export neutrality does not exist under the 
circumstances. 
• Tax credit. "Home" taxes the MNE's foreign profits at the same rate as domestic 
enterprises but provide a tax credit for taxes paid in the other jurisdiction. 
• Tax deduction. "Home" can allow the taxes being paid by the MNE to Foreign as a 
deduction from income taxable by Home, in effect the MNE's capital placed abroad are 
being subjected to double taxation. The overall tax rate on the MNE's capital 
is t = tH (1 - tF) + tF . Where tF and tu are respectively the "Foreign" and "Home" tax rates. 
If "Foreign's" tax rate is 40 per cent and "Home's" tax rate is 50 per cent, the overall tax 
rate of the MNE's capital t is equal to 70 per cent (f = tH(l-tF)+tF,t = 0.5(1-0.4)+ 0.4). In 
such a situation, neither import nor export neutrality is served. 
Countries such as Germany, France, the Netherlands and Canada employs the exemption 
procedure whilst others such as the United States, United Kingdom and Japan the partial credit 
system. Caves (1999:191) express the view that in the case when capital-import neutrality and 
capital-export neutrality prevails, that tax does not distort the foreign investment decision. 
Empirical research undertaken by Sedmiharadsky and KlaR in 2001 in South Eastern Europe 
confirms the view of Caves that tax does not distort the foreign investment decision. 
Sedmiharadsky and KlaR (2001:187) found the following have a bearing on the foreign 
investment decision and not the general belief that tax rates per say are a major determinant: 
71 
• Generally it is found that host country tax rate usually plays no role in initial decision of 
the MNE to invest abroad although it might be of importance insofar as location decisions. 
• There is increased sensitivity of real manufacturing capital to host country taxation over 
time being consistent with international mobility of manufacturing capital, which in turn 
suggests increasing potential of tax incentives, which influences HDL 
• They caution in their report in the application of the estimates used because true elasticity 
depends on a range of factors, which are difficult to control in empirical work. 
2.4.1.2 Deferral and transfer pricing regulations 
The effective rates of taxation's influence on MNE's depends on various factors such as the 
definition of taxable income which varies amongst countries, rules governing depreciation and 
even in the example used the rules of "Home" to include the MNE's' tax position in various 
foreign jurisdictions. 
Deferral could have a bearing on effective tax rates of MNE's (Caves, 1999:192). For instance, 
when countries adopt a tax credit scheme to tax MNE's' profits from activities abroad once the 
profits are repatriated, the following can easily occur. If the tax rate in "Home" is bigger than in 
"Foreign" (fa> tp) the foreign subsidiary of a "Home" MNE can pay tax levied at "Foreign's" tax 
rate (tp ) on its current profits, reinvest the balance for an unlimited period and pay the additional 
(fa - tF ) only when the profits are repatriated. 
In this situation when the tax rate in "Home" is bigger than in "Foreign" (fa > ?F ) the deferral 
lowers the effective tax rate paid in the capital invested abroad. In this example, the level of 
investment from abroad change as the subsidiary becomes self-sufficient and utilise reinvested 
earnings for expansion in the "Foreign" market. 
In a South African context, the Secondary Taxation of Companies (STC) imposes a 12.5 per cent 
tax on the distribution or deemed distribution of dividends. The distribution of the proceeds, if 
South Africa is the "Foreign" country, STC would result in 12.5 per cent tax on the distribution 
(dividend or deemed dividend). In this scenario, it will not be conducive to repatriate the profits as 
dividends. STC, a specific tax levied on distributions makes dividend distributions not an 
attractive alternative. It might be more prudent for the "Home" MNE, to forward a loan to 
"Foreign" (South African) subsidiary, charge interest and pay tax on it in "Home". In order to find 
72 
the best alternative, a critical analysis of thin capitalisation requirements, effective tax rates for 
"Home" and "Foreign" where dividends are taxed at 12.5 per cent on after tax returns whilst the 
difference in tax rates between "Home" and "Foreign" might make funding through loans more 
efficient. 
In following the approach of the transaction cost model where transaction cost are used in 
determining the organisation of economic activity it is clear that the transactions of MNE's often 
lacks comparable transactions in arm's length markets or conditions (Dunning, 2002:377). This 
reality confronts tax authorities and management of MNE's to devise a standard that could be used 
for the pricing of the transactions under consideration. 
Effective tax rates can possibly be manipulated by the MNE through opportunities presented by 
transfer pricing and thereby limiting the tax authority's ability to counteract its strategic behaviour. 
The empirical part of this research investigated the prevalence of transfer pricing in a specific 
MNE and the results are reported in Chapter 5. 
Basically, the MNE has the ability through virtue of non-neutral taxes the incentive to recognise its 
profits in the low-tax jurisdiction. Making use of the previous example, it is prudent from the 
MNE's perspective when the tax rate in "Home" is bigger than in "Foreign" (% < tp ) to use the 
subsidiary in "Foreign" to overstate its purchases from the parent in "Home" (what transpired in 
the empirical case in this research), or alternatively understate the cost of goods and services 
supplied to the parent until nominal profits earned in "Foreign" equalise at zero. This will occur 
when the MNE induce to lower or raise the price on any intra company trade until all the profits 
has been shifted to the low tax jurisdiction. 
Enforcement by tax jurisdiction of their transfer pricing regulations insofar as their ability to 
determine the arm's length consideration and the taxation of profits based on it further reduces the 
MNE's' arbitrary transfer of profits or recognition of expenses in the higher tax jurisdiction. 
Introduction of ad valorem tariffs on the declared value of goods imported could potentially limit 
extreme transfer pricing practices. 
Financial flows amongst members of MNE's are designed and designated as debt or equity and is 
often arbitrary with hybrid instruments being included in the balance sheet to maximise the benefit 
from deductibility of interest payments without corresponding equity contribution to the affiliate. 
73 
In the empirical part of the research, a similar structure was identified and the treatment from a 
transfer pricing perspective is discussed. 
2.4.2 Tax competition 
Global expansion unlocks opportunities insofar as providing tax benefits to enterprises they were 
not previously accustomed to. In the previous example, tax differentials did not exist, however, in 
practice it does and its impact can be substantial. 
Tax differentials exist amongst national jurisdictions, it provides arbitrage opportunities, which are 
not further explored in the research, and it is becoming increasingly important in business 
decisions Deprez (2003:373). It is not surprisingly that national regimes and MNE's were seeking 
for an instrument or organ that could address these inequalities that could severely impact business 
and tax administration alike, hence the establishment of the Organisation for Economic Co­
operation and Development (OECD). 
The OECD, since its inception in 1961 aims to coordinate economic policies and its focus on what 
it terms "harmful tax competition" and expands its work to limit the occurrence of international 
juridical double taxation, a phenomena which is brought about by globalisation (Bennett, 
1999:286 and OECD, 1995:P-1). The OECD Model (OECD, 2000:7) states "It has long been 
recognized among the Member countries of the OECD that it is desirable to clarify, standardize, 
and confirm the fiscal situation of taxpayers who are engaged in commercial, industrial, financial, 
or any other activities in other countries through the application by all countries of common 
solutions to identical cases of double taxation.". 
The role of the OECD is certainly not limited to the governance of transfer pricing practices and 
model conventions with respect of juridical double taxation. The scope included MNE's and their 
role in globalisation, which lead to the publication of the OECD Guidelines for MNE's as far back 
as 1976. At the time, the late seventies, growing concern of the activity of MNE's and their 
impact on domestic economies and societies was centre to substantial debate (Arghyrios, 1999:2). 
Although the primary focus was on the MNE, concerns dealing with the apprehensions over 
security of foreign direct investment (FDI) and "proper" limits of host country regulation of EDI 
and MNE's came under the scrutiny. 
74 
2.4.3 International tax competition 
International tax competition in its simplest form merely signifies the use of tax instruments by tax 
authorities to attract business. Deprez (2003:373) regards "international tax competition to occur 
when one country provides tax inducement to attract capital from another country." 
Hammer and Owens (2001:1) claims that the work over the last thirty years of the OECD 
succeeded in developing globally accepted standards and its efforts to reduce conflict amongst tax 
administrations contributed to a fiscal climate conducive to cross border trade and fair sharing of 
the tax base amongst countries. Hammer and Owens (2001:1) encourage fair tax competition 
within the paradigm of globalisation and acknowledge the concerns of governments relating to 
potential distortion of economic behaviour, which widens the opportunities of tax non-compliance. 
This view of fair tax competition is echoed in the OECD's (2001:4) project on harmful tax 
practices "... can work together to eliminate harmful tax practices, the OECD seek to promote tax 
competition that will achieve ... economic growth and development world-wide." The importance 
of attaining convergence amongst the business community and the OECD through the elimination 
of harmful tax practices is primarily driven by the OECD's project on harmful tax practices and 
aims to (Hammer and Owens, 2001:2): 
• Provide a level playing field in the tax area for cross border activities 
• Facilitate competition that is fair and transparent 
• Intend to ensure that all taxpayers meet tax obligations, a goal of mutual importance for 
business and tax administrations 
Various instruments are available to countries and can include differential tax rates, tax 
exemptions, deductions and rules that are currently part of the domestic tax legislative framework. 
A variety of incentives were found (based on a survey of 80 projects in least developed countries 
with 22 of the projects being initiated due to requests from the host countries) to be offered by 
countries and they are as follows (Caves, 1999:219): 
• Tariff protection with 34 of 76 cases evaluated. The mean tariff rate was 68 per cent 
• Import-quota protection, 34 of 77 cases 
• Tariff reduction on imported equipment, 43 of 78 cases 
75 
• Tariff reduction on imported components, 29 of 75 cases 
• Tariff reduction on imported raw materials, 26 of 76 cases 
• Tax holiday, 37 of 80 cases with the mean of the tax holidays being five years 
• Accelerated depreciation for tax purposes, 20 of 71 cases 
• Public provision of infrastructure investments, 18 of 70 cases 
Caves (1999:219) states that government assistance for instance in the export-orientated 
investments receive tax holiday and infrastructure investments. On the other hand, projects aimed 
at the domestic market receiving protection against competing imports. Competition and tax 
competition will not dissipate, with a potential market of 65 000 MNE's controlling 850 000 
foreign affiliates (UNCTAD, 2002: xv). 
2.4.4 Harmful tax competition 
The OECD's project on harmful tax practices (Hammer and Owens, 2001:3 and OECD, 2001:4,7) 
regards tax havens as a form of harmful tax competition. Tax havens, seen as a form of harmful 
tax competition are small countries such as the Bahamas, Cayman Islands and Guernsey, to name 
a few, which provide a "tax haven" to foreign enterprises which only needs to establish nominal 
residence, can receive money from abroad without having to disclose it, they are legally entitled to 
conduct their business in secret. 
This research does not concern itself with the merits to the existence or commerciality of tax 
havens, it merely reports on the existence thereof and incorporate a general view on it for 
completeness. In the case of tax havens, Bennett (1999:286) highlights that the benefit tax havens 
obtain is the increased domestic expenditure and the stimulation the domestic banking and 
financial infrastructure receive from the increased activity. The contemporary view and arguments 
against the use of a tax haven according to Bennett (1999:287) are: 
• The administrative and other cost of shifting funds and maintaining secrecy may outweigh 
the benefits derived from it, in this particular case, tax savings. 
• Interest on money held in a tax haven might be lower than in the domestic market or 
elsewhere. 
76 
• A growing number of countries refuse to recognise the existence of tax havens from a 
fiscal point of view. Treatment of transactions can be as severe as assuming that the funds 
in a tax haven are part of the MNE's assets in its home country and tax it as such. 
• Transfers to and from tax havens is more likely to attract the attention of the MNE's 
domestic authority with subsequent investigations into the fiscal affairs of the enterprise. 
• Tax havens are not part of bilateral tax treaties or agreements and are excluded from any of 
the benefits arising from these agreements and treaties. 
Although in certain circles, tax havens are seen to be the scourge in international tax 
administration whilst others regard it as part of the operating global environment. Whatever the 
opinion, it exists and provides MNE's with alternatives in structuring their global business. 
The impact of harmful tax competition or tax havens are not investigated, however, international 
business structures involving these tax havens are common, all cite business reasons for the 
establishment and continuous business dealings through it. It could be of value if an empirical 
investigation could identify the commercial benefits it provides to MNE's in the advent of greater 
tax harmonisation and equalisation of corporate tax rates. 
2.5 Global transfer pricing trends 
Literature on transfer pricing practices in general is limited. From Table 5 it can be derived that 
the pressure on MNE's from tax authorities is not dissipating. There might be a shift in focus to 
different areas, such as intellectual property and tangible goods but it remains a rewarding area of 
compliance and enforcement if 33.3% of transfer pricing audits results in an adjustment (Ernst and 
Young, 2003:7). 
77 
Table 5: Key global transfer pricing trends — a comparative survey 
Key Global Findings in 2001 Key Global Findings in 2003 
Since 1995, transfer pricing remains the prominent 
international tax issue for parent companies and 
they expect it to be so for the next two years. 
Eighty-six per cent of parent and ninety three per 
cent of subsidiary respondents identified transfer 
pricing as the most important international tax 
issue they currently face 
Some MNE's insist on single transfer pricing for 
both management and fiscal purposes whilst others 
maintains two sets of prices. 
Seventy six per cent of all respondents think an 
audit is likely to occur in the next two years. 
Two thirds of parent and half of subsidiaries have 
not considered the transfer pricing issues around 
their e-commerce activities. 
All companies are exposed to audits, however, the 
bigger companies have a higher than average 
exposure. 
Transfer pricing audits continue to be a major issue 
for companies around the globe and in 2001, nearly 
two thirds of the respondents to the survey report 
having suffered a transfer pricing audit somewhere 
in the organisation. 
Tangible goods account for the highest proportion 
of audits, although taxpayers are more concerned 
about services and financial transactions. 
Transfer pricing audits are generating slightly more 
adjustments in 2001 than in 1999. Adjustments are 
most prevalent in the field of technical and 
management services albeit that level of double 
taxation remains worryingly high. 
One-third of audits conclude with an adjustment 
being made with forty percent of adjustments 
resulting in double taxation. Less than twenty per 
cent of respondents have used the component 
authority process for relief of double taxation. 
MNE' s are missing shareholder value building 
opportunities by not integrating transfer pricing up 
front in strategic business actions such as mergers, 
acquisitions, divestures, e-commerce and 
intellectual property (IP) management. 
Intellectual property and financing transactions are 
more likely to result in adjustments 
Management of intellectual property (IP) has been 
relegated to tracking, registering, and not tax-
efficient exploitation. 
Services and intangibles are attracting increased 
attention from tax authorities world-wide 
The majority of the companies continue to base 
their performance measures on pre-tax financial 
results, a model that in difficult times could focus 
on inter-company transactions rather than market 
related transactions. 
Only eighteen per cent of MNE's that were 
involved in a recent merger used the opportunity to 
re-examine overall policies 
(Source: Ernst and Young 2001:5 and Ernst and Young 2003:7) 
Emerging from the findings is the seemingly reluctant use of the competent authority process with 
less than 20% of respondents suffering from double taxation making use of the process. This is 
significant when 40% of transfer pricing adjustment resulted in double taxation with double 
taxation agreements aiming to limit double taxation through the competent authority process. The 
comparative survey does not indicate whether this could be attributed to non-treaty partner cases 
where the competent authority process is not in place without corresponding tax relief. 
78 
2.5.1 Transfer pricing audit trends 
In conducting a global survey, it is asked whether it is likely to be exposed to an audit, what is the 
likelihood that an adjustment may follow and how likely is it to suffer penalties (Ernst and Young, 
2003:10). The incidence of transfer pricing examination by the annual revenue of the parent is 
significant as illustrated in Figure 5: 
Figure 5: Incidence of transfer pricing examination by annual parent company revenue since 1999  
Incidence of transfer pricing examination 
140 
120 
100 
80 
60 
40 
20 H 
0 
70% 
50% _ 
40% S 
30% -
20% Q" 
10% 
Less than $ $100-499m $500-999m $l-2.99b $3-4.99b $5-9.99b 
100m 
$10b+ 
Turnover 
1 Number of Cases ■ Examination by revenue authorities since 1999 
(Source: Ernst and Young 2003:11 and own compilation) 
Since 1999, close to half of parent company respondents stated that they were subject to a transfer 
pricing audit somewhere in the organisation. According to the survey, the following emerged: 
• Intangibles are attracting increased attention from tax authorities. 
• Sixty per cent of MNE's with consolidated revenues in excess of US$ 5 billion attracted 
transfer pricing audits compared to 31 per cent of MNE's with a consolidated turnover less 
than US$ 100 million. This is indicative that although large MNE's receives the majority 
of attention from a transfer pricing enforcement perspective, smaller MNE's are not 
exempt from transfer pricing audits. 
• Companies headquartered in Switzerland still remains the most vulnerable to an audit 
globally; 80 per cent of Swiss respondents experienced transfer pricing audits in the 
preceding three years. Headquartered companies in the Netherlands (76%), United States 
(71%), Sweden (69%) and France (65%) seem to follow the trend. 
79 
2.5.2 Susceptible transactions 
The enforcement of transfer pricing regulations resulted in MNE's being of the belief that certain 
transactions are more susceptible for future transfer pricing audits as illustrated in Figure 6 (Ernst 
and Young, 2003:10-11). Inter-company services are a part of the service economy and by its 
presence in connected party dealings will attract transfer pricing scrutiny. Ernst and Young 
(2003:12) state that from their experience MNE's shy away from contemporaneous documentation 
relating to the services. 
Figure 6: Transactions perceived susceptible for transfer pricing audits between 2001-2003  
Susceptible Transactions 
50% 
40% -
30% - 1 rt rL 
20% - 1 1 1 1 \ n l 
10% - 1 1 1 1 1 1 
0% - 1 1 1 I 1 1 ■ 
Admin 
Management 
Services 
Financing 
Sale of 
finished 
goods 
Intangibles Technical 
services 
Technology 
cost sharing 
agreements 
Commiss ion 
f o r s a l e o f 
goods 
Sale of raw 
materials 
Q2003 Home Country 43% 37% 36% 33% 30% 24% 24% 22% 
■ 2001Home Country 35% 28% 32% 28% 27% "9% 21% 22% 
(Source: Ernst and Young 2003:12 and own compilation) 
In the event that documentation does not substantiate service charges, adjustments could be more 
likely. In the research, services does not form part of the primary objective or an integral part of 
the scope, hence the discussion surrounding services as is the case with intangibles is not 
exhaustive. However, it is noteworthy, that that sale of finished goods, referred to as tangible 
goods, is still regarded as susceptible transactions, increasing from 32 per cent in 2001 to 36 per 
cent in 2003. 
80 
2.5.3 Transfer pricing audits and adjustments 
Ernst and Young (2003:14) reports that respondents who experienced transfer pricing audits since 
1999 reports that 893 separate issues were raised in the audits with 21 per cent of them remaining 
unresolved and 33.3 per cent of the remainder resulting in an adjustment. Illustrated in Figure 7 is 
a summary of the completed audits, which ended in a transfer pricing adjustment. 
Figure 7: Completed transfer pricing audits and adjustments  
Transfer Pricing Adjustment 
(Source: Own compilation and Ernst and Young 2003:14) 
From the graph, it is apparent that Korea, the Netherlands and Italy make transfer pricing 
adjustments in more than half the cases finalised. Canada, Germany and the US make transfer 
pricing adjustments in approximate two out of every five cases finalised. Tangible property 
transfer pricing audits resulted in adjustment in 31 per cent of the finalised cases with adjustments 
in relation to intangible property resulting in adjustment of 43 per cent of cases (Ernst and Young, 
2003: 15) 
South Africa was a participant in the 2003 survey but the South African survey did not include 
South African companies or transfer pricing audits. Therefore, no information is available on 
transfer pricing audit results in South Africa. 
81 
2.5.4 Country specific findings 
In the 2001 Ernst & Young report, 22 countries were included in the survey. The responses by the 
MNE's in the countries and their respective fiscal authorities' give an indication of the direction 
transfer pricing is taking in the countries being surveyed and are illustrated in Table 6: 
Table 6: Selected country specific responses 
Country 
Per cent of 
respondents that 
rate transfer 
pricing as very 
important 
Per cent of 
respondents 
expecting an audit 
soon 
Per cent of 
respondents that 
include transfer 
pricing as part of 
corporate strategic 
planning process 
Per cent of 
respondents that 
charge Intellectual 
property for tax 
purposes and 
management 
purposes 
Argentina 45% 66% 35% 11% 
Australia 48% 56% 4% 27% 
Belgium 60% 35% 30% 
Brazil 36% 84% 36% 
Canada 68% 84% 28% 25% 
Denmark 92% 92% 35% 
Finland 80% 84% 32% 
France 80% 67% 48% 50% 
Germany 52% 52% 67% 
Republic of Ireland 60% 47% 17% 
Italy 40% 12% 32% 40% 
Japan 76% 40% 28% 
Korea 23% 20% 17% 88% 
Mexico 72% 44% 40% 25% 
The Netherlands 64% 60% 12% 17% 
New Zealand 77% 91% 14% 17% 
Norway 40% 44% 20% 
Spain 64% 32% 32% 
Sweden 56% 52% 36% 
Switzerland 83% 63% 
United Kingdom 49% 25% 27% 
United States 57% 30% 10% 
{Source: Own compilation and Ernst & Young 2001: 29-51) 
It is concerning that such a small percentage of respondents include transfer pricing as part of 
corporate strategic planning process. Only in Germany, more than half of the respondents include 
transfer pricing as part of their corporate strategic planning process. 
2.6 Conclusion 
Globalisation brought about substantial changes in economies it came into contact. Globalisation 
has two distinct dimensions, firstly scope (or stretching) and secondly, intensity (or deepening). 
On one hand, globalisation defines a set of processes which embrace most of the globe or which 
82 
operate worldwide, the spatial connotation. On the other hand, globalisation also implies 
intensification on the levels of interaction, interconnectedness or interdependence amongst 
countries, which constitute the world community. 
Global capitalisation can fail. Inadequacies of the contemporary markets and institutions can lead 
to the failure of globalisation. Failure is discernable as market, institutional and moral failure. 
Market failure is driven by structural and endemic failures such as inappropriate macro economic 
policies, overvalued or tied currencies and a strong black market. Institutional failure is driven by 
an inadequate regulatory and supervisory system. Moral failure is as a result of especially 
nepotism and prevalence of corruption and bribery. 
Globalisation comprises structural transformation that affects enterprises and countries giving rise 
to new relationships and interdependencies. Globalisation creates a multiplicity of linkages and 
interconnections amongst countries and societies, which make up the present world system. The 
multiplicity of linkages and interconnections is aligned to the spatial perspective, linking 
globalisation with the MNE insofar as it relates to an integrated production network being spread 
over various geographic locations, a form of economic integration stretching national boundaries. 
Transfer pricing concurs within the multiplicity of linkages, linking globalisation with the MNE as 
an integrated production network spread globally, a form of global economic integration. MNE's 
uses FDI to achieve efficiencies and secure strategic assets. FDI, is not a once off occurrence, it 
has an initial and sequential component. Initially FDI is aimed at resource seeking and market 
seeking (securing). Sequential FDI is firstly aimed at efficiency seeking through rationalisation of 
production to exploit economies of scope and specialisation across value. chains (product 
specialisation) and along value chains (process specialisation). Secondly, sequential FDI is aimed 
at strategic (created) asset seeking to advance regional or global strategy. This strategic asset 
seeking is obtained through access to and leverage of technology, organisational capabilities and 
markets. 
A country, in which MNE's operates, are being affected by the MNE's ability to establish and 
operates through an integrated production network, spread globally. With economic interaction 
and interconnectedness of the MNE, it is not surprising that transfer pricing is becoming 
increasingly important, for managers of MNE's and tax administrations alike. Statistics echoes the 
prevalence of transfer pricing with MNE's regarding transfer pricing being regarded as the 
83 
prominent international tax issue. MNE's are considering the importance of transfer pricing with 
eighty-six per cent of parent companies and ninety-three per cent of subsidiaries identified transfer 
pricing as the most important international tax issue on the agenda. 
South Africa is not immune to the global trends concerning transfer pricing. South Africa's 
economy opened up considerable since democratisation in 1994. With the relaxation of exchange 
controls by the South African Reserve Bank, legislation was introduced in 1995 to prevent profit 
emigration. 
Introduction of legislation is not sufficient in itself to regulate transfer pricing. South Africa 
established in 2001 a dedicated, technical specialist unit to exclusively deal with transfer pricing. 
South Africa made use of the experiences and expertise of other countries as well as the OECD. 
Guidelines published by the OECD became the foundation of South African practice. South 
Africa engaged the international community further by becoming an observer at the OECD where 
the latest developments in transfer pricing are discussed, consensus being seeked for current work 
on transfer pricing and related matters. 
84 
Chapter 3 The pricing of cross border transactions 
3.1 Introduction 
A country, in which MNE's operates are affected by the MNE's ability to establish and operates 
through an integrated production and market network with global coverage. Transfer pricing 
concurs within the multiplicity of linkages, linking globalisation with the MNE as a network of 
global economic integration. Transfer pricing, the process by which MNE's set the prices at 
which they transfer goods or services amongst each other, occurs within this network of global 
economic integration. 
MNE's uses FDI to attain efficiencies and secure strategic assets. MNE's initial FDI is aimed at 
securing resources and markets. Subsequent to the initial FDI, MNE's continual FDI is aimed at 
enhancing efficiency through rationalisation of production to exploit economies of scope and 
specialisation across value chains (product specialisation) and along value chains (process 
specialisation). Further FDI is aimed at strategic assets to advance the MNE's regional or global 
strategy (Dunning, 2002:203). 
Economic integration and interconnectedness of the MNE is a reality. Hence, it is not surprising 
that transfer pricing is becoming increasingly important, for managers of MNE's and tax 
administrations alike. MNE's in 2003, acknowledged the importance of transfer pricing with 
eighty-six per cent of parent companies and ninety three per cent of subsidiaries identified transfer 
pricing as the most important international tax issue on the agenda (Ernst & Young, 2003:7). 
Acknowledgment of the importance of transfer pricing necessitate that pricing of cross border 
transactions is firstly based on the broad legislative framework. Principles and concepts such as 
the arm's length principle and comparability are the foundation of transfer prices. Transfer 
pricing, is process driven with certain methodologies being accepted as the international standard. 
An analysis of the methodologies in conjunction with research on their respective use provides 
insight into this complex topic. 
85 
3.2 The concept of transfer pricing 
Transfer pricing, in the context of this research, (refer to section 1.6.33 for the definition) is the 
process by which MNE's set prices at which they transfer goods or services amongst each other 
(South Africa, 1999:4). The process of transfer pricing does not necessarily involve the pricing of 
goods and services, which are for the most part based on economic realities. 
If a non-market value, being an inadequate or excessive consideration, is paid for the transfer of 
goods or services amongst the members of an MNE, the income calculated for each of those 
members will be inconsistent with their relative economic contributions. This distortion will 
influence the tax revenues of the relevant tax jurisdictions in which MNE's operates (South Africa, 
1999:5). In order to address the special considerations involved in transfer pricing, a specific 
section dealing with transfer pricing was introduced in the Act in 1995. 
3.2.1 Regulations and guidance 
3.2.1.1 Section 31 of the Act 
In anticipation of relaxation of exchange control, the Commission of Inquiry into certain aspects of 
the Tax Structure of South Africa recommended in 1996 in its first and second interim reports that 
transfer pricing provisions to be introduced into the Income Tax Act, 1962 (the Act). The 
complete section of the Act is disclosed in Chapter 1 under section 1.6.28 and can be read in 
conjunction with this discussion. 
South Africa (1999:6-7) clearly states that Section 31 was introduced into the Act in 1995, to 
counter transfer pricing practices which may have adverse tax implications for the South African 
fiscus. Section 31 consists of a combination of transfer pricing and thin capitalisation (specified 
debt-to-equity ratio) provisions. The measures to contest transfer pricing schemes are in essence 
contained in section 31(1) and (2) of the Act. The provisions of section 31(3) are more 
specifically aimed at countering thin capitalisation schemes. 
The OECD Guidelines (OECD, 1995:I-5,I-19,IV-3) as well as PN 7 (South Africa, 1999:9,27) 
reiterates that transfer pricing is not an exact science. Hence, in practice, the non-exact nature of 
transfer pricing necessitates discretion and in terms of Section 31, the Commissioner of the SARS 
may exercise discretion in the following circumstances in relation to cross border transactions: 
86 
• Where the acquirer of the goods or services is a connected person in relation to the supplier 
of those goods or services, including the supply of goods and services to or by a permanent 
establishment which either such acquirer or supplier has in South Africa or which either 
such acquirer or supplier has outside South Africa; and 
• The goods or services are supplied at a price other (greater or less) than the arm's length 
price. 
In practice, the Commissioner will exercise discretion in respect of all transactions entered into in 
respect of a product or service during any period. However, in terms of section 31(4) of the Act, 
the Commissioner's decision is subject to objection and appeal. This discretionary status of the 
application of transfer pricing is contributing to ambiguity and subjective interpretation. The 
Commissioner published Practice Note 2 and 7, which deals with the issues of transfer pricing. 
3.2.1.2 Practice Note 2 
Financial assistance and in particular thin capitalisation rules (prescription in terms of debt-to-
equity ratios) are applied to limit the deductibility of interest. The deductibility of interest is 
where there is a disproportionate ratio between the loan capital and the equity employed in an 
enterprise. 
Financial assistance falls outside the scope of the research refer to section 1.5. In ZA Case 01, the 
empirical case research, financial assistance formed part of the evaluation. The particular issue 
considered was the excessive portion of financial assistance. The discussion will provide only a 
short disclosure on excessive financial assistance 
Consideration paid for financial assistance is interpreted to include interest, related finance charges 
but also could include a discount or premium. The formulary approach followed in the 
determination of the "excessive" portion of financial assistance is based on the following (South 
Africa, 1996:3): 
• Where the loan, advance or debt is denominated in rand, a rate not exceeding the weighted 
average of the South African prime rate plus 2 percentage points will be an acceptable 
nominal annual interest rate. 
87 
• Where the loan, advance or debt is denominated in a foreign currency, a rate not exceeding 
the weighted average of the relevant inter-bank rate plus 4 percentage points will be an 
acceptable nominal annual interest rate. Any interest exceeding the above-mentioned 
prescribed rates will be regarded as excessive interest and will consequently not be allowed 
as a deduction for income tax purposes. 
Applying economic and commercial logic to this concept, the reward could not be construed to 
cater exclusively for interest only; there might be other considerations that could reflect the 
payment in "kind", such as market access, business strategies that could skew the reward being 
paid for financial assistance if an interest payment is the only criterion. 
ZA Case Ol's financial assistance failed substantially outside the debt-to-equity ratio allowed with 
all debt being interest bearing. In additional to initial loans, ZA Case 01, paid its MNE 
counterparts at the point of order whilst its MNE counterparts were paying it 30 days after receipt 
of goods. ZA Case 01 was locationally removed from its MNE counterparts, receipt of goods 
from order to receipt amounted to 8 weeks. It is clear that ZA Case 01 was in a position that an 
independent party would require compensation for the time value of money. 
3.2.1.3 Practice Note 7 
Practice Note 7 (PN 7) is based on the OECD Guidelines (OECD, 1995:P-1-AN-18) and 
assistance received from the Policy Advice Division of the Inland Revenue Department in New 
Zealand. South Africa is currently not a member country of the OECD but notwithstanding that 
fact, the OECD Guidelines are acknowledged as an important, influential document that reflects 
unanimous agreement amongst the member countries, reached after an extensive process of 
consultation with industry and tax practitioners in many countries. South Africa follows the 
OECD Guidelines in transfer pricing. 
PN 7 is a practical guide and is not intended to be prescriptive or an exhaustive discussion of every 
transfer pricing issue that might arise. Criticism with regards to the lack of specific guidelines 
must be seen within the premise that each case are decided on its own merits with allusion to each 
specific MNE's business strategies (refer to section 1.6.2 for a definition and section 3.2.2.2 where 
the importance insofar as comparability is discussed) being followed and commercial judgment of 
the management team under specific circumstances. 
88 
The OECD Guidelines should be followed in the absence of specific guidance in terms of PN 7, 
the provisions of section 31 or the tax treaties entered into by South Africa. Direct reference to the 
OECD Guidelines include the chapters in the OECD Guidelines dealing specific with intangible 
property (South Africa, 1999:34 and OECD, 1995:VI-1), intra-group services (South Africa, 
1999:34 and OECD, 1995:VE-l) and cost contribution arrangements (South Africa, 1999:34 and 
OECD, 1995:VIII-1). Transactions involving intangible assets and cost contribution arrangements 
falls outside the scope of this research. Over and above reference to specific, transfer pricing 
principles such as the arm's length principle (South Africa, 1999:8 and OECD, 1995:1-3), the 
practice note makes specific reference to financial transactions (South Africa, 1999:7) and tax 
treaties (South Africa, 1999:7). 
3.2.1.3.1 Financial transactions 
Financial transactions are dealt with in PN 7 and accordingly the definition of services as 
contained in section 31 with South Africa (1999:7) clearly stating that it "includes financial 
transactions and therefore applies to non-arm's length interest, discounts and other payments for 
the use" of or access to money (South Africa, 1999:7). The practice note (South Africa, 1999:7) 
alludes to the fact that the consideration for the use of funds obtained from, or conversely made 
available to, a connected person may be unacceptable to the Commissioner for reasons other than 
that of tests of solvency and equity position such as debt-to-equity ratio, times interest earned or a 
high rate of interest expense as provided in PN 2 (South Africa, 1996:1). 
It is possible that terms and conditions attached to financial assistance amongst connected parties 
could be structured and disclosed in such a way that routine tax assessment fails to establish 
whether it conforms to the arm's length standard. In the event that the consideration paid under 
the terms of the financial transaction does not conforms to the arm's length principle the 
provisions of section 31 will be applied for tax purposes (South Africa, 1999:7). Financial 
transactions and in particular those that falls within the scope of PN 2 are not the focus of the 
research, hence detailed analysis is not performed (refer to section 1.5). 
3.2.1.3.2 Double Taxation Agreements 
Interpretation and analysis of double taxation agreements (DTA's) falls outside the scope of this 
research (refer to section 1.5). This reference to DTA's here is primarily for clarity and it is not 
89 
analysed in any detail. Article 7 of the OECD Model provides for the attribution of profits to a 
permanent establishment (OECD, 2000:26) of an enterprise (OECD, 2000:28). Article 9 requires 
that the arm's length principle must be applied to commercial and financial transactions amongst 
associated companies or connected parties residing in the contracting states. These principles are 
embodied in each one of South Africa's tax treaties. 
It is important to note that tax treaties cannot impose tax liability; they merely allocate existing tax 
liabilities amongst countries with the tax liabilities being imposed by virtue of domestic 
legislation. International case law and as such its rulings are not prescriptive in the administration 
of international transactions but form part of the reference used in domestic cases. 
The articles in the OECD Model and in the specific tax treaties that deals with "business profits" 
and "associated enterprises" does not propose a hierarchy of methods nor does it indicate 
priorities as to the methods to be used to determine the attribution of profits or an arm's length 
price (OECD, 2000:30-31). In light of the guidance from the OECD, the Commissioner of the 
SARS holds the view that the treaties do not restrict or limit the application of section 31 of the 
Act (South Africa, 1999:7). This is regardless of the method selected to determine an arm's length 
consideration and it is apparent that no inconsistency exists amongst domestic law and the tax 
treaties, as both embody the arm's length principle (South Africa, 1999:7; OECD, 1995:1-1-1-27 
and OECD, 2000:30). 
Provisions of section 31 of the Act are applicable to persons, which are separate legal entities in 
their own right. The contents of PN 7 apply to determine the arm's length consideration for 
income tax purposes of cross-border transactions. Such transactions conducted by a person with a 
connected person; a person's head office with a branch of such person; or a person's branch with 
another branch of such person in the application of the tax treaties entered into by South Africa 
(South Africa 1999:7). 
3.2.1.3.3 Reasonableness of transfer pricing guidelines 
From PN7 it is apparent that South African MNE's should make a conscientious effort to establish 
that their transfer prices comply with the arm's length principle. The arm's length principle is set 
out in the Act, PN 7 and OECD Guidelines and provides guidance about the preparation of 
90 
contemporaneous documentation (OECD, 1995:V-1-V-10 and South Africa, 1999:23) to evidence 
their compliance with section 31 of the Act. 
In the event that a South African MNE have taken it upon itself to substantiate its connected party 
dealings in accordance with the arm's length principle, the Commissioner of SARS (South Africa, 
1999: 34) is probable to determine prima facie that the particular MNE's' transfer pricing practices 
is at low tax risk. Conversely, in the absence of adequate consideration by MNE's to their transfer 
pricing practices, they are likely to evoke greater scrutiny from the Commissioner into their 
international transactions. Although PN 7 is not prescriptive, it does provide guidance for the 
determination of an arm's length consideration (South Africa, 1999:34). 
3.2.2 The arm's length principle 
The basis of the arm's length principle (refer to section 1.6.1 for the definition) is that transactions 
amongst connected parties are to be conducted at arm's length (South Africa, 1999:8). In essence 
this means that the transaction should have the substantive commercial and financial 
characteristics of a transaction amongst independent or unrelated parties, where each party, out 
of own interest, strives to get the utmost possible benefit from the transaction under the particular 
circumstances (OECD, 1995:G-1,I-1, South Africa, 1999: 9). 
The challenge is to determine how an MNE should determine what price would have arisen if 
transactions amongst its members were subject to market forces, as it would have been if it was an 
unconnected transaction. This, notwithstanding the fact that a market, in the true economic 
elucidation of a willing buyer and willing seller does not exist in connected party dealings. 
The solution promulgated by the arm's length principle is that comparable transactions amongst 
independent parties, referred to as uncontrolled transactions should be used as a benchmark against 
which to appraise the MNE's prices or profits it derive from the controlled transaction (OECD, 
1995:1-3 and South Africa, 1999:9). Any material difference between the two transactions being 
compared that could influence the benefit derived by the parties to it can and should be identified 
and an adjustment be made accordingly. An arm's length price that reflects, or being interpreted 
as a fair proxy of the economic contributions made by the parties to the transaction can 
subsequently be determined for the controlled transaction under consideration. 
91 
South Africa has adopted the arm's length principle with the opinion that application of this 
internationally accepted principle will minimise the potential for double taxation. Several reasons 
have been given why OECD member countries and non-member countries accepted the arm's 
length principle. However, the major reason (OECD, 1995:1-3) is that the arm's length principle 
provides broad parity of tax treatment for MNE's and unconnected parties, in essence is has 
become the international norm. 
Considerations, other than tax, such as governmental regulations, price or exchange controls may 
distort the prices being charged amongst connected parties (OECD, 1995:1-22). The OECD 
Guidelines (OECD, 1995:1-22) and the Commissioner (South Africa 1999:30) recognise the 
factors that could potentially influence prices. PN 7 provides broad guidelines about business 
(refer to section 3.2.2.2 which deals with business strategies in terms of comparability) and 
economic realities (refer to section 3.2.2.2 which deals with economic circumstances in terms of 
comparability) that might indicate which information, data and other evidence could support a 
contention that a transaction has occurred at arm's length (South Africa, 1999:9). 
PN 7 (South Africa, 1999:9) as well as the OECD Guidelines (OECD, 1995:1-19) acknowledges 
that the determination of an arm's length consideration is not an exact science but requires 
judgment on the part of both the MNE and the tax authority. It is therefore in the best interest for 
all the parties involved to approach each case with careful consideration for the unique business 
and market realities pertinent to each individual case. The determination of an arm's length 
consideration does not necessarily constitutes a single price unless a direct price comparison is 
being made, it usually comprises of a range of prices or profit indicators and the facts of each case 
will determine where, within that range, a specific arm's length consideration will lie (OECD, 
1995:1-19). 
3.2.2.1 Determining an arm's length consideration 
3.2.2.1.1 Prescription 
Neither section 31 of the Act, PN 7 (South Africa, 1999:14) nor any of the tax treaties entered into 
by South Africa (OECD, 2000:30) is prescriptive insofar as any particular transfer pricing 
methodology to be used for the purpose of establishing an arm's length consideration for a 
particular transaction. Given the fact that there is no prescribed legislative preference, in practice 
92 
the method that could be regarded as the most appropriate method to be applied under the 
circumstances are used after considerable consideration of the facts at hand (OECD, 1995:1-27). 
3.2.2.1.2 The approach followed in practice 
Generally, MNE's make a concerted effort to prepare contemporaneous documentation pertaining 
to their transfer pricing practices. Although there is no explicit statutory documentation 
requirement in South Africa, it is in the MNE's best interest to keep such documentation as 
evidence of its transfer pricing practices (South Africa, 1999:23). Furthermore, the income tax 
return requires MNE's to supply certain information regarding their connected party dealings and 
in the absence of documentation, it will be very difficult to answer these questions truthfully. 
In assessing the transfer pricing practices of an MNE and establishing the arm's length 
consideration the following provides an indication of the deliberation in establishing arm's length 
dealings (South Africa, 1999:34): 
• Establish economic justification prior to the transaction is entered into 
• Establish and substantiate that the consideration being paid is an arm's length consideration 
• Prepare and retain contemporaneous documentation to support the economic justification 
and the substantiation of the arm's length consideration as well as the assessment of market 
conditions at the time when the pricing decisions were made 
• Qualify the selection of the most appropriate method used under the circumstances 
• Establish and consistently follow a systematic approach and process for setting transfer 
prices in accordance with the arm's length principle 
In the assessment process, the MNE is evaluated in terms of the functions the specific MNE is 
performing, the assets used in performing these functions and the risk assumed in the performance 
thereof. A practical approach to evaluate functional comparability is by undertaking and preparing 
a functional analysis (South Africa, 1999:11). 
The determination of the arm's length consideration is based on the functions; assets and risk 
identified during the functional analysis of the MNE under evaluation (refer to sections 3.2.2.2 and 
5.3.3 for more detail on the functional analysis and section Appendix 5.2 where the interview 
questionnaire is disclosed). In order to determine the arm's length range, comparable data is used. 
93 
3.2.2.2 Functional Analysis 
Reimbursement for the transfer of goods or services amongst unconnected parties usually reflects 
the functions that each party performs. Reimbursement take cognisance of the risks (total risk 
which is the sum of diversifiable and idiosyncratic risk, a more comprehensive discussion of risk is 
provided in section 4.3.5 ) assumed and the assets used in performing these functions. In the 
determination of comparable transactions, for the purpose of administering transfer pricing 
regulations, the functions and risks undertaken by the unconnected or independent parties should 
be compared to those undertaken by the connected parties that are investigated (OECD 1995:1-9). 
The OECD Guidelines (OECD, 1995:1-10) and PN 7 (South Africa, 1999:10) envisage that when 
various and distinct functions are performed by unconnected parties, the enterprise that provides 
most of the effort and of particular importance the rare or unique functions as well as assuming the 
most risk should earn a greater portion of the profit attributed to the transaction. This situation is 
not any different for an MNE, the part of the MNE that provides most of the effort and the rare or 
unique functions in addition to assuming the most risk should earn a greater portion of the profit 
associated to the transaction. 
The majority of the transfer pricing methods such as the Cost Plus, Resale Price, Transactional Net 
Margin and Profit Split methods (refer to sections 3.2.2.4 and 3.3.2 for a detailed discussion) focus 
on the functions performed, risks assumed and assets used instead of the goods or services being 
transferred. The establishment of functional comparability of the MNE and the independent 
enterprise(s) it is being compared to is important when the Cost Plus, Resale Price, Transactional 
Net Margin and Profit Split methods are used. 
In contrast to the high degree of functional comparability required by the previously mentioned 
transfer pricing methods, the Comparable Uncontrolled Price (CUP) method is based on a direct 
comparison of the price charged for goods or services in a controlled transaction and uncontrolled 
transaction. When a direct comparison is made, the characteristics of the goods or services are 
significant and important to consider. In practice, functional comparability can be established and 
evaluated by undertaking a functional analysis. A functional analysis is a methodological 
approach evaluating and organising facts pertaining to any enterprises' functions it performs, the 
assets being used and the risk assumed by undertaking these functions (South Africa, 1999:11). 
94 
The aim of the functional analysis is the objective identification of the relative contribution of the 
parties involved in the transaction under review. Through virtue of the design of a functional 
analysis, the emphasis is on identification of all economically significant activities. The identified 
activities relates to functions performed, assets used and risk assumed that are carried out by the 
member of an MNE that is under investigation and for which it should expect to be rewarded 
equitably. 
In addition, the functional analysis assists in the appraisal of comparables to be used in evaluating 
connected party dealings. A functional analysis is not a transfer pricing analysis in its own right. 
It is an analysis tool aimed at identifying the functions to be considered in addition to providing 
assistance in the determination of the most appropriate method to be used under the specific 
circumstances. The transactions to be evaluated dictate the dynamics of the functional analysis 
(South Africa, 1999:37) with the functional analysis addressing (refer to section 5.2 where the 
facts pertaining to the functional analysis of ZA Case 01 is disclosed) the following aspects: 
• An overview of the tested party (refer to section 1.6.34 for a definition) 
• Assessment of the general industry conditions affecting the tested party 
• Direct consideration of the affected transaction refer to section 1.6.9 for a definition) under 
review 
• Evaluation of the actual contractual terms of the affected transaction 
• The functions undertaken by the relevant connected parties to the affected transaction 
• Assessment of the profit contribution of connected parties in relation to the affected 
transaction 
• An appraisal of risk 
PN 7 (South Africa, 1999:11) further emphasises that consideration is required as to whether a 
purported allocation of risk is consistent with the economic substance of the transaction. In 
practice, the connected parties' conduct under the specific circumstances of a particular case is 
generally taken as the best evidence concerning the true allocation of risk. However, the functions 
undertaken by an entity can sometimes indicate of risk allocation amongst the connected parties. 
95 
Two further considerations are required in undertaking the functional analysis, economic 
circumstances and business strategies. 
3.2.2.2.1 Economic Circumstances 
There might be expectations that arm's length prices should vary across different markets, even 
going as far as to expect it for transactions involving the same or similar goods or services (OECD, 
1995:1-12). In an attempt to attain comparability for the purpose of applying the arm's length 
principle it is imperative to ensure that the markets being compared are comparable with 
differences not having a material effect on price, or appropriate adjustments can be made to negate 
the differences. The OECD Guidelines (1995:1-10) and PN 7 (South Africa, 1999:12) identifies 
some factors that could be relevant for market comparison albeit that the list is not exhaustive, 
comprises of the following: 
• geographic location of the market; 
• size of markets; 
• extent of market competition; 
• substitute goods and services availability within the markets; 
• transportation costs; and 
• the level of the market (retail or wholesale). 
These abovementioned factors might be relevant within the South African market mainly due to 
South Africa's relatively small open economy with comparables being difficult (if not impossible) 
to obtain. In practice, the Commissioner of SARS accepts that South African comparables are 
very difficult to obtain hence the acquiescence of foreign country comparables in transfer pricing 
analyses (South Africa, 1999:26). 
This acceptance of foreign comparables does not provide MNE's the opportunity of not assessing 
the impact of economic differences by virtue of using foreign comparables. The approach 
followed by using these foreign comparables should not diverge from what it would be if South 
African comparables were available. Whilst foreign comparables may prove to be useful, MNE's 
need to be prudent in their approach to ensure that appropriate adjustments reasonably reflects the 
differences amongst the South African and foreign market(s) being compared. 
96 
3.2.2.2.2 Business Strategies 
The relevance of business strategies insofar as comparability for transfer pricing purposes can be 
best understood in acknowledging that business strategies are a legitimate aspect of arm's length 
operations. Business strategies for the purpose of transfer pricing administration would take into 
account all the aspects that have a bearing on the day-to-day operation and conducting of the 
business (OECD, 1995:1-13). 
Applying commercial logic to the purported business strategy, such as a market penetration 
strategy, it is not farfetched for an MNE on such an endeavour to bear unusual expenses with little 
or very little profit if compared to their competitors. However, it might be acceptable over the 
short term; the benefits derived from following the strategy should realise and be unquestionable 
(South Africa, 1999:14). 
The issue at hand is still how to assess a business strategy that decreases profits in return for 
potential higher long-term profits in terms with the arm's length principle. The test remains if an 
unconnected party under similar conditions will be prepared to sacrifice its profits over a similar 
time. If the answer is undoubtedly "yes" and can be proven as such, then it is apparent that per 
definition the dealings are consistent with the arm's length principle. In the administration (South 
Africa, 1999:14) of the transfer pricing provisions consideration are given to the following: 
• Whether the conduct of the MNE is consistent with the professed business strategy; 
• If nature of the relationship amongst the members of the MNE to the controlled transaction 
justifies that the MNE bears the costs of the business strategy; 
• If there were a plausible expectation that the business strategy will produce a return for the 
MNE sufficient to justify its costs, within a period of time that would be acceptable in an 
arm's length arrangement. 
3.2.2.3 The concept of comparability 
The principle of comparability is entrenched in South African practice (South Africa, 1999:9) 
which follows the international norm as expressed in the OECD Guidelines (OECD, 1995:1-7) that 
the application of the arm's length principle is generally based on a comparison of the conditions 
in a controlled transaction with the conditions in transactions amongst unconnected parties. 
97 
Validity of such comparisons and by implication the arm's length consideration so determined 
must be sufficiently comparable to the economic characteristics of the transactions being assessed. 
Comparable means that none of the differences if any exist, amongst the transactions being 
compared could in any way materially affect the price or margin determined and if differences 
exists, that reasonable adjustments could not have been made to restrict or diminish the effect of 
the differences. 
When applying any of these accepted transfer pricing methods (described in the sections 3.2.2.4 
and 3.3.2), the comparability amongst the tested party and the independent entities it is being 
compared to is important. In contrast to this, the application of the CUP method, when a direct 
comparison is made amongst the price for a specific good or service, item characteristics is 
important. Hence, in practice comparability adjustments to reflect differences (refer to section 
4.3.3 for more detail), such as quality, inventory and country specific factor adjustments (refer to 
section 5.4.5.2 for further details). 
3.2.2.3.1 Internal and external comparables 
In practice, two types of comparables can be identified, i.e. internal comparables and external 
comparables and both contribute to the assessment of comparability in administering transfer 
pricing regulations (refer to Figure 18 where internal and external comparables in conjunction with 
methodologies are illustrated) (South Africa, 1999:15). 
• Internal comparable transactions are the transactions that take place amongst the specific 
MNE and independent, unconnected parties. These transactions can be used to make 
comparisons to transactions that take place amongst the MNE and its affiliates, in whatever 
legal or business form. 
• External comparables are these transactions amongst independent or unconnected parties 
without any reference to the specific MNE being evaluated. Detailed information about 
these external comparable transactions are not often freely available and use of these 
comparables must take place after careful consideration of the facts to achieve objectivity. 
External comparables are often used due to the lack of internal comparable information. In 
order to achieve the highest level of objective assessment, various electronic commercial 
98 
databases can be used to identify the external comparable dataset. In this research, use of 
Bureau VAN Dijk's Amadeus Pan-European database is made. 
Internal comparable transactions are preferred to external comparable transactions because they 
occur within the business and operational environment of the MNE being assessed and 
information is usually readily available. In applying the recognised transfer pricing 
methodologies, it would be expected that the traditional methods would be relatively easier to 
apply than what would be the case with external comparables. 
3.2.2.3.2 Factors influencing comparability 
The biggest concern currently under discussion at the OECD is the availability of comparable data 
and the sources of such data (OECD, 2005:1). The OECD Guidelines (OECD, 1995:1-9) and PN 7 
(South Africa, 1999:10-13) recognises that any of the following factors could influence 
comparability: 
• Characteristics of goods and services. Differences in the specific characteristics of goods 
and services are often a good proxy for the differences in their relative value in the market. 
Applying this principle in practice, characteristics will play an important role if price 
comparisons are undertaken. 
• The relative importance of functions performed. Commercially, in dealings amongst two 
parties one would expect that compensation and rewards would be associated with the 
relative functions each party performs in relation to each other. 
• The terms and conditions of the relevant agreements. In arm's length dealings the 
contractual terms, pertaining to a transaction defines explicitly the division amongst the 
parties to the agreement of the responsibilities, risks and rewards. 
• Economic and market conditions. Arm's length considerations vary across different 
markets albeit that similar property or services are being transferred. In light of the 
comparability challenge, it must be assessed if the differences are material and if regarded 
as material that appropriate adjustments are made. (Adjustment and the appropriateness of 
such adjustments are dealt with in the empirical section of this research.) 
• Business strategies. Business strategies form an integral part of any business and as such, 
cognisance of it should be taken in the determination of an arm's length consideration. 
99 
Failing to evaluate and investigate these strategies would result in subjective assessment. 
Business strategies that could influence profitability are usually the strategies concerned 
with innovation and new product development, the business' degree of diversification and 
risk aversion. Timing differences amongst enacting a strategy and reaping the rewards 
could provide challenges in administering transfer pricing regulations. 
3.2.2.3.3 Assessment of comparability 
Assessment of comparability forms an integral part of any transfer pricing analysis. International 
practice promulgate the functional analysis (OECD, 1995: G-5): "An analysis of the functions 
performed (taking into account assets used and risks assumed) by associated enterprises in 
controlled transactions and by unconnected parties in comparable uncontrolled transactions" as a 
comparability assessment, on which the determination of the arm's length consideration will be 
based. South Africa prescribes to the same principle (South Africa, 1999:11): "Functional 
analysis serves, therefore, to identify the economically significant activities (functions performed, 
assets employed and risks assumed) that are undertaken by the member of an MNE, and for which 
it should expect to be rewarded." This identifies the nature and characteristics of the connected 
party dealings that requires to be priced. 
The undertaking of a functional analysis and its results are dealt with in Chapter 5 by virtue of the 
case study. The challenge still remains, once a functional analysis has been undertaken and 
potential comparables have been identified, to make adjustments to enhance comparability within 
this context are required in terms of the OECD Guidelines (1995:1-7) 
3.2.2.3.4 Comparability adjustments 
In South Africa, comparability adjustments as set out in PN 7 stresses that the two transactions 
being compared will only be truly comparable if there are no differences amongst the two 
transactions that will have a material effect on the price, or if reasonably, accurate adjustments can 
be made to eliminate the effect of differences (South Africa, 1999:15). No guidance is provided 
what "differences" are referred to or what is "material effect on price" insofar as comparability 
adjustments with accompanying uncertainty. This lack of guidance increases ambiguity and 
subjectivity this research aims to minimise. 
100 
The OECD Guidelines (1995:1-17) mentions currency risk, whilst South Africa, highlights in PN 7 
examples of where adjustments may be necessary when comparable products or services are 
transferred amongst independent parties or the MNE and an independent enterprise (South Africa: 
1999:15): 
• terms of a sale (transactions may differ such as credit terms) 
• volumes transferred may differ significantly (bulk) 
• differences in contractual terms, for example, sell free on board ("FOB") to a connected 
person and at cost insurance and freight ("CIF") to an independent party. 
• Certain adjustments could be very difficult to effect, such as differences in-
o the quality of the products 
o geographic markets 
o market levels 
o amount and type of intangible property involved 
Although it is acknowledged that, the OECD Guidelines as well as South Africa's Practice Note 
provides guidance, the lack of specific examples give rise to uncertainty. This level of uncertainty 
increases if the lack of information on independent transactions in South Africa is taken into 
account. 
Due to the lack of South African information, reliance is placed on information obtained from 
international databases, with limited adjustment to comparables. This culmination of vague 
guidelines and lack of information increases the demand for a model, which could address 
comparable adjustments. 
3.2.2.4 Transfer pricing methodologies 
Most of the methods that are widely used in transfer pricing focus on the functions performed, 
assets used and the risk assumed rather than on the goods or services being transferred. Section 31 
of the Act does not impose a hierarchy of the prescribed and recognised transfer pricing methods. 
In essence, a hierarchy exists insofar as certain methods' results are more reliable. PN 7 (South 
Africa, 1999:14) provides guidance with regard to the accepted transfer pricing methods, broadly 
101 
referred to as the traditional transactional methods and the transactional profit methods (refer to 
section 3.2.2.4 for a comprehensive discussion). 
3.3 Transfer pricing methods 
The international standard with regards to transfer pricing is the arm's length principle with all 
treaties based on the OECD Model Tax Convention supporting it (OECD 2000:30). In order to 
apply the arm's length principle, the OECD in conjunction with tax authorities developed several 
methodologies which provide a framework of pragmatic approaches in connected party dealings 
(Miesel et at, 2003:1) aimed at addressing the following: 
• Tax defence: The methods lay down the rules under which transfer pricing discrepancies 
to be resolved. 
• Tax compliance: The methods satisfy documentation requirements and substantiation of 
connected party dealings to satisfy revenue authorities' requirements. 
• Business policy: Upon investigation of the methodologies applied in any of the 
abovementioned two options, it remains important for management to understand the 
responsiveness of applying the methodologies to formulate and substantiate their arm's 
length dealings by virtue of their transfer pricing policy. 
The arm's length principle (OECD, 1995:1-7, South Africa, 1995:8 and OECD, 2000:30) is central 
to the accepted OECD transfer pricing methodologies with the basis of it being; 
• Recognition that the arm's length principle is based on a sound economic principle that 
competitive market is the best instrument to allocate resources and rewards risk. 
• Positioning connected party dealings and the MNE on an equal, comparable footing with 
that of an independent enterprise for tax purposes, consequently eliminating any economic 
distortions that differential tax treatment could create. 
• Transfer pricing methodologies has been applied successfully in the past in various tax 
jurisdictions. 
Difficulties in applying the arm's length principle exist. However, cognisance of the fact that the 
separate entity approach is followed in applying the arm's length principle is divergent with 
reality. MNE's operate, as integrated enterprises with the benefits derived from such integration 
102 
such as economies of scale and scope in various spheres of the operations are not being 
considered. 
PN 7 (South Africa, 1999:13) and the OECD Guidelines (1995:11-2) reiterates that the most direct 
to establish arm's length dealings amongst connected parties is by virtue of comparing prices 
charged in controlled transactions to that being charged in uncontrolled transactions. However, in 
practice it is seldom possible, primarily due to information constraints. PN 7 (South Africa, 
1999:13) and the OECD Guidelines (1995:11-2) acknowledges information constraints and 
promulgate the use of more indirect methods of comparison whereby gross margins are used to 
determine the arm's length consideration, generally referred to as the traditional transactional 
methods. 
3.3.1 Traditional transactional methods 
3.3.1.1 Comparable uncontrolled price (CUP) 
PN 7 (South Africa, 1999:15) and the OECD Guidelines (1995:11-2) stipulates that in applying the 
CUP method, a "direct comparison is drawn amongst the price charged for a specific product, 
goods or service in a controlled transaction and the price charged for a closely comparable 
product, goods or service in an uncontrolled transaction, in comparable circumstances." The focus 
is on the product, goods or service being transferred and the price charged therefore without 
ignoring the relevant business functions and economic circumstances that could influence the price 
being charged. 
103 
Figure 8: Comparable Uncontrolled Price Method 
Connected 
Seller 
Externa ICUP 
Connected 
Buver 
/ 
Independent 
Customers 
Internal C U P 
Connected Connected 
Seller / Buver 
Operating 
Profit 
Comparison /Transfer 
Operating 
Profit Independent 
Buyer 
Market 
Functional 
Cost 
FunctionaJ 
Cost Ql 
Operating 
Profit 
1 Price ^ . ^ 
\ \v / 
Prtre 
Independent 
Seller 
Operating 
Profit 
T ^ ^ ^ ^ □ and Adjustment 
Functional 
Cost 
\ Comparison 
and 
/ Adjustment 
Functional 
Cost independent 
Buyer 
Company 
A 
Country AA \ 
Company B 
Country BB 
Company A 
Country AA 
Company B 
Country BB 
(Source: Miesel et al, 2002:7 and own compilation) 
In Figure 8, an external CUP, the arm's length price is determined by direct comparison of the 
price charged amongst connected parties and the market price for similar goods or services, 
charged amongst an independent buyer and seller (Miesel et al, 2002:6). In the second example 
of Figure 8, the price charged by a connected party to another connected party in relation to the 
price charged to an unrelated party, an internal CUP. 
PN 7 (South Africa, 1999:15) and the OECD (OECD, 1995: 11-4,11-5) further stipulates that in the 
event that differences exists between the two prices, that these differences may indicate the 
existence of non-arm's length conditions. In such circumstances, the price in the controlled 
transaction may need to be substituted for the price in the uncontrolled transaction. 
3.3.1.1.1 CUP Application 
As illustrated, in Figure 8, the CUP method is a direct and reliable way to apply the arm's length 
principle where it is possible to identify comparable uncontrolled transactions. The comparable 
uncontrolled price is determined by comparing similar products, goods or services transferred 
under similar circumstances. 
Comparability amongst the two transactions hinges on the premise that insofar as the two 
transactions are being compared if none of the differences amongst the two transactions have a 
104 
material effect on the price, or alternatively, if reasonably accurate adjustments can be made to 
eliminate the effect of differences that materially influences the price (OECD, 1995:11-3). 
Transactional comparability is not guaranteed by virtue of the product, goods or service being 
transferred being comparable. Business functions and the economic circumstances under which 
the transfer of products, goods and services took place must be taken into consideration (South 
Africa, 1999:15). 
PN 7 (South Africa, 1999:15-16) list examples of where adjustments might be required when 
comparable products, goods or services are transferred amongst connected parties and independent 
parties. PN 7 recognises that to adjust for differences in product quality, geographic location of 
markets and intangible property involved in the transactions could be very difficult. 
In practice, it proved to be very difficult to find a transaction amongst independent parties, which 
is comparable to a controlled transaction, without differences which have a material effect on price 
or for which accurate adjustments could be made to eliminate the effect of it on the price. In the 
empirical part of the research, it is apparent that for the cases under investigation, no CUP existed. 
3.3.1.2 Resale price method 
The resale price method is based on the price at which a product, which has been purchased from a 
connected party, is resold to an independent party (South Africa, 1999:14, OECD, 1995:11-5). The 
resale price is reduced by an appropriate arm's length gross margin to cover the reseller's selling 
and other operating costs, and to provide an appropriate profit, which is based on the functions 
performed, assets used and risks assumed by the reseller. The gross margin earned by the 
connected party reseller is compared to independent resellers, usually referred to as distributors, 
which perform similar functions to the connected reseller as illustrated in Figure 9. 
105 
Figure 9: Resale Price Method 
Connected 
Seller 
Connected 
Buyer Market 
Sales 
Cost of Sales 
Functional Cost 
Operating Profit 
Company A 
Country AA 
Sales 
Cost of Sales 
Gross Profit 
Functional Cost 
Comparable Uncontrolled 
Companies 
r "^i 
Transfer 
Price f 35% 
Company W 
Country BB 
Gross Profit 
Margins 
(Source: Miesel et al., 2002:10 and own compilation) 
Company A in country AA sells products to Company B in country BB which it sells to the 
market and independent buyers. The gross margin Company B realises from sales to independent 
parties is compared to the margins comparable companies realise. In the event that the margin 
falls outside the range determined by analysing comparable gross margins (as illustrated as a bar 
chart in Figure 9), an adjustment to the sale price from the connected party, Company A will be 
made to ensure that Company B's gross margin falls within the range of gross margins determined 
by the comparability analysis (Miesel et al., 2002:9). 
The resale price method, as illustrated in Figure 9, is based on the assumption that independent 
competitors, in this specific case, distributors, result in similar gross margins being realised on 
sales if they perform the same functions. In effect, the resale price margin establishes the price a 
connected buyer should pay to earn comparable gross margins to that of independent distributors 
performing similar functions. 
Adjustments under the resale price method are made for primarily differences in economic 
circumstances and the conditions of sale. Functional adjustments are critical in the application of 
the resale price method (refer to section 4.3.3 where working capital adjustments is discussed). 
The method requires comparability to the functions performed, assets used and risk assumed. 
Comparability adjustments might include adjustments for purchase or sales volume, payment 
106 
terms, contractual considerations, customs, insurance, warranty, testing marketing and advertising 
as well as any other sales and purchase terms. 
3.3.1.2.1 The Resale Price Method Application 
PN 7 states that the resale price margin of the reseller (Company B, in Country BB) in the 
controlled transaction is determined by reference to the resale price margin that the entity obtains 
on items purchased and sold in comparable uncontrolled transactions as illustrated in Figure 10 
(South Africa, 1999:16). Functional comparability is of critical importance and it is important that 
the functions performed by the independent companies are highly comparable to the functions 
performed by connected party, in the example, Company B, selling to the market. There should be 
no differences amongst Company B and the comparable companies, which could materially affect 
the price. 
Figure 10: Resale Price Analysis  
Connected Seller Connected Buyer 
Sales 
Cost of Sales 
Functional 
Cost 
Operating 
Profit 
Company A 
Country AA 
Sales 
Step 2 
Cost of Sales 
Gross Profit 
Functional 
Cost 
Comparable Analysis 
Query Database 
Qualitative Screening 
Quantitative Screening 
Select Comparables 
Determine Gross 
Margin 
Stepl Step 3 
Functional Analysis 
Company B 
Business Conditions 
Functions performed 
Risk 
Products 
Gross Margin 
Company B 
Country BB ^ > 
Step 4 
Adjustments 
■ • Terms of sale 
1 • Terms of payment 
1 • Inventory / Opportunity 
1 Cost 
1 • Economic conditions 
- - - ; ■ ^ -A 
Comparison 
• Adjusted comparable 
results 
• Actual results of 
Company B 
Source: Miesel et al., 2002:11 and own compilation) 
Fewer adjustments are expected under the resale price method than the CUP method because it is 
implausible that minor product differences could influence the gross margins. Profit margins for 
similar functions tend to be similar, as established in the empirical part of the research. The 
analysis illustrates in Figure 10 the practical application of the resale price method. As illustrated 
in Figure 10, the resale price method's focus is on the "resale price" to independent parties, in 
107 
reality the market price and the gross margin realised from the sale as an arm's length 
consideration for the functions performed by the reseller (Company B in the example). 
Cost efficiency and cost structure (that is measured as operational expenses in the incomes 
statement) differences will not influence the results as the comparable test is applied at the gross 
margin level. Cost structures and cost efficiency will have an impact on the net profit margin 
hence the approach followed exclude net profits in the determination of the arm's length standard. 
The resale price method is neither most appropriate (South Africa, 1999:17) where the reseller, 
(Company B), does not add substantially to the value of the product nor does it owns valuable 
marketing intangibles, which by definition will attract substantial profits. 
Distribution structures 
Alternative structures exists under which connected parties structure their distribution function to 
which the resale price method can be applied. The approach followed by MNE's is to limit the 
risk of the distributors evidenced by the variance in gross margins obtained by the various forms of 
distributors with the variance attributable to functional differences as tabled in Table 7. 
Table 7: Distribution structures 
Agency Distributor Pure Distributor Diversified Distributor 
Does not take title to goods Takes title to goods Functions similar to pure distributor 
Has no inventory, credit or foreign 
exchange risk 
Bears inventory, credit and foreign 
exchange risk 
Might own intangibles associated 
with the products 
Has no marketing responsibilities Performs some marketing activities Might undertake extensive marketing 
research 
Does not perform warehousing 
activities 
Might perform warehousing activities 
Does not posses intangibles Does not posses significant 
intangibles 
{Source: own compilation) 
With in the context of Double Taxation Agreements (DTA), the de-risked distributor (sometimes 
referred to as the risk stripped distributor) such as the agency distributor (in the first column of 
Table 7) needs special attention because it could give rise to a permanent establishment in 
accordance with Article 5 (OECD, 2000:25). Vietnam, Ukraine and Thailand, for example, 
reserve the right to include a warehouse in the definition of paragraph 2 to constitute a permanent 
establishment (OECD, 2000:282). Russia, Thailand, Ukraine and Vietnam reserve the right to 
treat an enterprise as having a permanent establishment if a person acting on behalf of the 
enterprise habitually maintains a stock of goods or merchandise from which the person regularly 
delivers goods or merchandise on behalf of the enterprise. 
108 
3.3.1.3 Cost-plus method 
The cost-plus method requires estimation of an arm's length consideration, by adding an 
appropriate mark-up to the costs incurred by the supplier of goods or services in a controlled 
transaction (South Africa, 1999: 17) and (OECD, 1995: 11-11). This mark-up should provide for 
an appropriate profit to the supplier, in the light of the functions performed, assets used and risks 
assumed. In the previous discussion of the resale price method, the application is primarily limited 
to distributors. The cost-plus method on the other hand, is primarily applied to the other side of 
the transaction, the manufacturing function and service activities as illustrated in Figure 11. 
Figure 11: Cost-plus method  
Connected 
Seller 
Sales 
Cost of Sales 
Functional 
Cost 
Operating Profit 
Cost of Sales 
Gross Profit 
Functional Cost 
Comparable Uncontrolled 
Companies 
Gross Profit 
Margins 
(Source: Miesel et at, 2002:10, 14 and own compilation) 
Under the cost-plus method, the profit derived from either providing a service by Company A to 
Company B or Company B buying materials for manufacture from Company A, are evaluated by 
means of the gross cost plus profit level indicator (refer to section 3.3.2.1.1 where the profit level 
indicators are discussed and the formulas for their calculation is provided). 
The underlying assumption of this method is that the competition amongst a large number of 
manufacturers or service providers will lead to similar prices and profit margins. It is apparent 
that the comparability analysis associated with the cost plus method is critical, as with the resale 
plus method. 
109 
3.3.1.3.1 A Cost-plus method application 
PN 7 (South Africa, 1999:17) provides guidelines insofar as to the application of the methodology 
and indicates that it is best suited when services are provided, semi-finished goods are sold 
amongst connected parties and connected parties have concluded joint facility agreements or long-
term buy-and-supply arrangements. The mark-up determined by the cost-plus should ideally be 
determined with reference to the mark-up earned by the same supplier in uncontrolled transactions. 
If this is not possible, the mark-up should be determined by using the mark-up earned in 
comparable transactions by an independent supplier performing comparable functions, bearing 
similar risks and employing similar assets to those of the MNE. 
An uncontrolled transaction is comparable to a controlled transaction for purposes of the cost-plus 
method (Figure 12) if one of two conditions is met. Firstly, if none of the differences amongst the 
transactions being compared or amongst the enterprises undertaking those transactions materially 
affect the cost-plus mark-up in the open market. Secondly, when reasonably accurate adjustments 
can be made to eliminate the material effects of such differences (South Africa, 1999:17-18). 
Figure 12: Cost-Pius Method Analysis  
Connected Seller Connected Buyer 
Sales 
Cost of Sales 
Functional 
Cost 
Operating 
Profit 
Company A 
Country AA 
Sales 
Step 2 
Cost of Sales 
Gross Profit 
Functional 
Cost 
Comparable Analysis 
Query Database 
Qualitative Screening 
Quantitative Screening 
Select Comparables 
Determine Gross Cost 
Plus 
Stepl Step 3 
Functional Analysis 
Company B 
Business Conditions 
Functions performed 
Risk 
Products 
Gross Cost Plus 
Company I! 
Country BB 
Step 4 
Comparison 
Adjusted comparable 
results 
Actual results of 
Company B 
Adjustments 
• Terms of sale 
• Terms of payment 
• Inventory / Opportunity 
Cost 
• Economic conditions 
cy 
Source: Miesel et al., 2002:15 and own compilation) 
The example in Figure 12, illustrates the upstream manufacturer and seller, Company A in 
Country AA, which transfer price to the buyer, Company B in Country BB, in accordance with the 
110 
gross margin Company B, realises on its connected purchases from Company A. The margin is 
measured as gross cost plus which is the ratio of gross profit to the cost of sales. 
An implicit assumption in the cost-plus method's application is that the competition in a large 
number of manufacturing concerns will lead to relatively similar prices and profits. In applying 
the cost-plus method, as is the case with the resale price method, a comparability analysis, is 
important (Miesel et al, 2002:12). The cost-plus method requires comparables insofar as the 
functions performed, assets used and risk assumed similar to that of the controlled party, (in the 
example, Company B). Adjustments to enhance comparability can be made for terms of sale, 
terms of purchase, inventory holding levels and economic conditions. 
Unlike with the resale price method, the cost structure under the cost-plus method plays an 
important role. The arm's length consideration, as the cost-plus factor being added to the cost base 
is self-explanatory insofar as cost measurement and recognition. Miesel et al, (2002:12) and the 
OECD (1995:11-14) stress the point that adjustment for accountancy treatment might be considered 
when the manufacturing cost definitions are inclusive of selling, general and administrative 
expenses and research and development cost. Miesel et al., (2002:13) further this view by 
promulgating that in industries where volume and capacity utilisation are volatile, cost-plus mark­
up based on direct or variable cost might represent the underlying pricing mechanism better than 
cost-plus mark-up based on total cost of sale which include indirect manufacturing overheads. 
Manufacturing structures 
In the research, the manufacturing function and the reward, which must be in accordance with the 
arm's length principle, are investigated. Generally, two types of manufacturing structures can be 
found with substantial differences in functions performed, assets used and risk assumed and they 
are referred to as contract manufacturers and fully-fledged manufacturers. 
Contract manufacturing 
Contract manufacturing involves a company "entrepreneur", Company A in Figure 13, hiring a 
provider of manufacturing services "the contract manufacturer" Company B, to manufacture the 
products that the entrepreneur (Company A) sells to customers. The entrepreneur (Company A) 
does not hire its own production employees nor does it lease its own plant and equipment to 
manufacture its products. The contract manufacturer (Company B) hires the necessary production 
111 
workforce and acquires the necessary plant and equipment for the manufacturing process. The 
contract manufacturing arrangement refers to the contractual relationship amongst the entrepreneur 
and the contract manufacturer and set forth the terms of the entrepreneur involvement in the 
manufacturing process, the assignment of the various risks associated with the cost of 
manufacturing and the compensation paid by the entrepreneur to the contract manufacturer. 
Figure 13: Contract and fully-fledged manufacturer  
Fully Fledged Manufacturer 
Connected Seller / Connected Buyei 
Sales of 
components, Raw 
materials or 
manufacturing 
) 
Buys 
manufacturing 
inputs and sell to 
market / 
Sales 
Sales 
j 
W Cost of Sales 
Cost of Sales Gross Profit 
Functional 
Cost 
Functional 
Cost 
Operating 
Profit 
Company A 
Country AA 
Company B 
Country BB 
Fully Fledged Manufacturer Evaluation 
S t e p 2 
Step 1 
i 
Functional 
Analysis 
Company B 
Business 
Conditions 
Functions 
performed 
Risk 
Products 
Gross Cost Plus 
Comparable Analysis 
• Query Database 
• Qualitative 
Screening 
• Quantitative 
Screening 
• Select Comparable* 
• Determine Gross 
Cost Plus 
S t e p 3 
S t e p 4 
Comparison 
Adjusted 
comparable results 
Actual results of 
Company D 
Adjustments 
Terms ot'salc 
Terms or' 
payment 
Inventory/ 
Opportunity 
Cost 
Economic 
conditions 
Contract Manufacturer 
Ent rep reneur 
Cont rac t 
Manufac tu re r 
Buys 
manufac tu r ing 
inputs , p rov ides 
to con t rac t 
manufac tu re r and 
. sell to marke t 
P rov ides se rv ice , 
D o e s not take title 
to g o o d s , d o e s not 
marke t or sell 
Sales 
C o s t of Sales 
Funct ional 
Cost 
Opera t ing 
Profit 
C o m p a n y A 
C o u n t r y A A 
Cos t of Sa les 
G r o s s Profit 
Funct iona l 
Cos t 
Operating 
Profit 
C o m p a n y B 
Coun t ry BB 
Contract Manufacturer Evaluation 
Step 2 
Stepl 
Functional 
Analysis 
Company B 
Business 
Conditions 
Functions 
performed 
Net-cost-plus 
Comparable Analysis 
• Query Database 
• Qualitative 
Screening 
• Quantitative 
Screening 
• Select Comparables 
• Determine Net-cost-
plus 
Step 3 
S t e p 4 
Comparison 
Adjusted 
comparable results 
Actual results of 
Company D 
Adjustments 
1 Terms of 
payment 
' Economic 
conditions 
(Source: Miesel et ai, (2002:16) and own compilation) 
112 
Contract manufacturer 
A contract manufacturer (Company B) is in essence a service provider (see Figure 13) without 
entrepreneurial risk with the entrepreneur (Company A) bearing the financial risk associated with 
raw material; work in process and finished goods inventories and the market risk associated with 
competition and customer acceptance of the product. This view is based on the fact that the 
entrepreneur (Company A) and not the contract manufacturer (Company B) bears these risk 
because the entrepreneur owns or has licensed the right to use the proprietary intangibles with 
respect to the product. 
The entrepreneur typically bears all the risk of owning inventories and has primary control over 
the time and quantity of production, complete control over the design, specifications and quality of 
products to be produced. Furthermore, the entrepreneur has responsibilities concerning the 
marketing of products and the actual negotiation and consummation of the sale of the products to 
the ultimate customer. It is important to note that the contract manufacturer is merely a service 
provider that earns a service fee and bears no direct financial or market risk with respect to the 
products it produces with the major characteristics being tables in Table 8. 
Table 8: Manufacturing structure 
Contract manufacturer characteristics Fully fledged manufacturers 
Essentially a contract manufacturer bears very little or no risk 
with the following key characteristics 
Fully fledged manufacturers differ considerably from a contract 
manufacturer with a high level of risk performing the following 
functions: 
• Performs basic manufacturing functions 
• Very limited material sourcing 
• Physical capital might be leased 
• Exposed to no inventory or bad debt risk 
• No research and development and usually no 
marketing functions or intangibles. 
• Manufacturing, 
• Material Sourcing 
• Carries inventory risk 
• Undertake research and development and 
• Often owns valuable intangible assets. 
(Source: own compilation) 
3.3.2 Transfer pricing transactional profit methods 
Transactional profit methods (OECD, 1995:111-1) examine the profit that arises from particular 
controlled and uncontrolled transactions. The transactional net margin method and the profit split 
method are recognised by the OECD (1995:111-1) and PN 7 (South Africa, 1999:18). 
Transactional profit methods are surrounded by an anomaly. An assumption is made that MNE's 
are entering into transactions in which profit is conditional. By applying these methods, it is 
assumed that MNE's determine prices conditional to which profit is made or imposed. Although 
the profit preposition is not a realistic assumption, the value lies within the premise whether a 
113 
transaction was affected by conditions that is divergent to what would have been under 
comparable conditions amongst independent parties. (OECD, 1995:111-1) 
Acceptance of the transactional profits methods relies on their inference with Article 9 of the 
OECD Model Tax Convention (OECD, 1995:111-2), in particular to the aspect of comparability. 
The application of the transactional profits methods is based on an approximation of arm's length 
pricing which requires a comparison of profits derived from a controlled transaction to that of an 
uncontrolled one. 
3.3.2.1 The Transactional Net Margin Method 
PN 7 (South Africa, 1999:19) and the OECD Guidelines (1995:111-1) recognises the Transactional 
net margin method (TNMM) as an appropriate method to test the arm's length principle. The 
TNMM examines the net profit margin that an MNE realises from a controlled transaction, relative 
to an appropriate base, for example cost, sales or assets. This ratio is referred to as a profit level 
indicator, which is discussed further in section 3.3.2.1.1. The profit level indicator of the tested 
party is compared to the profit level indicator(s) of comparable independent parties. 
PN 7 (South Africa, 1999:18), (which provides guidance insofar as the acceptable methodologies 
and the application of the said methodologies) draw a continuum amongst the TNMM, the cost-
plus (CP) and the resale price (RP) methods. The basis of such a comparison culminates in the use 
of profit level indicators; the TNMM compares net profit rather than gross profit with cognisance 
of the critical importance of functional comparability. 
In principle, the TNMM measures the level of net margin an MNE realises in a controlled 
transaction compared to the net margin uncontrolled or unconnected parties realise under similar, 
comparable conditions (OECD, 1995:111-9). PN 7 recognises that the TNMM is considered less 
reliable than the traditional transactions methods (South Africa, 1999:18). This constraint can be 
attributable to the use of net margins compared to gross margins with net margins greatly 
influenced by operating expenses, which could potentially have little relevance to the functional 
activities being tested and compared. Efficiencies are cited as another factor that could influence 
the application of the TNMM (South Africa, 1999:18). 
The OECD explores some advantages of the TNMM method, which can be summarised as follows 
(OECD 1995:111-10, 11): 
114 
• Some net margins such as return on assets or operating margin are less affected by 
transactional differences than what would be if price comparisons were undertaken. 
• On a practical level, it is not necessary to determine the functions performed and 
responsibilities assumed by more than one of the associated enterprises. This is of 
particular value when the other parties to the transactions are complex with numerous 
transactions. 
• Another practical consideration is that the TNMM is a pragmatic method that is being 
applied to one of the members of the MNE, usually the least complex party to the 
transaction. 
Factors unrelated to transfer pricing influence net margins, which in turn would influence the 
TNMM method and raise concerns about reliability. In making use of a one-sided analysis, this is 
in effect what happens when applying the resale price and cost plus methods. The profitability 
dynamics insofar as synergy and leverage of the MNE is negated and could possibly attribute to 
one member of the MNE a level of profit that implicitly leaves other members of the group with 
questionably low or high profits (OECD, 1995:111-11). 
3.3.2.1.1 Profit level indicators 
Selection of the most appropriate transfer pricing method is done in conjunction with the profit 
level indicator that would provide the best result under the circumstances. The ratios that are 
being used in transfer pricing documentation are the gross margin, gross cost plus mark-up, 
operating margin, net-cost-plus mark-up, return on average operating assets and return on capital 
employed (refer to Figure 17 for details pertaining to the profit level indicators used). 
The profit level indicator selection is of particular importance in applying the TNMM method 
where the profit level indicator is indicative of the test being applied in determining the arm's 
length consideration. In the event that the transaction under consideration is recorded in the cost 
of sales entry in the income statement of an MNE, it is prudent to make use of a profit level 
indicator, which uses the cost of sales as a variable. 
The CUP method is preferred because it accomplishes a direct product or service comparison and 
is not prejudiced by specific functions, which are performed by the entities being compared. 
Alternatively, the resale price and cost plus methods look at valuing the functions performed and 
115 
determine an arm's length consideration based on specific profit level indicators. Both the resale 
price and cost plus methods examines gross margins, hence operating expenses are excluded from 
the assessment and the impact of relative cost structures is of no consequence (South Africa, 
1999:14-15). Table 9 provides a broad summary of the transfer pricing methodologies and the 
profit level indicators or ratio's that could be used depending on the functions identified. 
Table 9: Transfer pricing methodologies and profit level indicators 
Transfer Pricing 
Methodologies 
Broad Functionality 
Manufacturer Distributor Service provider 
1 RP GM 
2 Cost plus GCP GCP 
3 TNMM(i) ROA/ROCE OM NCP 
(ii) NCP ROA/ROCE 
4 Profit split (i) ROA/ROCE OM 
(ii) NCP ROA/ROCE 
(Source: own compilation) 
The formulas used to calculate the profit level indicators (refer to section 1.6.13 that deals with 
financial ratios for more information) are as follows: 
Gross margin (GM) is the ratio of gross profit to turnover 
Gross Profit Turnover - Cost of Sales 
GM 
Turnover Turnover 
Operating margin (OM) is the ratio of operating profit to turnover 
_ Operating Profit _ Turnover - Cost of Sales - Operating Expenses 
Turnover Turnover 
Gross cost plus mark-up (GCP) is the ratio of gross margin to cost of sales 
Gross Profit Turnover - Cost of Sales 
GCP-- Cost of Sales Cost of Sales 
Net-cost-plus mark-up (NCP) is the ratio of operating profit to total costs 
Operating Profit Turnover - Cost of Sales - Operating Expenses 
NCP=~ Cost of Sales + Operating Expenses Cost of Sales + Operating Expenses 
Net-cost-plus mark-up is mathematically equivalent to 9M. 
{1-OM) 
Return on assets (ROA) is the ratio of operating profit to assets 
_ Operating Profit _ Turnover -Cost of Sales -Operating Expenses , 
Assets Assets 
Operating assets = Total assets - (Cash + marketable securities) 
116 
Return on Capital Employed (ROCE) is the ratio of operating profit to average capital 
e m p l o y e d j?nrp - Operating Profit _ Turnover - Cost of Sales - Operating Expenses 
Average Capital Employed Average Capital Employed 
Berry Ratio (not recognised in South Africa but widely used in the United States) is the 
ratio of gross profit to operating expenses 
Gross Profit Turnover-Cost of Sales 1 
Berry Ratio = 
Operating Expenses Operating Expenses (. OM*\ 
In practice, information constraints make the application of the traditional methods not viable 
mainly due to the lack of publicly available information on comparable uncontrolled transactions 
or gross margins. In an attempt to overcome these information constraints, it is often necessary to 
resort to the transactional profits methods. 
3.3.2.2 Profit split 
PN 7 (South Africa, 1999:19) and the OECD Guidelines (1995:111-3) recognises the profit split as 
an acceptable method to determine the arm's length consideration. In reality, MNE transactions 
are very interrelated it might be that they cannot be evaluated on a separate basis. Under such 
circumstances, unconnected parties might decide to set up a form of partnership and agree to a 
form of profit split (OECD, 1995:111-3). 
It is comprehensible that in the event that the MNE's transactions are interrelated, any attempt at 
separating the transactions might lead to subjective separated transactions. These transactions 
might not have been conducted on a one to one basis. Only when all the various transactions are 
grouped together, the true nature of the transaction emerges. Under these conditions, the profit 
split would make more sense to apply, than for instance the TNMM. 
Miesel et at, (2003:19) shares the observation citing that the lack of an economic sound basis on 
which the arm's length principle is applied, especially when using transactional methods, compel 
the use of the profit split methodology. The obvious strength following this approach is that the 
focus moves from the premise of the transaction towards the bilateral or multilateral aspects of 
transactions across the value chain, hence attributing profits based on value creation. 
The value in following any approach are that it should provide the most appropriate result which 
can be deemed as a reward consistent with the arm's length principle. Similar to any of the 
117 
transfer pricing methodologies, the profit split has limitations, which are (OECD, 1995:111-4; 
South Africa, 1999:22): 
• The profit split is based on external market data that are considered in valuing the 
contribution of the parties to the transaction. This external market data are often not 
comparable to the transactions under review that increases subjectivity 
• Application of the profit split is difficult insofar as access to information. In order to apply 
the profit split, information is required on a group wide basis concerning the parties to the 
transactions. This requires information from various jurisdictions and foreign affiliates that 
do not readily provide information for foreign tax authorities. 
The approach tax administrations follow is usually informed by the OECD Guidelines. In general, 
the approach followed in South Africa according to PN 7 (South Africa, 1999:20) and the OECD 
Guidelines (1995:111-5) is based on two methodological approaches, the first is based on a 
contribution analysis, as illustrated in Figure 14 and the second is referred to as the residual profit 
split method. Using a contribution analysis approach, the profit split is based on a comparability 
study of independent enterprise financial information of an uncontrolled transaction where the 
combined return is comparable to that of the controlled transaction. 
Under both approaches, it is essential to determine the combined profit attributable to the parties to 
the transaction. PN 7 (South Africa, 1999:21) and the OECD Guidelines (1995:111-5), states that 
the contribution analysis and the residual profit split are not exhaustive or mutually exclusive. 
There may be alternative ways to split a profit to achieve a reliable arm's length result (refer to 
Appendix 7.3 where alternative approaches is proposed for further research). 
The next step in the analysis according to Figure 14 focuses on profit allocation. When the 
contribution analysis is used, the combined operating profit (profit before interest and tax) is 
divided amongst the parties based on the relative contribution of each party to that combined gross 
profit. In making use of the residual profit split, the parties to the transaction are assigned a 
portion of profit according to the basic functions that it performs. In the event that not all the 
profit or loss is allocated based on the functional allocation, the residual profit or loss is then 
allocated amongst the parties based on their relative economic contribution in respect of the 
amount to be allocated. 
118 
Figure 14: The contribution analysis approach 
Tested Party 
Market 
Transfer 
Price 
Controlled 
Buyer Cost 
Buyer's profit 
share 
f Seller's profit share 
Controlled 
Seller Cost 
Value Chain 
Comparable Gross Margins DD 
Comparable profit 
< ^ Comparable profit 
Controlled 
Buyer Cost 
Buyer share of 
profit 
Buyer share of 
profit 
Seller's share of 
operating profit 
Independent 
Seller Cost 
Comparables 
Combined 
Operating 
Profit 
(Source: Miesel et al., 2003:21 and own compilation) 
The proposed approaches by the OECD Guidelines and South Africa's Practice Note concerning 
the profit split highlight the potential subjective nature of the profit split. No conclusive guidance 
is provided. Profit and cost allocation result in a level of subjective analysis. In practice, the 
profit split method is used for the determination of an arm's length consideration in complex 
transactions when none of the other accepted methodologies provides a reliable result, a method of 
last resort. 
The circumstances under which the profit split is used, for instance when inseparable transactions 
render the traditional methods unreliable, give rise to its complexity. Miesel et al, (2003:20) 
promulgates the use of a capital employed profit level indicator as a basis on which to formulate 
the profit split methodology. 
The motivation behind such an approach is self-explanatory; an implicit comparison of the arm's 
length price of capital is determined by the capital markets. In following this approach, capital 
employed forms the basis on which profits are split. Investment markets are competitive and it 
would ordinarily be expected that over time the operating profit of an integrated MNE to provide a 
market related return on the capital employed. 
119 
Uncertainty exists with respect to profit split. The method is not frequently used; refer to Figure 
17 where the profit split is used in 12 per cent of advanced pricing agreements, 7 per cent in 
tangible goods, 10 per cent in licensing arrangements and one per cent in cost sharing transactions. 
3.3.3 Alternative methodologies 
The OECD recognised methodologies, which are used to determine the arm's length principle, 
were discussed in detail. In the United States of America, other methodologies are also accepted 
in accordance with their specific regulations pertaining to transfer pricing. Inclusion of these 
methodologies provides a comprehensive synopsis of transfer pricing methodologies. 
Intangible property evaluation in terms of applying the arm's length principle is excluded from the 
scope of this research. In order to get a better understanding of the alternative methodologies 
being used in transfer pricing, methodologies that are geared to evaluate intangible property 
transfers are included for completeness rather than extending the scope to include intangibles. 
3.3.3.1 Comparable uncontrolled transaction method 
The comparable uncontrolled transaction ("CUT") method, which is being used in the United 
States of America (USA) by the Internal Revenue Service (IRS), is principally similar to the CUP 
method with the focus on comparable transactions rather than on price (Miesel et al., 2003:6). The 
CUT method is illustrated in Figure 15. 
Application of the CUT method is aligned towards evaluating intangible property transfer rather 
than tangible property or services (Halperin and Srinidhi, 1996:62). The CUT method is applied 
where the transfer of the same or similar, essentially comparable, intangible property amongst 
connected parties and unconnected parties under similar circumstances (Sherman and McBride, 
1995:32). 
120 
Figure 15: Comparable Uncontrolled Transaction 
Connected 
Jjcensee 
Operating 
Profit 
Royalty 
Functional 
Cost 
Licensee's ', 
profit after 
royalty ' 
^>- Licensee's/ 
Cost / 
Source: Own compilation and Miesel et al., 2003:8) 
In applying the CUT method, a comparison is made amongst the connected party transaction and 
an uncontrolled transaction as illustrated in Figure 15. The valuation of the royalty, under the 
CUT method is based on the transfer of intangible property from Company A in country AA to 
Company B in Country BB under comparable circumstances. Reliability in applying the CUT 
method is severely affected by diminution of product comparability; the method requires 
intangible property related to similar types of products or processes within the same industry or 
market (Miesel et al, 2003:8). 
3.3.3.2 Comparable profits method 
Miesel et al, (2003:13) states that in principle, when the resale price and cost plus methods are 
correctly applied it should present economically valid and similar results. However, in practice 
with vertically integrated enterprises it is not uncommon that MNE's achieve profits in access of 
the combined profits of unconnected parties performing similar functions. 
This situation can be attributed to the fact that in vertically integrated enterprises, pricing margins 
are eliminated whilst in the unconnected parties it is crucial for survival. In practice, this implies 
that comparable data is not available in parallel markets for pricing purposes and Miesel et al, 
121 
(2003:13) proposes the use of the comparable profits (see figure Figure 16)method or the profit 
split method. 
Figure 16: Comparable profits method  
Controlled distributor 
Operating Assets 
Less 
Non-Interest bearing 
liabilities 
Equals 
Capital Employed 
ROCE--
Operating Profit 
Average Capital Employed 
Turnover - Cost of Sales - Operating Expenses 
Average Capital Employed 
Controlled Distributor 
X 
Comparables 
Operating Assets 
Divided 
Capital Employed 
Equals 
Return on Capital 
Employed 
Comparable Profit 
Operating Profit 
Distributor's selling and 
general administrative 
expenses 
(Source: Miesel et al., 2003:17 and own compilation) 
The OECD Guidelines (OECD, 1995:11-11 and 11-13) and PN 7 (1999:17-19) acknowledge the 
difficulties that could be encountered in applying the resale price and cost plus methods. Miesel et 
al., (2003:13) proposes the comparable profits method to be used by using profit level indicators 
such as the return on capital employed. The comparable profits method is used to value routine 
manufacturing and distribution functions with enterprises using similar resources (Halperin and 
Srinidhi, 1996: 62). 
In applying the comparable profits method and using the return on capital employed as the profit 
level indicator, the basis of comparison is the economic premise that if capital and product markets 
are in competitive equilibrium, then over time companies with similar risk characteristics will earn 
similar returns on their capital employed (Miesel et al., 2003:17). 
122 
3.3.4 Practical test of transfer pricing methods 
PN 7 (South Africa 1999:28), the OECD Guidelines (OECD 1995:1-27) and Sherman and 
McBride (1995:29) acknowledge that the use of multiple methods should result in similar arm's 
length consideration. 
Ernst and Young (2003:17) and Miesel et al, (2003:18) reports on the recognised transfer pricing 
methods and their respective practical use and application. Miesel et al. (2003:18) made use of 
data from the Inland Revenue Service (United State's equivalent to the South African Receiver of 
Revenue) pertaining to 191 Advance pricing agreements (APA) to determine methodology use 
with the results as illustrated in Figure 17. 
Figure 17: Transfer pricing methods in practice 
Transfer pricing methods based on 191 US APA's 
Comparabe Profit 
Other l~ 62% 
7.9% . ^ t ^ ^ ^ ^ ^ ^ - — _ _ _ / 
Tost Plus ' \ ^ ^ _ T—— 
5.2% A \ ' ftk / 
Resale Price / \ ^ N. I W \ / 
5.2% / \ \ Yl ft / 
C U P o r C U T H / 
9.9% « / 
Lost MarK-up 
~^~ 13.2% 
ROCE 
""" 14.9% 
Berry Ratio 
11.4% 
^ ^ G r o s s Margin 
10.5% 
\ . Return on Sales 
10.0% Profit Split ^ ^ ^ ( ^^-—— 
12.0% 
(Source: Miesel et al, 2003:18) 
Ernst and Young (2003:17) determined from a parent company perspective what methods are used 
for which transactions and the results are tabled in Table 10. 
123 
Table 10: Transfer pricing methods used by parent companies 
Tangible 
Goods 
Inter company 
Services 
Licensing 
Agreements 
Cost Sharing 
Agreements 
Financing 
Survey base 417 428 248 197 45 
C U P % 35 20 Internal 37 
External 15 
2 33 
Resale Price % 18 
Cost % 16 28 4 
Cost Plus % 31 57 1 51 9 
Profit Split % 5 10 1 
Profit-based% 7 17 1 
Other % 8 7 23 16 4 
Not Stated 1 1 1 4 49 
Note: Multiple responses were permitted 
(Source: Ernst and Young (2003: 12)) 
It is apparent form both of these studies, not a single method can be singled out as the most 
appropriate or being used under virtually all circumstances. Cost based methods are used in the 
majority of cases involving the pricing of inter company service as well as in cost sharing 
agreements. 
These results confirms the position of the OECD Guidelines (OECD, 1995:1-27) and PN 7 (South 
Africa, 1999:13) that the most appropriate method in a specific case will depend on the facts and 
circumstances of the case under consideration and the extent and reliability of data on which to 
base a comparability analysis. It should always be the intention to select the most appropriate 
method, the method that produces the highest degree of comparability. 
3.4 Alternative to arm's length principle 
3.4.1 Global formulary apportionment 
The OECD Guidelines (1995:G-5) defines global formulary apportionment ("GFA") as "A method 
to allocate the global profits of an MNE group on a consolidated basis among the associated 
enterprises in different countries on the basis of a predetermined formula." The global formulary 
apportionment methodology is founded on global profit allocation on a group-consolidated basis 
across national tax jurisdictions and consists of the following (OECD 1995:111-21): 
• Determination of the member of the MNE to be taxed, i.e. which of the subsidiaries and 
branches of the MNE makes up the global taxable entity 
• Accurate determination of global profits 
124 
• Establishing the formula to be used to allocate global profits 
The separate entity approach followed by the OECD member countries, which is generally 
accepted as the international norm, is central to the arm's length principle. Not surprisingly, the 
OECD does not subscribe to this approach and does not consider the global formulary 
apportionment as a realistic alternative and their standpoint is based on the following (OECD 
1995:m-21-HI-24): 
• It is difficult to institute a system that both protects against double taxation and ensuring a 
single taxation. In order to achieve this, extensive international co-ordination and 
consensus on predetermined formulas and the composition of the MNE under 
consideration must be reached. 
• If countries agree to the principle, putting it into practice would be administratively 
difficult because each country aim to derive utmost benefit from its international 
transactions. Developing countries currently does not have the capacity to administer their 
tax systems as the developed world and they will clearly be disadvantaged under such a 
system. 
• Transition to global formulary apportionment would present political and administrative 
complexity requiring a high level of international co-operation. 
• The arbitrary and subjective nature of formulas might result in distortions with the basis of 
allocation being open for manipulation. 
• Application of the global formulary apportionment under an universal currency have merit, 
foreign exchange movements will complicate matters in the absence of an evaluation of the 
facts and circumstances of the specific MNE. 
• The design of global formulary apportionment fails to recognise the separate entity 
approach, geographic and market differences that impacts on profitability. 
• Dispense with intra-group transactions, withholding taxes will not be practical in the 
circumstances to the detriment of the tax systems of the developing economies of the 
world. 
125 
Proponents of formulary apportionment and those against it highlight the reality of transfer 
pricing. No specific approach or method yields an acceptable result under all circumstances. 
3.5 Conclusion 
Pricing of cross border transactions seen in relation to globalisation requires considerable 
consideration and places pressure on national tax authorities and management of MNE's. Transfer 
pricing is increasing in importance with eighty-six per cent of parent companies and ninety-three 
per cent of subsidiaries identified transfer pricing as the most important international tax issue on 
the agenda. 
Of all the transfer pricing methods used, not a single method can be singled out as the most 
appropriate or being used under virtually all circumstances. Cost based methods are used in the 
majority of cases involving the pricing of inter company service as well as in cost sharing 
agreements. 
Formulary apportionment, as an alternative to the existing methodologies and the arm's length 
principle is not practical because it would be administratively difficult to execute because each 
country aim to derive utmost benefit from its international transactions. Developing countries 
currently does not have the capacity to administer their tax systems as the developed world and 
they will clearly be disadvantaged under a formulary apportionment system. 
Application of the arm's length principle is generally based on a comparison of the conditions in a 
controlled transaction with the conditions in transactions amongst unconnected parties. In 
determining the arm's length consideration the intention should always be to select the most 
appropriate method, the method that produces the highest degree of comparability and provides the 
most reliable result of the arm's length consideration. 
The objective of obtaining the highest degree of comparability and the most reliable result is 
indicative of subjective interpretation, a situation that does not instil certainty. The best way for 
the MNE to address the potential risk of transfer pricing adjustments is to ensure that they are 
conversant with respect to this particular aspect of their international business. 
Transfer pricing is not an exact science; hence, uncertainty exists in the application of principles 
and methodologies. This uncertainty and in particular the hypothesis which forms the basis of the 
126 
determination of the arm's length consideration give rise to clarify the ambiguity surrounding 
transfer pricing, especially comparability. The CATPM, and the theoretical basis on which it 
based provides an opportunity to Umit subjectivity and ambiguity providing more clarity on the 
arm's length consideration for MNE's and tax authorities. 
127 
Chapter 4 A comparability analysis and transfer pricing 
adjustments 
4.1 Introduction 
Transfer pricing is based on the principle that transactions amongst connected parties are to be 
conducted at arm's length (refer to section 1.6.1). The problem to be resolved is how an MNE 
should determine what price would have arisen if transactions amongst its members were subject 
to market forces (the unconnected party test). 
Application of the arm's length principle is based on a comparison of the conditions in a controlled 
transaction with the conditions in transactions amongst unconnected parties. The OECD 
Guidelines (OECD, 1995: 1-7 - 1-28) provides guidance in the application of the arm's length 
principle in relation to connected party dealing(s) and highlight consideration for comparability 
analysis, recognition of the actual transactions undertaken, use of the arm's length range, multiple 
year data, etc. 
Once the MNE considered the abovementioned factors in relation to its connected party dealings, 
similar consideration to unconnected party dealings is required. The solution advanced by the 
arm's length principle is that a comparable transaction amongst unconnected parties should be 
used as a benchmark against which to consider the MNE's transfer price. Any difference amongst 
the two transactions being compared can be identified and adjusted accordingly. This premise 
emphasises comparability and hence this research aims to develop and test a transfer pricing 
model, which recognises comparable transactions, and make an objective estimate based on the 
arm's length principle. 
Transfer pricing is a process by which the arm's length consideration is determined with reference 
to the comparability prerequisites. This chapter follows the same approach. Prior to the 
determination of the arm's length consideration, comparability and adjustments to potentially 
comparable data are investigated in order to enhance comparability objectively. 
By virtue of making use of existing approaches in evaluating companies, an approach is followed 
to utilise these methodologies to determine the arm's length consideration. In order to minimise 
128 
subjective analysis and interpretation, a comparability adjustment transfer pricing model 
(CATPM) is developed and defined. The CATPM recognises factors that influences profitability 
(on which the arm's length consideration is based) and by virtue of multi regression analysis 
estimate objectively "what would have been" in accordance with paragraph 1 of Article 9 of the 
OECD Model Tax Convention. 
4.2 Comparability considerations in transfer pricing 
The concept, which underscores the arm's length principle, is comparability, identified by virtue of 
the conditions, which are critically aligned to the connected or associated transactions and that 
amongst unconnected parties. With reference to the conditions that could influence comparability, 
referred to as comparability factors, (characteristics of goods and services, functionality, terms and 
conditions of contract, economic circumstances and business strategies), with respect to the 
connected transaction are to be identified, measured and compared to that of unconnected parties 
(OECD, 2005 (a):2). 
In adherence to the requirements of comparability in order to determine the arm's length 
consideration, the CUP method (see section 3.3.1.1) is based on a direct comparison (OECD, 
1995:11-2) between the affected transaction and an unconnected transaction. Comparable 
adjustments are made insofar as the comparability factors' influence on the price of the product 
being transferred (OECD, 1995:11-3) as illustrated in Figure 18. The CUP requires internal 
comparables on which the arm's length price is based because the price comparison is based on the 
price charged for the same goods or services provided to an unconnected party and a related party 
(refer to Figure 18). 
The absence of internal comparable information (used in the CUP, refer to section 3.2.2.3.1 for a 
discussion on internal and external comparables) necessitates the use of external comparable 
information (in all the other transfer pricing methodologies). With external comparables, the 
comparability test is not on the price of the goods and/or services being transferred, rather the 
focus is on the margin or profit derived from the affected transaction as illustrated in Figure 18. 
129 
Figure 18: Comparability analysis consideration 
Internal 
Comparable 
Tested Party and 
the affected 
transaction 
External 
Comparable 
Determine 
comparable price 
Determine 
comparable profit 
*!-' 
i. Characteristic of goods & services 
ii. Functions performed (functions, assets, risk) 
iii. Contractual terms pertaining to the transaction 
iv. Economic circumstances 
v. Business strategies 
Comparability 
Adjustments 
All factors that could 
influence price 
according to 
comparability factors 
All factors that could 
influence profit 
according to 
comparability factors 
Transfer 
pricing method 
Comparable 
uncontrolled price 
(CUP) 
Cost plus, resale price, 
transactional net 
margin, profit split 
Arm's length 
price 
Arm's length 
profit 
(Source: own compilation) 
In the determination of the arm's length consideration as illustrated in Figure 18, both on the price 
(internal comparable used in conjunction with the CUP) or profit margin (external comparable 
used in conjunction with all the other methods) the comparability factors are considered and the 
factors that influences the price or margin is adjusted accordingly. 
In adjusting internal comparables, consideration is given to the factors that influence the price, 
predominantly the characteristics of goods and services (OECD, 1995:1-1, 1-7, and South Africa, 
1999:12). PN 7, (South Africa, 1999:10) provides an indication of the factors that should be 
considered for tangible goods, intangible property and services that are as follows: 
• Tangible property with specific reference to the physical features, quality, reliability, 
availability and volume of supply of the goods or services under consideration. 
130 
• Intangible property with specific reference to form of the transaction, type of intangible 
property (patent, trade mark etc), duration of protection, degree of protection (exclusivity) 
and anticipated benefits from use of the intangible property. 
• Services with specific reference to nature and the extent of services performed. 
The list is not exhaustive, but provides guidance on what factors could influence the transfer price. 
Any variance of the abovementioned could potentially influence the transfer price (for example, 
different quality), hence adjustments to reflect direct comparability is required and performed. 
Information pertaining to the characteristics of goods and services (physical features, quality, 
reliability and availability) are available and adjustments based on the characteristics of goods and 
services that influence the transfer price is possible. 
When external comparables are used, specific, detailed information on a transactional level 
(companies does not disclose all the information on a transaction-by-transaction basis) concerning 
unconnected parties are not available (OECD, 1995:1-17,11-2). In the absence of detailed 
information on which to base the determination of the arm's length consideration, financial 
information is used albeit that it requires judgment (South Africa, 1999:9). The OECD Guidelines 
(1995:1-5) and South Africa's PN 7 (South Africa, 1999:27) acknowledges that transfer pricing is 
not an exact science. This non-exact nature of transfer pricing is acknowledged through 
acceptance that the arm's length consideration constitutes not a single price or margin, but a range 
of prices and the facts of each case will determine where, within that range, a specific arm's 
length price will lie. The "non-exact" nature leads to ambiguity on the part of tax authorities and 
the affected companies as tax payers. The comparable adjustment transfer pricing model aims to 
diminish the ambiguity in the use of external comparables in determining the arm's length 
consideration. 
4.3 A comparability adjustment transfer pricing model 
Transfer pricing and the determination of the arm's length consideration is based on three 
fundamentals, i.e. functions performed, assets used and risk assumed (OECD, 1995:1-8,1-9, South 
Africa, 1999:10, 28). In practice, comparability is influenced by the availability of comparable 
information. 
131 
Reliance is placed on the use of a foreign (Pan-European) database, Amadeus, that contains 
financial information of unconnected parties required for the determination of the arm's length 
consideration. The use of data from a foreign database provides challenges insofar as 
comparability. The comparability adjustment transfer pricing model (CATPM) aims to address 
comparability through the determination of the arm's length consideration. The use of foreign 
comparable data in transfer pricing and the use of a bond yield adjustment to affect a country risk 
premium is starting to gain recognition in the confidential OECD discussion literature (OECD, 
2005(b):6) 
4.3.1 The CATPM proposition 
The primary aim of any transfer pricing model should be the determination of the arm's length 
consideration. In order to achieve the objective of determining the arm's length consideration the 
following are to be considered: 
• The foundation of transfer pricing is founded on Paragraph 1 of Article 9 of the OECD 
Model Tax Convention that deals with the arm's length principle as follows: "[When] 
conditions are made or imposed amongst... two [associated] enterprises in their 
commercial or financial relations ... which would have been made amongst independent 
enterprises (unconnectedparties)... "(OECD, 1995:1-3). 
• A transfer pricing model, according to Paragraph 1 of Article 9 of the OECD Model Tax 
Convention, proposes to encapsulate "which would have been made amongst independent 
enterprises" (OECD, 1995:1-3 and South Africa, 1999: 8). 
• Independent enterprises would therefore be indicative of the arm's length consideration 
and based on the independent enterprise proposition that requires an understanding of how 
unrelated companies evaluate potential transactions. Unconnected parties, when 
evaluating the terms of a potential transaction, will compare the transaction to the other 
options realistically available to them, and they will only enter into the transaction if they 
see no alternative that is clearly more attractive (OECD, 1995:1-7) 
• On this basis, the CATPM proposes to measure the arm's length consideration ( a ) as the 
product of the price (P) of goods and services and the quantity (q) of the goods and 
132 
services less the cost (C) of providing the goods and services. In mathematical notation, 
the arm's length price for a product or service (z) can be written as or,- = P,q( ~ ct (1) 
• The arm's length consideration, either the price or profit margin so determined (see 
equation 1) are a result of the interaction of: 
o the selling price for goods and services, 
o the quantity supplied or sold, 
o in addition, the cost attributed in providing the service or selling of the goods. 
In order to develop and propose a transfer pricing model that determines the arm's length 
consideration, the variables (price, quantity and cost) that influence the arm's length consideration 
are considered. Consideration of price, quantity and cost is focussed by analysing unconnected 
parties, the test in determination of the arm's length consideration. 
4.3.1.1 Price determination 
Transfer prices (see 1.6.32) are the prices charged for goods and services amongst various entities. 
The arm's length consideration, at = P,qt -C,, that is one of the foundations of transfer pricing (see 
1.6.33) encompass a process of price determination. Therefore, a study of price determination is 
undertaken in a competitive market by unconnected parties. The comparative benchmark 
(unconnected parties dealing at arm's length) that is considered in transfer pricing is studied. 
4.3.1.1.1 Basic concepts of price determination 
In general, total revenue of a business is equal to the market price of the goods and services it sold 
multiplied by the quantity sold. The profit or loss derived from the sales of goods and services is 
the total revenue from the sales less the cost of the goods and services, in essence, a-t = F^,- -C,-, 
the same proposition put forward for transfer pricing. 
An individual enterprise is not concerned with only the total revenue earned in isolation, marginal 
revenue (income) as well as the average income of goods and services are an important 
consideration. Marginal revenue is important because marginal revenue is the additional revenue 
an enterprise earns by selling an additional unit of a product (Smit et al., 2002:221). In a 
competitive market (individual seller of goods and services has no influence on the price of the 
goods and services; thus a "price taker") the price of the product is accepted as given. In such a 
133 
competitive market, the additional revenue derived form the sale of the goods and service will be 
equal to the price of the goods and service. Illustrated, the marginal income or revenue (MR) will 
be a straight line, (constant for all levels of sales) as illustrated in Figure 19 (Panel 1). 
The price for goods and services remains constant, irrespective of the quantity sold; hence the 
marginal income remains constant (the Piqi in the profit formula at = P;q; -Ci). The profit derived 
from the sale of goods and services is not constant. The cost, Q is not constant, (change in 
accordance with the change in quantity) hence when the quantity sold is less than the cost involved 
in selling the goods and services, a loss is realised as illustrated in Figure 19 (Panel 2). The cost 
associated with the goods and services is depicted as marginal cost (MC) in Panel 2. Marginal 
cost (MC) is the additional cost an enterprise assumes in order to increase output by one additional 
unit. 
Figure 19 Marginal income and profit maximization 
P a n e l 1 M a r g i n a l I n c o m e P a n e l 2 M a x i m u m prof i t i n s h o r t t e r m 
Price Price 
M C 
/ Loss 
P = MR 
P 1 
E / ^ p = MR 
0 *-
Quantity 
0 c 4j *■ V Quanti ty 
(Source: Smit et at, 2002: 221, 222) 
Profit from the sale of goods and services are made where the marginal cost (MC) is less than the 
price (P) or marginal revenue (MR) of the particular goods and service. The optimum or 
maximum profit for the sale of goods and services can be made at point E in Panel 2. If the 
quantity sold increases beyond point E, the price is constant and the cost increase, a loss is realised 
(refer to section 4.3.1.1.2 where losses are further explored). 
When the cost is greater than the revenue derived from the sale, the profit, or the arm's length 
consideration a; is negative due to C; being greater than P;qi. In a market where the quantity 
supplied is less than Q1 (shortage), enterprises will enter the market to share in the profit available 
in the market. As soon as the quantity supplied reaches point Q1, profit is maximized. Any 
additional supplies will result in losses for each additional supply beyond Q . 
134 
4.3.1.1.2 Price determination under perfect competition 
Under perfect competition, the market purely functions according to the principles of supply and 
demand (Smit et al, 2002:223). Prices of goods and services are set by the market (Mansfield, 
1989:239). Smit et al, (2002:223) and Mansfield (1989:238) identified characteristics of perfect 
competition, the presence thereof are indicative of perfect competition, which are as follows: 
• Perfect knowledge of the market by all buyers and sellers 
• Numerous market participants (buyers and sellers) in the market with no individual 
participant (buyer and seller) being able to influence market price 
• Products traded in the market is homogeneous (no consumer preference amongst products 
in the market) 
• All products in the market is perfect substitutes for each other 
• Absence of market entrance restrictions (government regulations) 
• Production factors (natural resources, labour, capital and entrepreneur) are perfectly mobile 
Price determination over the short term is based on demand for goods and services being perfectly 
elastic (refer to 1.6.12 for a definition of elasticity of demand) due to the lack of preference to a 
particular good and service (illustrated in Figure 20). Marginal revenue (MR) equals the price of 
the goods and service due to the enterprise being a "price taker" (accept the market price). 
Figure 20 Price determination in a competitive market 
Pr i c 3 JvZC 
1 TC 
P 1 ^^^-J
3 / 
P = M R = T R = D e m a n d 
Q 1 Q u a n t i t y 
(Source: Smit et al, 2002: 224) 
Over the short term, the demand curve for the particular good and service represents the price 
(total revenue (TR) and marginal revenue (MR, see Figure 20 where P=MR=TR=Demand)). Total 
revenue (TR) represents the total revenue realised under different quantity combinations. Total 
135 
cost (TC) in Figure 20 represents the total cost under different quantity combinations inclusive of 
fixed and variable cost, it can be viewed as the total cost in relation to different quantities supplied 
or demanded. 
Independent (unconnected) parties aims to achieve the utmost benefit from the transaction would 
prefer to supply to the market at the point where MC = MR, the point of profit maximisation. 
Under perfect competition individual enterprises cannot influence the price (individual enterprises 
are price takers), hence MR = TR that is equal to the price P1 at a quantity level of Q1, the point 
where MC=MR (profit maximisation rule, as illustrated in Figure 20). 
Applying the above mentioned principles of price determination under perfect competition to 
transfer pricing, the arm's length consideration will be at point E, a break even point where 
MC=MR and TC=TR. If the same circumstances are used with a change in price from P to P 
(see panel 1 of Figure 21) and to P (see panel 2 of Figure 21) and quantity from Q to Q (see 
panel 1 of Figure 21) and to Q (see panel 2 of Figure 21), the following emerged: 
Figure 21: Profit under different price quantity combinations  
Panel 1 Price increase 
Price M C 
Panel 2 Price decrease 
Price M C 
A 
Q1 Q 2 Quanti ty 
r 
/ \ T C 
\ 
I / V 
1 / -* 
I s ■* / / •* 
D J^: -— a' L^ 
/ I _ - - ' ' MR=TR= 
G2 ' Demand 
i 
Q Q
L Quanti ty 
(Source: Smit et al., 2002: 225) 
At a higher price, P in Figure 21, (panel 1), the independent (unconnected) party will increase its 
profit because it reached break-even at price level P in panel 1. The "maximised profit" (F ; F ) 
(see pane] 1 of Figure 21) is as a result of total revenue (TR) being bigger than total cost (TC) at a 
given quantity (Q2), (TRxQ2) > (TCxQ2). Profit maximization is possible over the short term. 
Over the long term, as soon as the market realizes of the profit potential in a specific market, new 
entrants will enter the market and their entrance will influence either the quantity (Q) or the price 
(P) or both. Barriers to entry, as described by Porter (2004:210- 12) can potentially limit the 
threat of new market entrants through focus strategies being followed by existing market 
136 
participants. The importance of strategies in transfer pricing is recognised with business strategies 
being identified as one of the comparability factors (see 3.2.2.2.2) (OECD, 1995:1-8-1-22, EH-12 
and V-7). 
Another possibility exists, as illustrated in Figure 21, (panel 2.) If the assumption is made that the 
price decreases to P3 (can occur as a result of declining demand (business cycle) or a market 
penetration strategy of new entrant through lowering prices in order to gain market share) profit 
maximisation is in essence loss minimisation. The unconnected party strives to achieve the utmost 
benefit from the transaction (South Africa 1999: 8) which is under this scenario is to limit losses 
(G1 to G2) as far as possible. Total cost (TC) is greater than total revenue (TR) at price level (P3) 
and quantity (Q3), (TRxQ3) < (TCxQ3). The total variable cost (TVC) curve (see Figure 21 panel 
2) represents the total variable cost decreases as utilisation increase (unit cost decrease with 
increased quantity) until optimum capacity is reached, total variable cost increase when quantity 
increases beyond full capacity). If the price falls below P the unconnected party will not survive 
even over the short term, it is unable to fund its total variable cost (higher than price P in Figure 
21 panel 2) irrespective of quantity sold. 
This abovementioned loss-making situation is not founded only in theory, it is recognised in 
transfer pricing. Unconnected parties are exposed to business cycles that result in periods of 
profits and losses. The business cycle and business strategies' impact on transfer pricing is 
recognised and is considered in the determination of the arm's length consideration (OECD, 
1995:1-21). PN 7 (South Africa, 1999:29) provides examples of losses, which are as follows: 
• huge start-up costs 
• unfavourable economic conditions 
• inefficiencies and 
• temporary strategic decisions. 
In context of the CATPM formula, a,- =Piqi-Ci the previous scenario of losses (see Figure 21 
panel 2) can be explained as when Q is greater than the product of Piqi, and then the arm's length 
consideration will be a loss. Circumstances such as those listed in PN 7, could be explanatory 
albeit over a relative short period. In conformance to these principles, unconnected parties are not 
137 
rejected as potential comparables due to them being regarded as loss-makers (see sections 4.5.1.4 
and 5.4.3). 
4.3.2 Price determination in accordance with transfer pricing principles 
Price determination in a competitive market illustrates (see Figure 20 and Figure 21) that 
independent parties strive to maximize profit, which is the point of departure in transfer pricing 
where each party will strive to get the utmost possible benefit from the transaction (South Africa 
1999:8). For the purposes of transfer pricing, the independent party test is required. The test is 
performed with relation to functions performed; assets used and risk assumed (OECD, 1995:1-8-
10). The basic arm's length consideration proposition a-t =Piqi-Ci still holds. The determination 
of Pi, price, and Q cost, requires further consideration. The price and conversely, the cost are 
determined by virtue of defining functions performed, assets used and risk assumed by a 
connected party and compared to unconnected parties. 
In order to identify the significant functions the member of the MNE undertakes, a functional 
analysis is to be undertaken of the tested party (OECD, 1995:1-9,111-9, South Africa, 1999:28). 
The purpose of a functional analysis (refer to 1.6.16 to for the definition) is to understand the 
qualitative nature of the functions, assets and risks, to facilitate a comparison with other 
enterprises with similar functions, assets and risks (see section 5.3.3). Such a comparison and in 
particular comparability, is central to the arm's length principle (OECD, 1995:1-7). Another 
consideration is the adjustments, which are made to potential comparable data (to enhance 
comparability) on which the arm's length consideration is based 
The OECD Guidelines clearly state that in determining comparability (including what adjustments 
are necessary to establish it) an understanding of how unrelated companies evaluate potential 
transactions is needed. Unconnected parties, when evaluating the terms of a potential, comparable 
transaction, will compare the transaction to the other options realistically available to them, and 
they will only enter into the transaction if they see no alternative that is clearly more attractive 
(OECD, 1995:1-7). 
Unconnected parties take into account economically relevant differences amongst the options 
realistically available to them (such as differences in the level of risk or other comparability 
factors) when valuing the options available to them. Therefore, when making comparisons in 
138 
order to apply the arm's length principle, tax administrations as well as the management of MNE's 
should also consider these differences (in functions performed, assets used and risk assumed). The 
differences amongst the situations being compared (unconnected to related party) and adjustments 
needed to achieve comparability are complex. 
Accurate adjustments to comparable data are aimed at reflecting differences amongst the affected 
transaction and those of unconnected parties, which it is being compared to (South Africa, 
1999:9). Working capital adjustments are adjustments which are aimed at recognising the 
comparable cost basis, Q (inventory adjustment), or the comparable price Pj (accounts receivable 
and payable) in the proposition of the arm's length consideration at =p.q.-cl. Quantity, qi is 
considered in working capital adjustment as a basis of comparison (accounts payable, receivable or 
inventory compared to sales) on which the adjustment to sales (price) or cost of sales are made. 
4.3.3 Working capital adjustments 
The dilemma facing managers of MNE's, advisory firms and tax administrations concerning 
comparability adjustments is receiving attention at an international level. The OECD recognises 
working capital adjustments such accounting adjustments (accounts payable), balance sheet asset 
intensity adjustments (inventory and accounts receivable) and other adjustments without providing 
specific guidance on what it entails and how it should be undertaken (OECD, 2005(b):3-5). With 
South Africa being granted observer status in 2004 at the OECD, the pragmatic approach this 
research proposes are part of South Africa's commentary on comparability adjustments. 
Unadjusted income statements of comparable companies can lead to inaccurate representations of 
a comparable's true economic profitability because accounting based operating income can be 
distorted by the means through which a company finances its purchases and sales. Financing of 
purchases on a cash basis or terms influences the price of purchases or cost in the purchaser's 
income statement. Cash purchases compared to term purchases have a lower price primarily due 
to the time value of money (Brigham et ah, 1999:236). 
The buyer, in such a transaction, on the other hand, by virtue of not paying cash, has access to the 
goods albeit that it has not been paid for. The purchasing entity can invest the money owed until 
payment is due and earn a return, usually higher than the price differential (difference amongst 
cash purchases and term purchasers) and effectively obtains an opportunity benefit. Both parties 
139 
to the transaction can manage their working capital in terms of receivable and payment terms. In 
order to reflect these differences in financing activities amongst the tested party and the 
comparables, accounts receivable and payment adjustment can be performed. 
The time value of money has an opportunity cost attached to it. The opportunity cost impacts on 
working capital. Divergence of accounts receivable, inventory holding (both assets) and accounts 
payable amongst the tested party (see 1.6.9 for a comprehensive definition) and comparables 
influences working capital requirements over a specific time frame. Therefore, adjustments are 
performed that recognises differences in prices (P,-) and cost (Q) in the proposition of the arm's 
length consideration or,- = P^ -C;. 
In the absence of any specific guidelines on the methodology used in performing working capital 
adjustments and in particular to accounting adjustments, asset intensity (such as inventory) and 
other adjustments mentioned by the OECD (2005:3-5), working capital comparability adjustments 
is documented in this research. The adjustments is not characterised as accounting adjustments, it 
is closer aligned to balance sheet intensity adjustments (OECD, 2005:4), broadly characterised as 
asset and liability adjustments. 
Other adjustments refer to any adjustment not being either an accounting or balance sheet intensity 
adjustment (OECD, 2005:5). In section 4.3.4 the appropriateness of an interest differential 
adjustment is considered. The research, in addition to the comparability adjustment transfer 
pricing model proposes the use of government bond yields to adjust for country risk and is 
discussed in detail in section 5.4.5.2. 
4.3.3.1 Working capital comparability adjustment 
4.3.3.1.1 Accounts Receivable Adjustment 
Since accounting data do not break out the element of sales that can be considered financing 
income, an estimate of this amount needs to be determined. In order to estimate the difference in 
financing, a comparison of the accounts receivable to sales ratio amongst the tested party and the 
comparables is necessary. 
The assumption is that companies that extend terms that are more generous will generally have 
higher accounts receivable to sales ratio than those companies that offer less generous terms. The 
140 
difference in the accounts receivable to sales ratios amongst the tested party and any individual 
comparable will reflect the difference in sales terms offered to their respective purchasers. 
If the comparables' receivables are adjusted to affect the same accounts receivable to sales ratio of 
the tested party, a calculation are performed to indicate what the comparables' receivables would 
be if they offered the same terms to their purchasers. The opportunity cost is determined by 
multiplying the difference amongst the comparables' adjusted receivables and the comparables' 
original receivables by the prime lending rate (comparable arm's length borrowing rate "i" in the 
formula). An estimate of the additional financing income (an adjustment to the sales price of 
goods and services in accordance with the prime lending rate), which the comparables would earn 
is determined as if the same terms as the tested party's is offered. 
Increasing or decreasing the comparables' sales ("Sc" in the formula) by this amount will, 
therefore, result in an adjusted sales level that reflects similar financing to that of the tested party 
( 'TP" in the formula). The equation used for the average accounts receivable ("AAR" in the 
formula) adjustment is: 
Change in Average Accounts ReceivableComparable [AAARC) 
\(AARYP 
{—) xsc -AARC 
(AARYP (AAR')C 
xSr \. s ) K s ) 
Adjusted Sales Comparable 
{AdjSc)= Sc + 
4.3.3.1.2 Inventory Adjustment 
AAARcx (i+0 (2) 
The other asset that could require adjustment insofar as its impact on working capital is inventory. 
In essence, a cost is associated in keeping inventory, firstly in the price of the purchased goods and 
secondly a lost opportunity to sell it and realise a profit on its sale. The longer inventory is kept, 
the smaller the profit on the sale of the goods due to the increase in the cost of inventory holding. 
In contrast to the cost of inventory increasing over time, the selling price remains stable (does not 
increase at the prime interest rate on a daily basis) that results in a profit squeeze. 
141 
In order to estimate the difference in the opportunity costs of holding different levels of inventory, 
a comparison of the inventory intensity (ratio of inventory to sales) of the tested party and the 
comparables are conducted (Brigham et al., 1999:87). This comparison is measured as the ratio of 
inventory to sales (Libby et al, 1998:710). By applying the inventory to sales ratio of the tested 
party to the comparables' sales, an adjusted inventory level can be calculated for the comparables 
that reflects the tested party's inventory intensity. The next step in the inventory adjustment 
involves multiplying the change in the comparables' inventory (adjusted inventory less unadjusted 
inventory) by the prime lending rate. This allows the calculation of an estimated difference in 
opportunity costs due to holding different levels of inventory over the period under consideration. 
In order to make the comparables' income statement data reflect this estimated difference in 
opportunity costs, the estimated difference is subtracted from the comparables' operating 
expenses. In the case where the tested party is holding higher inventory levels, the comparables' 
adjusted inventory will be higher, the opportunity cost estimate will be positive, operating 
expenses will be reduced, and the comparables' operating income will be increased to reflect the 
comparables' cost savings from holding fewer inventories. In the case where the tested party is 
holding lower inventory levels, the comparables' adjusted inventory will be lower, the opportunity 
cost estimates will be negative, operating expenses will be increased, and the comparables' 
operating income will be decreased to reflect their higher opportunity costs. The equation used for 
the inventory adjustment is: 
Change in Average Inventory Comparabte (AAIC) 
(fH -AIC 
w-m] XSC 
Adjusted Cost of Sales Comparabie [AdjCOSc)= COSc-{AAIcxi) (3) 
As with accounts receivable, which are an asset, opportunity cost equally applies to accounts 
payable, a liability. The adjustment would affect the sales of the comparables; it would increase to 
compensate for terms sales. 
142 
4.3.3.1.3 Accounts Payable Adjustment 
As in the receivables adjustment discussed in section 4.3.3.1.1, adjustments to the level of 
accounts payable need to be made in order to account for differences amongst the tested party's 
and the comparables' financing. Since accounting data do not break out the element of cost of 
goods sold that can be considered an interest expense, an estimate of the cost of goods sold is 
necessary. In order to estimate which portion of the cost of goods sold is an interest cost (time 
value of money); a comparison of the accounts payable to sales ratio of the tested party and the 
comparables is necessary. The assumption is that companies that receive terms that are more 
generous will generally have higher accounts payable to sales ratios than those companies 
receiving less favourable terms. The difference in the accounts payable to sales ratios amongst 
the tested party and any individual comparable will reflect the differences in sales terms offered by 
their respective suppliers. 
If the comparables' accounts payable to sales ratios are adjusted to reflect the same accounts 
payable to sales ratio of the tested party, a calculation can be performed to determine the 
comparables' accounts payables if their suppliers offered them the same terms. By multiplying the 
difference amongst the comparables' adjusted payables and the comparables' original payables by 
the prime lending rate, an estimate of the amount of additional interest cost that the comparables 
would pay in their cost of goods sold (if financing its purchases the same way the tested party 
does) can be calculated. Increasing the comparables' cost of goods sold by this amount will, 
therefore, result in an adjusted cost of goods sold level that reflects similar financing to that of the 
tested party. The equation for the accounts payable adjustment is: 
Change in Average Accounts PayableComparable (AAAPC) 
(AAPX 
xSc -AAPr 
(AAPX (AAP^ 
xSc {. s ) {. s 
Adjusted Sales Comparable {AdjCOSc)= COSc + AAAPnX' l ■c- (i+0 (4) 
In addition to adjustment of specific items of the financial statements, that reflects specific 
comparability differences, locational or geographic differences exist. The geographic differences 
143 
between the tested party and any of the comparable, unconnected parties could give effect to a 
difference in the arm's length consideration. Interest rate differences are sometimes used as a 
proxy for locational differences with the adjustment primarily being based on interest rates. 
4.3.4 Interest rate adjustment 
The OECD recognises that interest rates could be used in adjustments that reflects geographic 
differences amongst the tested party and the comparables (OECD, 2005(b):6). No guidance is 
provided in any approach or methodology that could be used. 
Potential use of interest rates as a comparability adjustment mechanism is discussed in section 
4.3.4 albeit in relation to a country risk premium. Interest rates used in the context of working 
capital adjustment as discussed in sections 4.3.3.1.1, 4.3.3.1.2 and 4.3.3.1.3 adjust asset intensity 
relative to the prevalent market related lending rate (arm's length rate) and is the opportunity cost. 
Interest rate in the working capital adjustment is a determinant for opportunity cost and should not 
be interpreted as a country risk premium that is discussed in 5.4.5.2. 
Working capital adjustments have an impact on the price and cost definitions in the arm's length 
consideration definition, a; =piqi-Ci. Accounts payable and receivables adjustment result in an 
adjustment to the sales (price) whilst an inventory adjustment results in an adjustment to the cost 
of sales. Although the working capital adjustments is based on price and cost adjustment, the 
profit a; is adjusted as a result of the other adjustments. 
Comparability adjustments are equally difficult to objectively measure due to the detail of 
available data on which to base the adjustments and the inexact nature of functional difference. 
For instance, determining an exact amount (profit amount or profit margin) that the comparable 
dataset of a fully-fledged manufacturer (refer to Table 11 for more information on entity 
characterisation) needs to be discounted to reflect an assembler is not possible. Transfer pricing is 
deemed not an exact science (OECD, 1995:1-5 and South Africa, 1999:9) but acknowledgement of 
the non-exact nature of transfer pricing does not diminish the challenge to define and test a model 
that would decrease ambiguity in determining the arm's length consideration. 
Transfer pricing aims to determine the arm's length consideration, which are either expressed as a 
price, (if the CUP method is used) or a margin (when any of the other methodologies are used; 
refer to Figure 18 where methodology application is considered). A comparability adjustment 
144 
transfer pricing model must take cognisance of all the comparability factors (more than mere 
working capital adjustments) and determine what could be considered as an arm's length 
consideration, which is founded on the risk - reward trade off (OECD, 1995:1-10, South Africa, 
1999:34). Comparability is difficult to measure, however, risk is measured with various 
methodologies (such as capital asset pricing model and accounting beta method) available that is 
used in corporate finance and valuations (Brigham et al, 1999:178, 392). 
4.3.5 Risk fundamentals 
Risk is a concept which relates to uncertainty and the relative likelihood of events occurring which 
are uncertain (Brigham et al, 1999:160). These uncertain events can have a positive or negative 
impact on whoever assumes this uncertainty or risk. The bigger the uncertainty the bigger the risk 
and if someone is prepared to assume such uncertainty, the expected reward is commensurate with 
the perceived uncertainty or risk. 
In transfer pricing the view is that risks follow functions. The functions performed (taking into 
account the assets used and the risks assumed) will determine the allocation of risks amongst the 
parties to the transaction, and the conditions each party would expect in arm's length (OECD, 
1995:1-10). In practice it is virtually impossible to find complete comparables (companies that is 
directly comparable to the tested party) and in order to fulfil the comparability test, adjustments to 
comparable data occurs. In reference to risk, functional differences exist, albeit small, which in 
turn give rise to differences in risk that is observable with the difference in returns. 
For example, an MNE automotive manufacturer decides (as a business strategy) to transfer 
inventory ownership (the asset) to a regional procurement entity. The MNE manufacturer does not 
hold inventory nor does it procure or manage the inventory (the functions) which result in the risk 
associated with the function and asset being transferred to the regional procurement entity. In 
undertaking a transfer pricing evaluation in this example, if the manufacturer that is "risk stripped" 
is the tested party, then comparables to that effect needs to be found. It is possible to find 
comparable manufacturers but it is difficult to determine if the comparables has the same risk 
profile even if functional comparability has been established. Hence, adjustment to inventory in 
these circumstances is appropriate (refer to section 4.3.3.1.2 for a comprehensive discussion on 
inventory adjustment). 
145 
4.3.5.1 Allocation of business risk 
The exact level of business risk that can be removed from a connected party depends on the 
particular manner in which a "fixed or target return" is achieved based on the basket of functions, 
assets and risk undertaken by that particular connected party. Connected parties' reward is based 
on a guaranteed net-cost-plus margin on the basis that the functions, assets and risk associated with 
the transaction under consideration are being transferred to another entity within the same MNE. 
Hence, the connected party's functions, assets and business risks as well as return (profit) have 
effectively been transferred from one entity (transferor) to another recipient entity (transferee) of 
the same MNE. The consequence of the business risk transferral is that the arm's length 
consideration (profit) from the transferor reduces (less functions, assets and risk) whilst the 
transferee's arm's length consideration increases commensurately (more functions, assets and 
risk). 
This practice gives rise to various entity characterisation definitions. In the specific case the 
research deals with, a manufacturer according to a broad characterisation is analysed. Within the 
spectrum of manufacturing entity characterisation, risk and the arm's length consideration can be 
transferred through the transfer of functions and assets. The transfer of functions, assets and risk 
impacts on the arm's length consideration both the connected parties derive from the affected 
transaction. 
Entity characterisation is graphically presented in Figure 22 as a spectrum, with functionality, 
assets and risk increasing in complexity from left to right with the arm's length consideration 
following the same trend. The upper bound of the spectrum for manufacturing entities can be 
described as a fully-fledged manufacturer, while the lower bound can be described as an assembler 
with the contract manufacturer positioned amongst the two extremes. 
146 
Figure 22: Manufacturing entity characterisation 
Functions, Assets, Risk; Returns 
(Source: own compilation) 
The expected returns for companies characterised on this spectrum correlates with the functions 
performed and risks assumed. In general, the returns earned by an entity characterised as a pure 
contract manufacturer undertaking minimal risks should be subject to smaller variances in rewards 
than those earned by fully-fledged manufacturers operating within a similar industry. The 
activities the different manufacturing entities undertake are summarized in Table 11. 
In the practical case undertaken in the research, an initial assessment would classify the tested 
party, ZA Case 01 as an assembler. However, after the functional analysis (see 5.3.3), the tested 
party is closer aligned to limited scope manufacturer. This is even further complicated if the 
TNMM (see 3.3.2.1) is applied in the determination of the arm's length consideration. 
The complication arises when the arm's length consideration is based on a net profit margin rather 
than gross margin (connected party dealings are price in the cost of sales line in the income 
statement). Not all the operating expenses included in the determination of the net profit are as a 
result of connected party dealings. External expenses (such as labour and consumables) are 
procured through the open market, which reflects arm's length conditions. The combination of 
operating expenses from the open market and from connected parties does not reflect only 
connected party dealings, which complicate the determination of the arm's length consideration 
(see the functional analysis of ZA Case 01 in section 5.3.3.) 
147 
Table 11: Identified manufacturing entity characteristics 
Assembler Consignment / Contract Manufacturer Limited-Scope Fully-Fledged 
ToU Manufacturer Manufacturer 
Manufacturer 
Assembler is A consignment / A contract manufacturer A limited scope Typically undertakes all of 
engaged in the toll manufacturer typically undertakes the manufacturer has the entrepreneurial and 
piecing together of is functionally operational functions required some of the operational activities 
components. equivalent to a to manufacture a product. responsibilities of the associated with an entity in 
Assemblers contract However, a contract fully-fledged its respective industry. A 
undertake few manufacturer manufacturer typically does manufacturer but also fully-fledged manufacturer 
entrepreneurial except that a not undertake many some of the undertakes strategic 
activities and bear consignment/toll entrepreneurial activities, characteristics of the activities such as production 
limited risk. An manufacturer does which would result in risk contract scheduling; design of 
assembler is usually not own bearing or the development of manufacturer. As production floors and 
constrained to ■ raw materials, intangible assets. A contract opposed to the fully- production processes; 
operate according ■ work-in- manufacturer usually utilizes fledged development of product 
to the product process, the production technology, manufacturer, it does specifications, quality 
specifications, ■ finished product specifications, quality not own the control and quality 
quality assurance goods or assurance and quality control intangibles associated assurance procedures; 
and quality control ■ inventory. procedures, and production with the products. research and development or 
procedures, and schedules established by the However, the limited product development; 
production Consequently, its customer. Contract risk manufacturer development of purchasing 
schedules remuneration is manufacturers may also undertakes routine policies and materials 
established by the usually calculated perform basic assembly or activities regarding specifications, and inventory 
customer. The by using a small manufacturing tasks that sourcing of raw plans; and determination of 
value added mark-up on costs require few technical skills of materials, production corporate strategy. 
contributed by an similar to a its production employees scheduling, and sub­ Consequently, fully-fledged 
assembler is limited service fee thus other than those skills learned contracting third manufacturers incur those 
to the reflecting the on-the-job. As a result, the parties. The entity is risks that are typically 
manufacturing reduced risk returns earned by a fully- not guaranteed a associated with these 
function that is not exposure. fledged manufacturer or minimum turnover activities (e.g., inventory 
operationally or assembler operating in the and prices by the shrinkage risk and market 
economically same industry and markets ordering party. risk) and enjoy the benefits 
efficient for the differ significantly. Contract Therefore, the of intangibles that are 
customer to manufacturers are typically appropriate developed (e.g., product 
undertake itself. compensated in three remuneration of the and/or production 
different ways: limited risk technology to the extent that 
■ a set price per unit of manufacturer is it is not acquired from third 
production; lower than that of the parties, trademark/trade 
■ a mark-up on direct fully-fledged name, reputation for product 
manufacturing costs manufacturer but quality) from pursuing these 
incurred; or higher than that of actions. 
■ service fee, which serves the contract The operational functions 
as a fully loaded cost manufacturer. include both the 
reimbursement. manufacturing or assembly 
activities necessary to 
complete the product, and 
the daily administrative 
tasks required to maintain a 
viable production facility. 
South African South African South African example: South African South African example: 
example: example: Daimler BMW with the 3 series, example: Tiger Wheels manufacturer 
Tyco Trucks which Chrysler with the Daimler Chrysler with the C Good Year Tyres of wheels 
assembles for Colt LCV Class Mercedes Benz 
International and 
Peterbuilt 
(Source: own compilation) 
When analyzing controlled parties that bear such an artificially low level of risk by reference to a 
set of broadly comparable independent firms, which is the case under TNMM, it is a challenge to 
148 
identify independent firms that are, sufficiently comparable to the controlled parties in terms of 
risks assumed. In practice, a solution to address this issue is by selecting firms that perform 
functions that are similar to the tested party's, based on the principle that the nature of business 
risks are typically related to the types of functions performed. 
The relationship amongst functions performed and risk assumed is evidenced in the case 
incorporated in the research (see 5.3.3 where the functions are identified as well as 5.4.2 for the 
comparable analysis based on identified functions). In circumstances where a tested party has 
been effectively guaranteed a fixed return (as assembler, contract or toll manufacturers, see Table 
11), functional similarity does not adequately address this risk differential because small 
functional differences is difficult to identify in comparables. In such cases, an adjustment to the 
comparables for this risk differential seems warranted such as working capital adjustment (see 
4.3.3). 
4.3.5.2 Measuring risk 
An asset exposed to risk is defined as an asset for which the investor is uncertain of the amount 
and the timing of the expected return. Total risk, therefore, embodies all the fundamental sources 
of uncertainty, and includes business risk, financial risk, liquidity risk, exchange rate risk, and 
country risk (Urken et al., 2003:39). Form this premise it follows that to compensate for such 
uncertainty, investors assess a risk premium to their required rates of return over their risk-free rate 
(such as government bond yield, see 5.4.5.2 where government bond yield is further explored) 
when investing in risky assets (Brigham et al, 1999:185). 
Portfolio theory contains a number of models, such as the Capital Asset Pricing Model (CAPM) 
that-attempt to capture this risk-return relationship (Brigham et al, 1999:178 and Urken et al, 
2003:40). In order to incorporate this concept of risk-return relationship in transfer pricing 
practice, the comparability adjustment transfer pricing model (CATPM) should recognise these 
various risk factors. 
Urken et al, (2003:41) employed the Capital Asset Pricing Model ("CAPM") which recognizes 
the univariate relationship amongst systematic risk and return, to motivate a risk adjustment factor. 
(Refer to Appendix 2 where an analysis and comparison was undertaken between the CAPM, 
CATPM and the arm's length principle). The CAPM framework makes a clear distinction 
149 
amongst systematic (or market) risk and unsystematic (or diversifiable) risk which equates to total 
risk An underlying concept of the CAPM is that it regards investors' primary concern being the 
overall risk of their portfolios with the relevant risk of an individual asset is its contribution to the 
overall risk of a well-diversified portfolio (Brigham et al., 1999:178). 
Under this approach, the relevant risk measure for an individual risky asset is its co-movement 
with the overall market portfolio of risky assets (Urken et al., 2003:40, Brigham et al., 1999:180). 
Furthermore, this co-movement, measured by an asset's covariance (is a measure which combines 
the variance (volatility) of returns with the tendency of those returns to move up or down at the 
same time that the market) with the market portfolio, is equal to an asset's systematic (or market) 
risk and is referred to as an asset's beta coefficient (Brigham et al., 1999:180,203). Hence, risk 
premiums in a market consisting of diversified investors reflect systematic risk, and that risk can 
be observed in the marketplace via an asset's beta coefficient. 
Curtis and Ruhashyankiko (2003:1) explore the assets' risk - return relationship further, they view 
risk adjustments conventionally with risk adjustments seen as a proxy that may provide an 
acceptable adjustment to the expected returns. However, these adjustments may not provide an 
appropriate adjustment to the risk itself; it might be an adjustment to give effect to the variance of 
the expected returns. 
The risk - return relationship and adjustments to affect expected returns is important for transfer 
pricing purposes. Although the CAPM observes risk via an assets' beta coefficient (Brigham et 
al, 1999:180) and it follows that adjustments to reflect differences in risk need to be based on 
these differences in beta coefficient (Urken et al., 2003:40,41) in comparing the risk associated 
with assets. The view of Curtis and Ruhashyankiko (2003:2) that the beta coefficient risk 
adjustments performed might not result in an appropriate adjustment to the risk itself, rather to the 
underlying asset, which gives rise to certain risk. Uncertainty insofar as an adjustment to the risk 
itself or an adjustment to the asset which give rise to the risk confirms the need for a model which 
recognises assets or asset use and make adjustments to enhance comparability in terms of 
functions, assets and risk. 
150 
4.3.5.3 Risk - return trade off 
The OECD state that in the open market, the assumption of increased risk will also be 
compensated by an increase in the expected return (OECD, 1995:1-10). The OECD guidelines 
provide an example, which is of particular importance within the context of this research. The 
OECD guidelines reiterate that the functions performed (taking into account the assets used and 
the risks assumed) will determine to some extent the allocation of risks amongst the parties to the 
transaction, and therefore the conditions each party would expect in arm's length dealings 
(OECD, 1995:1-11). 
For example, when a distributor takes on responsibility for marketing and advertising by risking its 
own resources in these activities, it would be entitled to a commensurately higher anticipated 
return from the activity. The conditions of the transaction would be different from when the 
distributor acts merely as an agent, being reimbursed for its costs and receiving the income 
appropriate to that activity. Similarly, a contract manufacturer or a contract research provider that 
takes on no meaningful risk (meaningful in terms of impact on return) would be entitled to only a 
limited return or profit. 
Various adjustments (working capital) to accounts receivable, accounts payable and inventory are 
performed to reflect comparative levels of opportumty cost (refer to section 4.3.3 for a 
comprehensive discussion). However, these adjustments do not take cognisance of total risk and 
its particular definitive components, which is recognised by the CAPM and the proposed model (a 
comparable adjustment transfer pricing model) of this research. 
The risk - return assumption of risk is based on the concept of risk aversion under which a trader, 
investor, or agent is willing to bear more risk if there is an appropriate compensation in terms of 
expected returns. The resulting positive risk - return relationship has become ubiquitous over the 
years and is embedded in rational expectations of asset pricing models such as the CAPM (Curtis 
and Ruhashyankiko, 2003:1). In order to clarify the risk - return relationship in the context of 
transfer pricing, a simple analysis by making use of the entity characterisation continuum (see 
Table 11 for manufacturing entity characterisation) are undertaken in the next section. 
151 
4.3.5.3.1 Entity characterisation and risk - return interaction 
The research aims to illustrate the application of the arm's length principle with the guidance 
provided by a comparability adjustment transfer pricing model. Risk or the lack thereof can be 
illustrated in accordance with manufacturing entity characterisation tabulated in Table 11. The 
higher the risk associated with performing a particular function, the wider the dispersion of the 
data is expected (increased risk observable as increase in volatility, hence wider data dispersion) as 
illustrated in Figure 23. 
Figure 23: Risk Return based on entity characterisation 
A L. Frequency of 
observations 
1 * / s Is 
Loss si 
s 1 
s / 
\ N 
\ N 
0 % f29b fj% 
Relative Returns 
{Source: Curtis and Ruhashyankiko 2003:1) 
The dotted line Figure 23 represent, in manufacturing entity characterisation terms the fully 
fledged manufacturer as described in Table 11, which undertakes a range of activities and 
functions that are exposed to risk with the median return at// with some entities realising negative 
or loss-making returns. 
On the other hand, the lower risk manufacturers, such as the contract manufacturer or assembler, 
realises a median return of jfe with no entities realising negative returns. In theory this is 
appropriate, in practice, it is difficult to determine comparable data, which fall absolutely within 
these classifications. The use of statistical techniques such as inter quartile ranges are used which 
excludes outliers that could potentially influence the arm's length consideration, which in the 
example will be / ; for a fully-fledged manufacturer. 
The affect of adjustments to the comparable range and in particular to the median, which are 
usually considered as the arm's length consideration is illustrated in Figure 23 (South Africa, 
152 
1999:27). Prior to making the adjustments, uncertainty exists whether adjustment(s) to the 
comparable data would move the median reward// to the right (increase) or to the left (decrease). 
The reward (profit)/; decreases in situations where the comparable entities assume higher risk (in 
relation to identified assets) than the tested party does and by virtue of enacting these adjustments; 
the rewards of the comparables are adjusted downwards on a comparable asset base. The assets 
involved in these adjustments are inventory and accounts receivable whilst accounts payable, a 
liability in accounting terms, are also included in the working capital adjustments. 
4.4 Fundamentals of a Comparability Adjustment Transfer Pricing 
Model 
An important requirement of any transfer pricing model is that its application ensures 
comparability in the determination of the arm's length consideration. The Capital Asset Pricing 
Model ("CAPM") provides insight insofar as risk - reward interaction and the reward associated in 
terms of assets. Risk is quantified by virtue of the beta coefficient, a measurement of the return of 
assets compared to the market (Brigham et al, 1999:180). 
The CAPM has value insofar as quantifying risk but does not address it in terms of transfer pricing 
where it is imperative to measure returns (profit) on a transaction-by-transaction basis with the 
arm's length consideration being based on comparable information. In order to establish a 
consistent basis for the analysis, the financial statement analysis and terminology as well as 
acronyms used are in accordance with those documented in sections 1.6.13 and 1.6.14. 
The approach used to define the Comparability Adjustment Transfer Pricing Model ("CATPM"), 
as illustrated in Figure 24, is based on defining a model based on economic fundamentals. The 
fundamentals are demand and supply side variables as illustrated in Figure 24, measured by 
financial statement information (refer to 1.6.13 and 1.6.14 for details on financial statement ratios 
and acronyms used). 
There will be convergence amongst demand and supply, however, the aim is to establish and 
adjust for factors that enhance comparability in the determination of the arm's length 
consideration. The supply side of the model is based on an extended DuPont analysis as well as 
determining tax (Brigham et al, 1999: 54, 86 and 90) and financial leverage (Brigham et al., 1999: 
77 and Libby et al, 1998: 712). 
153 
Figure 24: A Comparability Adjustment Transfer Pricing Model 
s c 
-o cy> — ■ rt> 
E 
Vo >£ 
y-
<t g_ 
i . s. £2. u 5 OQ 
3 3 o ™ 
£ 5 B i 
3 "S 
e? F •7T 
a <—>■ 
W 
=3 
ca 
<^ W i 
ss' s 3 
' 2 Q . 
—» 3 £. 
§ O 
DS 
3 
M 
3* ■s 
—. y» 1—' 
Arm's length consideration 
a, = Piqi~Cl 
Supply side influence on 
a, =Piqi-Ci 
Leverage 
Demand side influence on 
or,. = Piq,-C, 
CATPM 
Financial Statement ratios Market variables 
Financial, Tax Liquidity, Activity, Solvency 
X 
Inventory, Receivables 
Positioning Analysis 
Correlation 
Ratios & Profit level 
indicators 
Multiple Regression 
Ratios & Profit level indicators 
Arm's length consideration 
in comparables' market (EU) 
Coefficients 
Bond Yield Adjustment 
3 
S3 
CD CT-
o — 
o s.-3 ^ "S > 
F 2 
"* re-
Arm's length consideration or, = /^g, —Ct in South African market 
(Source: own compilation) 
The demand side of the model is primarily concerned with undertaking a market analysis based on 
demand-pull and business ratio's (Brigham et al., 1999:86 and Libby et al., 1998:710). The 
supply and demand side of the CATPM progresses to a positioning analysis, positioning of the 
tested party in relation to comparable companies, the foundation of the arm's length consideration. 
In making use of foreign comparable data, in particular from the European Union (EU), the 
positioning analysis result in positioning the tested party in the EU, (refer to 4.4.3 and Appendix 
4.5 where the results of the positioning analysis were disclosed). The fundamentals of the model 
can be summarised by the following key attributes: 
• The model provides the foundations for the relationship amongst market and business risks 
on the one hand and accounting profitability from financial statements on the other 
• The model introduces insights from the demand side and market analysis to allow 
subsequent adjustments to reflect difference in economic conditions across jurisdictions 
• The model improves the comparability analysis by using ratio analysis (Brigham et al., 
1999: 86 and Libby et al, 1998:710), or the relevant profit level indicators (refer to section 
154 
3.3.2.1.1 for a description of the profit level indicators). The ratio analysis in conjunction 
with the profit level indicators provides measures of functions, assets and risks obtained 
from the financial statements and guide the analysis of comparables, even in the absence of 
industry comparables. 
• The model enhances the comparability analysis by deriving weights that determine the 
quantitative impact of mutually exclusive (see 1.6.24) and collectively exhaustive (see 
1.6.4 ) ("MECE") ratios on profitability through positioning analysis. The positioning 
analysis uses econometric regression techniques to produce point estimates of arm's length 
return and small ranges within, or outside the inter-quartile range (Albright et a l , 2003:191 
and Berenson and Levine, 1999:197). 
4.4.1 CATPM components 
The comparability adjustment transfer pricing model ("CATPM") is aimed at a substantial 
enhancement of the comparability analysis, which forms an integral part of any transfer pricing 
evaluation, as required by the OECD Guidelines (OECD, 1995: 1-6 - 1-8). The components of the 
model is founded on the supply and demand side dynamics underlying the affected transaction 
amongst connected parties in relation to that of determined comparables (refer to section 4.5.1 
where the comparability analysis in the determination of a comparable set is discussed and 
disclosed in detail). 
4.4.1.1 Supply side 
The supply side of the model in Figure 24 is based on ratio analysis (refer to section 4.4.1.1.2 for 
more details) and the extended DuPont analysis in Figure 25 (refer to section 4.4.1.1.2 for a 
detailed discussion) in conjunction with financial ratio analysis, in particular two leverages; tax 
and financial. Each of these concepts is discussed in more detail in the following sections. 
4.4.1.1.1 Leverage 
The concept of leverage is similar to elasticity (relative change in quantity in relation to relative 
change in price, which caused the change in quantity) but leverage can be best explained by a 
reference to physics. In physics, leverage implies the use of a lever to raise a heavy object with a 
small force. The concept of leverage in business simply refers to that a relatively small change in 
155 
variables such as sales or cost could potentially result in a bigger change in returns or 
profitability. 
For example, debt financing has a cost associated with it, usually an interest rate. In the event that 
the company that borrows at 10 per cent from a bank earns 15 per cent on the borrowed funds, the 
return on capital is magnified or leveraged by 5 per cent. Brigham et al. (1999:79) indicates that 
leverage is possible due to the following: 
• The interest rate cost is deductible as an expense for tax purposes, which effectively lowers 
the tax expense and increases operating profit. 
• If the expected rate of return (earnings before interest and tax (EBIT)) divided by total 
assets exceeds the interest rate on debt, the portion that it "exceeds" provides additional or 
leveraged returns. 
4.4.1.1.2 Business ratio analysis 
Business ratio analysis provides the connection amongst supply and demand captured in the 
comparability adjustment transfer pricing model (CATPM). Libby et al, (1998:707) as well as 
Brigham et al, (1999:72) does not recognise business ratio analysis per se, it is seen as a 
combination of financial statement and ratio analysis. Financial statement analysis' objective is to 
enable comparison, conceptionally similar to transfer pricing insofar as the comparability analysis. 
The financial statement comparison according to Libby et al, (1998:706) entails time series 
analysis and comparison with similar companies, both aspects are included in transfer pricing. 
Business ratio analysis (refer to 1.6.13 for more details), on the other hand according to Libby et 
al, (1998:707) aims to identify significant relationships in a proportional manner amongst two or 
more financial statement items. In order to expand on the pragmatic approach followed in this 
research, a ratio analysis of the Automotive and Components Industry in South Africa of listed 
companies on the Johannesburg Securities Exchange (JSE) over the timeframe of the research 
(1996 through to 2002) is tabled in Table 12. 
Libby et al, (1998:710) and Brigham et al, (1999:87) provide guidance insofar as business ratios 
and highlights that ratios measures specific aspects of a business and can be grouped in the broad 
categories relating to profitability, asset structure, liquidity, solvency and market value which is 
evidenced from Table 12: 
156 
Table 12: Selection of ratios of the automotive and component industry of South Africa 
2002 2001 2000 1999 1998 1997 1996 Average 
Asset structure 
Total asset to turnover 3.12 2.25 2.46 2.28 2.28 2.53 2.76 2.53 
Funding structure 
Total assets to funding 2.50 2.22 1.76 1.62 1.83 1.54 1.60 1.87 
Fixed assets as % of funding 51.27 47.46 38.13 37.62 35.50 34.04 35.82 39.98 
Long-term loans as % of total debt 9.88 22.16 17.58 22.65 22.02 25.39 28.34 21.15 
Solvency and liquidity structure 
Current ratio 1.21 1.24 1.54 1.69 1.57 1.79 1.91 1.56 
Quick ratio 0.53 0.69 0.81 0.95 0.86 0.91 0.89 0.81 
Debt to assets 0.67 0.71 0.53 0.50 0.59 0.47 0.52 0.57 
Debt to equity 2.02 2.41 1.11 0.98 1.41 0.89 1.10 1.42 
Interest cover 2.75 1.52 1.54 1.57 1.33 2.68 3.27 2.09 
Debt to cash flow 5.90 4.89 7.37 4.04 11.80 5.57 4.86 6.35 
Cash flow interest cover 3.29 4.70 2.30 2.33 1.61 2.76 3.29 2.90 
Profitability structure 
Operating profit margin (%) 4.39 2.64 3.45 6.45 4.77 5.08 5.58 4.62 
Net profit margin (%) 2.33 0.58 0.48 1.74 0.32 2.05 2.68 1.45 
Return on assets (%) 13.71 5.95 8.47 14.53 10.86 12.85 15.41 11.68 
Return on equity 21.90 4.46 2.49 7.29 1.76 9.77 15.55 9.03 
Leverage factor 1.93 1.07 1.25 1.24 0.58 1.18 1.53 1.25 
Retention rate (%) 77.27 113.04 34.58 85.93 145.13 71.40 78.24 86.51 
Return on external investments (%) 14.08 14.71 22.44 51.17 69.59 13.30 24.72 30.00 
(Source: ABSA (2003: 27)) 
Although these business ratios provide an indication of the business within specific reference to 
aspects such as liquidity and profitability, it is also imperative in comparison of businesses with 
itself and competitors. From Table 12, the following observations of the South African 
Automotive and Component Industry can be made: 
• Asset structure indicates the relation between assets and sales. On average, South African 
companies' assets exceed 2.53 times their turnover. This is a significant indicator that the 
South African industry is asset intensive. 
• Funding structure indicates the size of funding to a reference base such as assets or long-
term debt. On average the South African industry fixed assets amounts to 39.98 per cent of 
funding with long-term debt being 21.15 per cent of total debt. Funding in the industry is 
predominantly short-term in nature. 
• Solvency and liquidity structure refers to the ability of a company to meet its long-term 
obligations on a continuing basis. For example, cash flow interest cover is on average 2.9 
that indicates that cash flow generated covers the interest expense 2.9 times, a good 
157 
solvency measure. Current ratio measures the relationship between total current assets and 
total current liabilities. The current ratio is a measure of the "cushion" of working capital 
for the volatility in the flow of funds in the working capital accounts. The average current 
ratio is 1.59, which indicates that current assets cover current liabilities by 1.59 times, a 
good measure of liquidity. 
• Profitability structure is a primary measure of the overall success of a company. Tests of 
profitability focus on measuring the adequacy of income by comparing it with one or more 
activities that are measured in the financial statements (Libby et al, 1998:709). The 
measures used in Table 12 is similar to the ones used in the research (see 1.6.13), hence no 
further detailed discussion is undertaken. 
This same approach is used in transfer pricing and in particular the comparability adjustment 
transfer pricing model (CATPM) where the aim is to determine the business ratios that provides a 
positive correlation in estimating the arm's length consideration. Transfer pricing is comparison 
driven (comparable, independent party requirement, see 1.6.1 and 1.6.5) therefore it is imperative 
that any model that aims to determine the arm's length consideration should be based on a 
comparative base, in this instance, financial ratios of comparable companies. The comparison, for 
transfer pricing can either be on a price (under the CUP methodology) or a profit indicator 
amongst the parties to a transaction to be tested or the companies to which the comparison are 
made. 
Information availability in most of cases determines which methodologies or approaches is to be 
used in the transfer pricing analysis (OECD, 1995:11-9 and South Africa, 1999:13). Financial 
information in most cases are readily available, hence the reliance on using financial information 
to determine the arm's length consideration. 
Financial ratio analysis is not limited to transfer pricing only; it is widely used in business and 
provides insight into corporate finance, management performance measures, investment decisions 
etc (Libby et al, 1998:707 and Brigham et al, 1999:72). In light of the wide spectrum of users of 
financial ratios from different disciplines, various approaches and models are used to illustrate 
financial performance. The financial ratios widely used as evidenced in Table 12 forms an integral 
part of the extended DuPont analysis (refer to section 1.6.11 for a list of the financial ratios used in 
the research). 
158 
4.4.1.1.3 The Extended DuPont Analysis of Profitability 
The DuPont System of Analysis merges the income statement and balance sheet into two summary 
measures of profitability (Brigham et al, 1999:89). 
• The Return on Assets (ROA) and the Return on Equity (ROE) 
• The system uses three financial ratios to express the ROA and ROE: Operating Profit 
Margin Ratio (OPM), Asset Turnover Ratio (ATR), and Equity Multiplier (EM). 
The objective for any company is to ensure that the capital invested in operations generates 
sufficient liquidity for the company to finance short-term and long-term activities without putting 
solvency at risk. 
Figure 25: Extended DuPont Analysis  
Income Statement 
Tax Paid 
Interest Paid 
Cost of Sales 
Plus 
Depreciation 
Sales 
Less 
Cosi of Sales + 
Depreciation 
1 
Balance Sheet 
Current Assets 
Less 
Non interest bearing current 
liabilities 
Interest Bearing Debt 
Divide By 
Equity 
(Net Working Capital 
Plus 
Fixed Assets 
Debt /Equity Equity Multiplier V 
(1-KD/E)) I 
(Source: Brigham et al., 1999: 86) 
Return on equity (the return the shareholders will be interested in) according to the DuPont System 
of Analysis is (Brigham et al., 1999: 86): 
ROE-
NP 
Equity EBT EBIT 
NP EBT 
-x x 
EBIT Sales x-
Sales Capital 
Capital 
Equity 
(5) 
159 
The equation within the bracket of the return on equity equation, x — is equal to return 
Sales Capital 
on investment (ROI). Return on equity (ROE), incorporating return on investment can be written 
as RQE= NP = NP x EBT xROIxCapital and if the return on investment (ROI) equation is 
Equity EBT EBIT Equity 
expanded, the return on investment (ROI) equation can be written as (Brigham et at, 1999:87): 
„„T EBIT EBIT Sales TA REC Inv Sales CA CL Debt ((~, 
RQT = = v x X X X X X X • \ " / 
Capital Sales TA REC Inv Sales CA CL Debt Capital 
The first two terms in the ROI equation provides the return on assets (ROA). This means that the 
ROA is included in the ROI, which in turn forms part of the ROE equation. These terms used in 
the extended DuPont model with their respective relevance to transfer pricing insofar as functions 
performed, assets used and risk assumed is tabled in Table 13. 
160 
Table 13: Ratio's measuring functions, assets and risk 
Transfer Pricing Categorization 
Specific 
implication 
Transfer pricing 
categorisation 
(functionality 
driven) 
Ratio Description 
Operational 
ability 
Function performed 
driven OM=
EBIT 
Sales 
Operating margin, widely used in transfer 
pricing analysis as a profit level indicator 
under the TNMM method 
Use of sources 
finance to 
obtain leverage 
benefits 
Function performed 
driven FLev = 
EBIT 
Financial leverage 
Use of tax 
(timing, 
deferral) to 
obtain leverage 
benefits 
Function performed 
driven 
NP TLev = 
EBT 
Tax leverage 
Cash flow 
position 
Function performed 
driven 
cp _ Sales 
CA 
Cash position as expressed by sales to 
current assets, generated cash flow 
Financial and 
funding 
structure 
Function performed 
driven FSRM =
 Capital 
Equity 
Financial structure and risk management. 
Companies' financing decisions determine 
the mix of debt and equity aimed at 
operational funding. It is also important 
from a transfer pricing perspective, 
especially with the safe harbour rule of 3:1 
debt to equity (South Africa 1996: 3). 
Activity Assets TAT= Sales 
TA 
Total assets turnover 
Error or 
mismatch 
Accounts receivables 
risk 
„ __ Ret 
Re.cTO = 
Inv 
Accounts receivables turnover 
Error or 
mismatch 
Inventory risk YYQ _ inventory 
Sales 
Inventory turnover 
Liquidity Short term liquidity 
risk STLiq= — H CL 
Short term liquidity 
Solvency Long term solvency 
LTSol= Debt 
Capital 
Long term solvency 
Liability Liabilities 
LiabSt = 
Debt 
Liability structure 
(Source: Brigham et al., (1999: 87) andLibby et al., (1998: 710) and own compilation) 
In exploring ratio analysis and the extended DuPont ratio analysis, the supply side of the CATPM, 
allows for the identification of ratios that reflects functions performed, assets used and risk 
assumed. The determination of the arm's length consideration is based on functions performed, 
assets used and risk assumed (OECD, 1995:1-8,1-9, South Africa, 1999:10, 28). 
161 
Ratio analysis in conjunction with the extended DuPont analysis allows for the recognition of the 
following factors that could be assessed in terms of its impact on profitability and is measurable 
with information obtained from the financial statements: 
• Activity as expressed by the relative relation between sales and total assets 
• Liquidity as expressed by the relative relation between current assets and current liabilities 
• Solvency as expressed by the relative relation between debt and capital 
• Financial leverage as expressed by the relative relation between earnings before tax (EBT) 
and earnings before interest and tax (EBIT) 
• Tax leverage as expressed by the relative relation between net profit (NP) and earnings 
before tax (EBT) 
Connected parties do not operate in complete isolation from the market and is exposed to the 
market forces of supply and demand. The supply side of the CATPM defined two leverages, i.e. 
tax and financial and in addition to that, ratios reflecting business activity (sales to assets), 
liquidity and solvency. Ratios, which could be indicative of the demand side, are ratios that relate 
to sales and inventory. In the event that demand-pull deteriorates, sales are expected to decline 
with inventory holding to increase. This observation is based on demand being measured by sales, 
accounts receivable and inventory (both assets on the balance sheet) that provides "access" to 
goods that can be sold. Within this context, the CATPM's supply and demand side converge; 
business ratio's reflects supply and demand dynamics. The ratios that reflects the demand side of 
the CATPM is as follows: 
• Inventory as expressed by the relative relation between inventory and sales 
• Accounts receivable as expressed by the relative relation between accounts receivable and 
inventory 
4.4.1.2 Demand side 
The demand side of the model is based on business ratios such as inventory and accounts 
receivable and a market analysis. The market analysis is primarily concerned with demand 
variables that is firstly under the control of the tested party (as well as the comparables), and 
secondly under the control of competitors and lastly, external, uncontrollable variables. 
162 
4.4.1.2.1 Reference to the Capital Asset Pricing Model 
The capital asset pricing model (CAPM) postulates the relationship amongst risk and return with 
reference to an asset (Brigham et al, 1999:178). Risk, according to the CAPM, is the sum of 
market risk, (systematic risk) factors out of the control of the company, such as interest rates and 
exchange rates, (corresponds with demand side and in particular the market analysis) and referred 
to as systematic risk and on the other hand, idiosyncratic risk which is under the control of the 
company (Brigham et al., 1999:180). The approach of the CAPM leads to the realisation that the 
company can by virtue of managing idiosyncratic risk limit overall risk close to the level of market 
risk that is out of their control. 
In order to enable comparisons amongst companies, risk is not recorded in financial statements nor 
is it measured in any specific manner. However, the impact risk had on companies is recorded in 
their financial statements in the form of earnings or profits (use of the profit in relation to assets or 
capital provides measurement opportunities). The relative base on which these profits are earned, 
the assets, (an essential factor in the CAPM) are recorded inclusive of the risk the company was 
exposed to in realising the profits. 
Hence, following on a pragmatic approach by analysing the financial statements and profitability 
ratios, comparisons amongst companies are possible. The comparisons undertaken include risk for 
all the companies (systematic and idiosyncratic) due to the fact that profitability are a result of the 
underlying risk (irrespective if it realises or not) with reference to a base, an asset (refer to section 
4.3.5.2 where risk measurement and reference to the CAPM is discussed in more detail). 
4.4.1.3 Market analysis 
Market analysis, within the context of transfer pricing, aims to describe the market in which the 
tested party and its comparables operate (South Africa, 1999:25). Thompson and Strickland 
(1999:100) identifies seven factors to be considered when a market and industry analysis is 
undertaken which are as follows: 
• Dominant economic characteristics of the industry 
• Competition 
• Competition drivers 
163 
• Competitive position of major market participants or strategic groups 
• Competitor analysis 
• Key success factors 
• Industry prospects and overall attractiveness 
South Africa's PN 7 (South Africa, 1999:12) and the OECD Guidelines (OECD, 1995:1-12) 
provide a list of factors to consider when markets are analysed and compare which are: 
• the geographic location of the market; 
• the size of markets; 
• the extent of competition in the markets; 
• the availability of substitute goods and services; 
• the transport costs; and 
• the level of the market (retail or wholesale). 
These guidelines do not venture in providing specific details how such factors are to be 
considered. The potential effect the factors might have on the arm's length consideration is not 
discussed at all. 
It is not surprising that confusion and ambiguity emerges with the interchangeable use of the terms 
"market" and "industry analysis". For the purposes of this research, the terms are used in the 
following context: 
• The term 'industry' normally refers to a group of companies producing technologically 
related products or services. The group need not and normally will not all compete with 
one another, either because they operate in different geographical markets or because they 
operate at distinct steps in the value chain (manufacture and distribution). For example, the 
automotive industry comprises components suppliers as well as vehicle assemblers. 
Industries can be broadly or narrowly defined but tend to be relatively broad. For example, 
reference is often made to the software industry and the IT sector. 
• The term 'market' in contrast focuses on the consumer (purchaser) needs that are being 
satisfied and leads directly to the identification of competitors. In many cases, the 
164 
definition of the market(s) in which the company is active is obvious. For example, there 
is clearly a market for cars, which is distinct from that for buses. 
In light of defining the CATPM, it is useful to review the types of variables, which are likely to 
influence demand, and the extent to which these variables are controllable by the tested party. 
This of importance since the tested party aims to determine thresholds for controllable variables to 
maximise profitability and manage risks to minimise the effect of those risk on profitability. The 
following table is a summary of variables considered in conducting a market analysis. 
Table 14: Demand variables 
Under Company Control Under Competitor's Control Universe or macro economic factors 
The product's own price Prices of competing products The level of real / nominal and 
The price of related products from Prices of substitutes products disposable income or (average or per 
the company's product line, i.e. Advertising and / or marketing for capita) 
substitute products the affected products Gross Domestic Product (GDP) 
Future prices for the product and growth 
related or substitute products Inflation rates 
Advertising and / or marketing for Interest rates 
the affected products Fiscal policy 
Product design characteristics and Government policy (e.g., through 
performance criteria restrictions on advertising of tobacco 
or alcohol, supply side measures such 
as the Motor Industrial Development 
Programme ("MTDP") 
Tastes and preference, applicable 
when product differentiation is 
technology driven 
(Source: own compilation) 
In determining the supply and demand side of the CATPM and in particular the business ratio 
analysis, various ratios have been identified from a supply and demand perspective. Demand is 
measured in terms of inventory and accounts receivable ratios. Supply is measured by liquidity, 
activity, solvency ratios as well as financial leverage and tax leverage. 
4.4.2 CATPM regression equation 
In determining the arm's length consideration, (a) of n unconnected parties that are comparable to 
the tested party (i) based on functions performed, assets used and risk assumed, for the purpose to 
determine point estimates from weights (w) that are obtained from the supply and demand ratios 
which are MECE can be written as a-t - wx \prt )+ w2{Sr;)+ w3et . (7) 
165 
Demand risk (Dn) consists of inventory risk nven ory and receivable risk eceiva es _ 
\ Sales ) i ^ Inventory J. 
f FRT1 ^ f /VP "^  
Supply risk (Sn) consists of two leverages, financial and tax , as well as liquidity 
— , activity a es \ a n cj solVency —e-— measures (refer to section 1.6.13 for acronyms 
used in financial ratios). 
The regression is based on the MECE ratios and their impact on profitability, with id) being the 
intercept, ( s ) the error term and (j3x.../3n) the coefficients of the regression. The equation is 
0 Inv 0 Rec a CA a Sales 0 Debt D EBT 0 NP 
a, = a+B, + /?, +/?, + B, + B, +B< +B1 + s 
' l Sales 2 Inv 3 CL 4 TA 5 Capital 6 EBIT 7 EBT /gN 
4.4.2.1 Sample size 
In the determination of the arm's length consideration, the potential comparable unconnected 
parties are determined in accordance with functions, assets and risk assumed. Functionality thus 
drives the database query. Comparable functionality is driven by the facts established during the 
functional analysis. In this research, the focus is on a specific case, a manufacturer of automotive 
products. In addition to the query criteria used to establish independence (unconnected parties) the 
NACE (Nomenclature generale des activites economiques dans les communautes Europeennes), 
an industry classification system is used (see Appendix 2 for more details). The NACE code that 
reflects a manufacturer of automotive products in conjunction with the independence criteria are 
used to define the potential comparable dataset. 
The practical application of determining a potential comparable dataset requires to be tested 
insofar as establishing an acceptable sample size. Berenson and Levine (1999: 383) and Albright 
et ah, (2003: 398) alludes that the sampling error (that influences the reliability of the results 
obtained from the sample) needs to be minimized as far as possible. Albright et al, (2003:398) 
acknowledges that in order to minimize sampling error, larger sampling sizes are used. In 
estimating the arm's length consideration including the arm's length range and the relative 
position (see 4.4.3) within the range by the CATPM, samples are not used: the entire population of 
potential comparables companies in accordance with the screening criteria are used. 
166 
4.4.3 Positioning analysis 
The OECD transfer pricing guidelines does not provide any authoritive view on the position of a 
connected party within the arm's length range (OECD, 1995:I-l-AN-52). The approach followed 
by SARS for transfer pricing, is the same as any other section of the Act, the burden of proof that 
vests with the taxpayer (tested party). SARS regards positioning of the tested party within the 
arm's length to the point in the range that best accounts for the facts and circumstances of the 
controlled transaction (South Africa, 1999:27). In the absence of any evidence of the positioning 
of the tested party within the arm's length range, the Commissioner may select the mid-point in 
the range (South Africa, 1999:27). 
The subjective nature of adjusting to the mid-point in a range substantiates the need to establish 
an objective approach in determining the position of the tested party within the arm's length range 
(refer to 1.6.2 for a definition). In order to determine the position within the arm's length range 
which dually constitutes the arm's length consideration is of value. One of the CATPM (refer to 
section 1.2 and 4.4 ) fundamental propositions is to enhance the comparability analysis through 
providing an objective measure based on regression techniques to produce point estimates of the 
arm's length consideration relative to the inter-quartile range. 
In order to determine the point estimates, weights are obtained from the supply and demand ratios, 
which are mutually exclusive, and collectively exhaustive ("MECE") (Albright et ah, 2003:191 
and Berenson and Levine, 1999:197) in estimating profitability. The CATPM (refer to section 
Appendix 3.1 for a discussion and comprehensive tabulation on the inference of the key equation 
of the CATPM), defines profitability of the tested party (i) as: 
• Profitability; =fia; (total risks)i, (9) 
• Where fiat is the function (f) performed (manufacturing) and assets (a) (property, plant, 
equipment, inventory) of tested party (i) in relation to total risk tested party (i) assumed in 
performing the functions and using the assets. 
• The basis on which the arm's length consideration, a-t =Piql-C! (see section 4.3.1 where 
the equation is discussed) is based on identifying comparable unconnected parties through 
a comparability analysis to determine (a, ) as the product of the price (Pi) of goods and 
167 
services and the quantity (#,•) of the goods and services less the cost (C,-) of providing the 
goods and services. 
• The value of (af) is as a result of the market interaction (supply and demand as well as the 
total risk associated with it) in accordance with the requirements of Paragraph 1 of Article 
9 of the OECD Model Tax Convention (OECD, 1995:1-3). 
4.5 CATPM test 
In order to implement the CATPM and useage in transfer pricing requires testing and application 
to actual data. For this purpose, the South African company, the tested party's name is omitted 
with reference to it made as ZA Case 01 and limited financial information is provided, to ensure 
confidentiality (refer to section 1.4.2.1 for details pertaining to the classification of the research). 
However, the research methodology used in finding potentially comparable data is disclosed. 
4.5.1 Comparability Analysis 
In order to test the CATPM, the research is based on adherence to comparability requirements. 
Hence, the compensation for the transfer of property or services amongst two unconnected parties 
will usually reflect the functions that each enterprise performs, taking into account the risks 
assumed and the assets used. 
According to South Africa's PN 7, economic theory predicts that when a group of unconnected 
parties performs various functions, the enterprise that provides most of the effort and, more 
particularly, the rare or unique functions, and assumes the most risk should earn a greater portion 
of the profit (South Africa, 1999:10). In determining whether two transactions are comparable, the 
functions and risks undertaken by the independent parties should be compared to those undertaken 
by the connected parties. The functions of ZA Case 01 discussed in 5.3.3 are used to determine 
the comparable dataset to be used in testing the CATPM. 
4.5.1.1 Comparable Search 
The entities being viewed as comparable to the tested party were tested on functional 
comparability (manufacturer), assets used and the risk assumed. 
168 
4.5.1.1.1 Industrial Classification 
Standard Industrial Classification ("SIC") codes classify business enterprises by their type of 
economic activity (see Appendix 2 for a complete list of classifications). Any industrial 
classification system uses a hierarchical system, dividing economies in sectors and sub-sectors. 
The system used in Amadeus is comparable to the SIC standard and is referred to as the 
"Nomenclature generate des activites economiques dans les communautes Europeennes" 
("NACE") classification. 
4.5.1.2 Data source 
4.5.1.2.1 South African Source 
In South Africa, a database containing South African unconnected party information does not 
exist. South African public listed entities' financial information is available. The majority of the 
entities' financial information is on a consolidated basis, which makes it unacceptable for transfer 
pricing purposes. Consolidated financial information results in transactions being netted off, the 
result of the total transactions are disclosed, the underlying transactions that might include affected 
transactions are not disclosed. In applying transfer pricing principles, unconsolidated information 
is used. The lack of a South African data source necessitates the use of a foreign database, as 
acknowledged by South African PN 7 (South Africa, 1999: 26). 
4.5.1.2.2 Bureau van Dijk's Amadeus Database 
Bureau van Dijk's "Analyse Major Databases from European Sources", commonly referred to as 
Amadeus Database, contains financial and business information of approximately 1.1 million 
companies. According to Amadeus' disclosure on data, to be included on the database for the UK, 
Germany, France, Italy, Ukraine and Russian Federation, an enterprise must have the following: 
• Operating revenue equal to at least € 1.5 million, 
• Total assets equal to at least € 3million, 
• Number of employees equal to at least 15. 
4.5.1.3 Functional Determination - Screening Criteria 
Two screening criteria is applied in undertaking a comparable search of the data, the first being 
quantitative screening and the second being qualitative screening (not undertaken in the test of the 
169 
CATPM, due to its subjective nature). Quantitative screening use ratios or thresholds to find 
companies that are similar to the tested party (thresholds are determined by the functional 
analysis). 
The July 2005 version, update 130 of the Amadeus database, was used for the comparable search. 
4.5.1.4 Quantitative screening 
4.5.1.4.1 Geographic Region 
Market conditions vary greatly amongst countries and country specific factors can influence 
profitability. Bearing this in mind the search concentrated on a common geographic area such as 
the European Union. There were 1.118 million companies identified and the results from this step 
can be summarised as follow: 
Table 15: Screening Results - Geographic Region 
STEP | Search Criteria Value of criteria Step Result Search Result 
1 \ Countries European Union 1 118 824 1 118 824 
(Source: own compilation) 
4.5.1.4.2 Independence 
Related companies cannot be used in a comparable set due tot the fact that they might have 
transfer pricing issues of their own. The Amadeus database consists of 1.152 million companies 
that do not have subsidiaries with 883 090 of the companies in the European Union. Independent / 
dependent companies according to the search criteria (A+, A, A-) of companies with no 
shareholders recorded with more than 24,9% direct or total ownership as well as unknown 
ownership (U) resulted in 666 245 possible companies with only 407 585 companies being in the 
EU and not having any subsidiaries with the result from these steps as follow: 
Table 16: Screening Results — Independence 
STEP Search Criteria Value of criteria Step Result Search Result 
2 No of subsidiaries None 1 152 540 883 090 
3 Independent / Dependent Co.'s. A+, A, A-,U 666 245 407 585 
(Source: own compilation) 
Access to intangible assets such as know-how, patents and trade marks may provide the owner of 
such intangibles the potential to earn profits in excess to that of a similar company, operating in 
the same industry without the intangibles. This clearly poses a problem and might inflate the 
results if screening is not done to exclude companies with intangible assets. In applying this 
screen, 319 765 companies on the database do not have intangible fixed assets with 78 318 of the 
170 
companies being in the EU, do not have subsidiaries and conforms to the 
independence/dependence screen as follows: 
Table 17: Screening Results — Intangible Assets 
STEP Search Criteria Value of criteria Step Result Search Result 
4 Intangible Fixed Assets 2001,2000,1999,1998 
Max = 0 for all years 
319 765 78 318 
(Source: own compilation) 
4.5.1.4.3 Industrial classification 
By using industrial classification as search criteria, companies are selected on the grounds of their 
respective industry classification, an indication of relative comparability. The industry 
classification codes being used is the NACE Rev. 1.1, code 341 Manufacture of motor vehicles, 
342 Manufacture of bodies (coachwork) for motor vehicles, manufacture of trailers and semi­
trailers. The result from this abovementioned step is as follow: 
Table 18: Screening Results — Industrial classification 
STEP Search Criteria Value of criteria Step Result Search Result 
5 NACE Rev. 1.1 Primary code: 341 
Manufacture of motor 
vehicles, 342 
Manufacture of bodies 
(coachwork) for motor 
vehicles, manufacture 
of trailers and semi­
trailers. 
2 712 100 
(Source: own compilation) 
4.5.1.4.4 Financial items 
In order to find companies that are similar in size, a qualitative screen based on turnover was 
applied. Companies with a turnover more than € 140 million were accepted. The reason why this 
screen is applied is to maximise the potential that potentially comparable companies that might 
benefit from economies of scale are included in the comparable search. 
Further cognisance is taken of the turnover growth of the tested party (ZA Case 01) over the years 
under consideration, hence the minimum screen. The results from these steps can be summarised 
as follow: 
Table 19: Screening Results — Financial Item 
STEP Search Criteria Value of criteria Step Result Search Result 
6 Operating revenue / turnover (th Euro) Last available year 
Max=140 000 
1 054 392 81 
(Source: own compilation) 
111 
In applying this screen, 1 054 392 companies in the Amadeus database satisfy the operating 
revenue criteria with 81 companies being in the EU, do not have subsidiaries, conforms to the 
independence / dependence screen and do not have intangible fixed assets. 
Lastly, (step 7) a screen was applied in terms of the trade descriptions as disclosed on Amadeus. 
The screening text criteria used was "BUS! or BUSES! or COACH! or COACHBUILDERS! or 
COACHBUILDING! or COACHES! or COACHWORK! or LORRY, or LORRIES, or TRUCK, 
or TRUCKING or TRUCKS". In applying this screen, 6 606 companies in the Amadeus database 
satisfy the trade description text screen with 66 companies being in the EU that do not have 
subsidiaries, conform to the independence / dependence screen, do not have intangible fixed assets 
and conforms with the operating revenue criteria. The search yielded 66 comparable companies 
providing data for 2002. Over the period 1998 to 2002, 197 observations provided financial 
information. 
4.5.2 CATPM Modelling 
The data obtained from Amadeus database is used in the determination of the arm's length 
consideration, following the CATPM approach (see 4.4.2). Prior to any further analysis, scatter 
plots of the data are drawn with the scatter plots of net-cost-plus (NCP) as profit level indicator 
and four factors of the CATPM, financial leverage, receivables, inventory and liquidity as 
illustrated in Figure 26. The following observations with reference to the comparability analysis 
and scatter plots illustrated in Figure 26 are noteworthy: 
• Financial data of the comparable companies of 1998 to 2002 is used to minimise the effect 
of business cycles and cyclical trends in the data. (The use of multiple year data is the 
accepted norm according to the OECD (1995:1-20)) 
• Scatter plots for all the variables under consideration for the CATPM do not indicate non­
linear relationship 
• The scatter plots illustrated in Figure 26 indicates a high correlation amongst NCP and 
inventory as well as NCP and liquidity 
• Outliers (observations that lie outside the general pattern of points on the scatter plot) are 
present and were not omitted from the data. Albright et al, (2003:557-558) do not provide 
172 
any significant approach to follow in the case with outliers. The following was considered 
in not excluding the outliers in the analysis: 
o It noted that in the case when an outlier is not clearly a member of the population 
of interest, it is best to exclude it. The population's determination is based on 
various factors under the comparability analysis. Hence, outliers can only be 
excluded based on being outliers, which is unacceptable seen in the light that the 
CATPM attempts to limit subjectivity in the analysis. 
o The number of outliers is very small considering the number of observations; 
hence, it is unlikely that the outliers could significantly influence the results. 
o The output from the CATPM is reported with the outliers included. 
Figure 26: Scatter plots NCP, inventory and liquidity 
2.4 T 2.4-r 
2.0 - 2.0 
to 1.6 
f 1.2-
Correlation = 0.753 
1 1.6 ■ 1.2-
Correlation = 0.851 
« 0.8 H s 0.8 -j 2 0.4, 
z 0.0 ( itt 4 N t ♦♦ ♦♦ 
o 
1 
0.4-
0.0 - * mftk HI >» K ♦ ♦ 
- 0 .4 - ♦ -0.4 ♦' 
0.00 0.25 0.50 0.75 1.00 1.25 1.50 1.75 
CATPM Inv Risk 
2.00 0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5 5.0 
CATPM Liq Risk 
(Source: own compilation) 
Although all seven variables are theoretically essential to the CATPM (see Appendix 4.5 for all 
the scatter plots), removing one or several can reduce or eliminate multicoUinearity (nearly a linear 
relationship among a set of explanatory variables (Albright et al., 2003:635)) while maintaining 
the MECE requirement. In order to achieve the elimination of multicoUinearity whilst maintaining 
the MECE, a correlation matrix for the seven variables and the three profit level indicators (Pli's) 
was calculated as illustrated in Table 20. 
173 
Table 20: Correlation Matrix CATPM factors 1998 to 2002 
CATPM 
Inv Risk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
CATPM Inv Risk 1.000 
CATPM RecRisk -0.056 1.000 
CATPM Liq Risk 0.522 ; 0.073 1.000 
CATPM Activity Risk -0.348 -0.129 -0.162 1.000 
CATPM Sol Risk -0.003 -0.023 -0.009 -0.097 1.000 
CATPM Fin Lev 0.015 0.039 0.157 -0.020 0.067 1.000 
CATPM Tax Lev 0.009 -0.021 -0.029 -0.111 -0.004 -0.135 1.000 
(Source: own compilation) 
The correlation matrix indicates that liquidity and inventory are somewhat correlated; the 
coefficient of correlation is 0.522 which means that one of the two factors could be excluded from 
the regression. There is no established threshold for elimination or no rule for determining which 
one of the pair should be eliminated, therefore for the purposes of this regression both are 
accepted. 
Hence, the empirical MECE ratios are inventory risk, receivable risk, liquidity risk, activity risk, 
solvency risk, financial leverage and tax leverage as defined in the following regression formula. 
a, = a +1 
Inv 
Sales + fi: 
Rec CA Sales 
2 Inv 3 CL+/J4 TA + & 
Debt 
Capital + 06 
EBT 
EBIT 
NP 
EBT - + s (10) 
The regression aims to predict Y, profitability = Net-cost-plus and EBIT margin, from a set of X 
variables (the CATPM factors), which are the empirical mutually exclusive and collectively 
exhaustive ("MECE") factors (risks) and leverages. In order to decide which of the variables 
should be included in the model, a stepwise regression was performed. Refer to Appendix 4.3 for 
a stepwise regression for Net-cost-plus for the period 1998 to 2002. The final model of the 
stepwise regression for Net-cost-plus is illustrated in Table 21. 
174 
Table 21: CATPM Net-cost-plus regression 
Multiple R 0.933103276 
R Square 0.870681723 
Adjusted R 
Square 0.865892158 
Standard 
Error 0.129807592 
Observations 197 
ANOVA 
df SS MS F 
Significance 
F 
Regression 1 21.441813 3.0631162 181.78719 2.188E-80 
Residual 189 3.1846521 0.01685 
Total 196 24.626466 
Coefficients 
Standard 
Error tStat P-value Lower 95% 
Upper 
95% 
Lower 
95.0% 
Upper 
95.0% 
Intercept -0.19676069 0.0354138 -5.556043 9.279E-08 -0.26661776 -0.12690 -0.26661 -0.126903 
CATPM Inv 
Risk 0.138581868 0.010719 12.92864 8.341E-28 0.11743766 0.159726 0.117437 0.159726 
CATPM 
Rec Risk 0.000760639 0.0002693 2.8245934 0.0052421 0.00022943 0.001292 0.000229 0.001291 
CATPM Liq 
Risk 0.194147327 0.0095393 20.352343 1.639E-49 0.17533014 0.212965 0.175330 0.212964 
CATPM Fin 
Lev -0.07309953 0.0201062 -3.635678 0.0003574 -0.11276083 -0.03344 -0.112760 -0.03343 
(Source: own compilation) 
4.5.2.1 Interpretation of multiple regression results 
The outputs to be considered are highlighted in Table 21. R Square, (R2), the coefficient of 
determination is a measure of goodness of linear fit (Berenson and Levine, 1999:749). R always 
has a value between 0 and 1 and the coefficient of determination can be interpreted as the fraction 
of variation of the response variable (Net-cost-plus (NCP)) explained by the regression line (as 
defined by the CATPM factors) (Albright et al., 2003: 571). 
The coefficient of determination, R2, in Table 21 indicates that inventory, receivable, liquidity 
factors and financial leverage explain 87% of variation in NCP (refer to Appendix 4.3 where the 
stepwise regression is presented). Alternatively, only 13% of the variation of NCP is not 
explained by the CATPM, in particular the inventory, receivable, liquidity and financial leverage 
factors. 
175 
The standard error of estimate, as provided in the regression output in Table 21, is the standard 
deviation (is a measure of variation, how values fluctuate around the mean or average) around the 
line of regression (Berenson and Levine, 1999: 749) The standard error of estimate is equal to 
0.1298. Generally, the standard error of estimate indicates the level of accuracy of the predictions 
made from the regression equation. The smaller the value, the more accurate predictions ought to 
be (Albright et al, 2003: 570). The standard error of estimate of 0.1298 of the regression in Table 
21 indicates the typical error likely when the fitted value (CATPM factors) based on the regression 
line to predict or estimate NCP. In order to determine the acceptability of the accuracy and the 
expected error, a comparison with the standard deviation of the factors under consideration is 
made. 
Table 22: Summary Statistics for CATPM factors 
Summary measures for selected variables 
Net-cost-
plus 
CATPM Inv 
Risk 
CATPM Rec 
Risk 
CATPM Liq 
Risk 
CATPM Fin 
Lev 
Count 197.000 197.000 197.000 197.000 197.000 
Mean 0.087 0.275 8.527 1.601 0.925 
Median 0.037 0.106 1.525 1.365 0.956 
Standard deviation 0.354 1.086 35.265 1.167 0.474 
First quartile 0.020 0.055 0.797 1.087 0.747 
Third quartile 0.076 0.175 3.557 1.775 1.017 
Interquartile range 0.055 0.121 2.760 0.689 0.270 
(Source: own compilation) 
In analysing the test for overall fit, the ANOVA table illustrated in Table 21 are considered. The 
R square value is acceptable (value of 0.8706); the standard error of estimate of 0.1298 is 
significantly smaller than the standard deviation of the NCP of 0.354. Furthermore, the F-ratio 
181.78 is high (if it is large, then the explained variation is large relative to the unexplained 
variation, thus it has explanatory value) and its significance F (P-value) test is very small 2.188"80. 
According to Albright et al (2003:632) if the P-value is less than 0.05 in combination with a large 
F-ratio, then the explanatory variables such as inventory, receivable, liquidity and financial 
leverage has some explanatory power of NCP. 
Another consideration about the regression output is t- values. The f-values for the regression 
coefficients indicates which of the potential explanatory variables (CATPM factors) are useful in 
explaining NCP, the response variable. A lvalue measures the ratio of estimated coefficient to its 
standard error, it is an indicator of how many standard errors the regression coefficient is from 0 
(Albright et al., 2003:632). A t- value can be used to determine if any particular explanatory 
176 
variable of the CATPM should be included in the CATPM regression equation. In the event that 
an explanatory variable's coefficient equals 0, it is pointless to include such a variable in the 
CATPM equation, the 0 coefficient will cancel its effect on the response variable, NCP. Table 21 
does not indicates a t- value of 0 for any of the explanatory variables, hence none of them are 
excluded from the CATPM equation (refer to section 4.4.2 for a 
,. ■ , a Inv „ Rec _ CA _ Sales a Debt _ EBT „ NP ,.,.,, discussion) a; = a+J3x -^—+^2 - r — + A 7^7+^4 -^r+fis n v +A -j^+Pi ~^^+e • C11) Sales Inv CL TA Capital EBIT EBT 
In analysing and interpreting, the results obtained from the CATPM, and in particular, the 
regression, the following emerges: 
• Inventory, receivables, liquidity and financial leverage is significant explanatory variables 
in estimating the response variable (NCP) 
• The estimation of the response variable the coefficient of determination, R2 explains 87% 
of variation in NCP 
• The ANOVA table illustrated in Table 21 indicates a high F-ratio of 181.78 (if it is large, 
then the explained variation is large relative to the unexplained variation, thus is has 
explanatory value) and its significance F (P-value) being very small 2.188"80. The 
explanatory variables with a P-value less than 0.05 in combination with a large F—ratio, 
then the explanatory variables such as inventory, receivable, liquidity and financial 
leverage has some explanatory power of NCP (Albright et al., 2003:632). 
• The regression analysis indicates that in using the coefficients determined with the 
CATPM that the arm's length consideration ax can be formulated as 
& =-0.197 + 0 . 1 3 8 5 8 - ^ + 0 .0076— + 0.194147— - 0 . 0 7 3 1 ^ - (12) 
Sales Inv CL EBIT 
The fitted pattern of the data, in particular the CATPM factors (MECE ratios), inventory and 
liquidity and the profit level indicator, Net-cost-plus (NCP) as well as the residual (the difference 
amongst the actual and fitted value of the response variable) and fitted values (a fitted value is the 
predicted value of a response variable) is illustrated in Figure 27. In Figure 27, Panel 4 where the 
residual and the fitted values are illustrated, it seems that a reasonably good fit is achieved with 
majority of the residuals being between 0.25 and -0.25 and fitted values between 0 and 0.75 with 
177 
some outliers being indicated by points outside the majority of the residuals and fitted values as 
discussed. 
Figure 27: Fitted values  
Panel 1: Net Cost Plus Panel2: Liquidity 
3.75 - ♦ 
3.00 
2.25 ■ 
-d 
S 1.50 -
s 
0.75 ■ 
♦ 
♦ 
k 
0.00 ■ Jr 
i i i i i ' ' 
-0.8 0.0 0.8 1.6 2.4 3.2 4.0 4.8 
Net Cost Plus 
3.75 -, ♦ 
3.00 -
2.25 ■ ♦ 
S 1.50 -\ 
0.75 ■ 
♦ 
► 
0.00 ■ *r 
0.0 2.5 5.0 7.5 10.0 12.5 
CATPM Liq Risk 
15.0 17.5 
Panel 3: Inventory Panel 4: Residual and fitted values 
3.75 i ♦ 
3.00 
2.25 ■ 
13 
♦ 
S 1.50 -
0.75 
< 
♦ 
0.00 | \ 
-0.75 - i i < i 1 ' ( ) 2 4 6 8 10 12 
CATPM Inv Risk 
0.75 
0.50 -
0.25 
| 0.00 
-0.25 
-0.50 
-0.75 
- * 
-0.75 0.00 0.75 1.50 2.25 3.00 3.75 
Bitted 
(Source: own compilation) 
4.5.2.2 Application of the CATPM regression output 
In order to determine the arm's length consideration a-t the multiple regression of the CATPM 
formulated the arm's length consideration as a,=a+B, +B7 + /J ,—+/L- +s or 
6 ' l Sales 2 Inv 3 CL HA EBIT 
a1 =-0.197 + 0.13858-^-+0.0076^-+0.194147— - 0 . 0 7 3 1 - ^ - with the the explanatory variables 
Sales Inv CL EBIT 
inventory, receivable, liquidity and financial leverage being the factors to estimate the arm's 
length consideration. In order to estimate the arm's length consideration, the following approach 
is followed: 
178 
• Determine the explanatory variables (CATPM factors or risk indicators) for the tested 
party. 
• Use the estimated significant weights or coefficients determined by the regression analysis 
(inventory, receivables, activity and financial leverage) to estimate the arm's length 
consideration. The arm's length consideration is in accordance with OECD Model Tax 
Convention "...conditions are made or imposed amongst... two [associated] enterprises in 
their commercial or financial relations ... which would have been made amongst 
independent enterprises (unconnectedparties) ..."(OECD 1995:1-3). 
• The basis of the estimation of the NCP arm's length consideration is the sum of the product 
of the estimated significant weights and the tested party's explanatory variables. The 
explanatory variables are only the ones indicated as significant (inventory, receivables, 
liquidity and financial leverage) by the multiple regression, including that of the intercept, 
as indicated in Table 23. 
Table 23: CATPM Result 
Regression N C P for the period 1998 to 2002 
Estimation of the Arm's length consideration 
(Indicate physical calculations as point of 
application) 
Tested Party Hypothetical Median Company 
Tested 
Party 
Ratio's 
(Median) 
Regression 
Output 
Coefficients 
or weights 
Weights 
x Tested 
Ratio's 
Median 
Ratio's 
Regression 
Output 
Coefficients 
or weights 
Weights 
X 
Median 
Ratio's 
Intercept 1.000 -0.1968 -0.1968 1.0000 -0.1968 -0.196K 
Inventory Risk 0.384 0.1386 0.0532 0.1062 0.1386 0.0147 
Receivable Risk 0.596 0.0008 0.0005 1.5253 0.0008 0.0012 
Liquidity Risk 1.115 0.1941 0.2165 1.3651 0.1941 0.2650 
Financial Leverage -0.114 -0.0731 0.0083 0.9560 -0.0731 -0.0699 
Sum 8.17% 1.43% 
Difference amongst Tested Party and 
Comparable Data 6.74% 
Tested Party Profit Level Indicator 
Variance Premium (Discount) 
2.40% 2.40% 
-5.77% 0.97% 
(Source: own compilation) 
The tested party's, ZA Case 01, financial information in terms of the CATPM equation is provided 
in the part of Table 23 marked Tested Party. The coefficients of the explanatory variables that 
provide an R square of 0.87 is provided (refer to Table 21 for the regression output). For instance, 
inventory risk for the tested party have a value of 0.384 and the coefficient as determined by the 
regression analysis is 0.1386, resulting in a CATPM factor of 0.0532. The sum of all these 
179 
CATPM factors is 8.17%. According to the proposition of the CATPM, it is estimated that ZA 
Case 01 arm's length consideration, as measured by NCP, amounts to 8.17% in the EU, based on 
its explanatory variables (inventory with a value of 0.384, receivable with a value of 0.596 etc). In 
contrast to the output of the CATPM, the tested party (ZA Case 01) realised a NCP of 2.4%, 
clearly not indicative of what the estimation of the arm's length consideration purport to be. 
Positioning analysis concerning the output from the CATPM is significant. The South African PN 
(South Africa, 1999:27) reiterates that in the event an adjustment is made (when the tested party 
falls outside the arm's length range), the midpoint is appropriate. This research, in the context of 
ZA Case 01 indicates that the arm's length NCP consideration is higher than the median or mid­
point. 
The median arm's length consideration, according to the CATPM is 1.43%, considerably lower 
(6.74%) than 8.17% (the estimated NCP). The position of ZA Case 01 within the arm's length 
range is closer to the third quartile of the arm's length range (refer to Appendix 4.5 where the third 
quartile is included in the analysis) and not the mid-point or median of the arm's length range. 
4.6 Conclusion 
The CATPM provides guidance insofar as explanatory variables in determination or estimation of 
the arm's length range. Positioning analysis in conjunction with the CATPM results, indicates the 
position of the tested party within the arm's length range. In the event that an adjustment is made, 
the point in the range to where the adjustment will be affected can be determined with objectivity, 
an improvement on adjustments to the mid-point of a range, without any substantive measures or 
evidence. 
In general, it could be concluded that the arm's length consideration for ZA Case 01, as expressed 
by the NCP as the Pli in applying the TNMM to be 8.17 per cent for the financial years 1998 
through to 2002. The conclusion on the arm's length nature of ZA Case 01 dealings is within the 
ambit of the following conclusive observations: 
• A considerable amount of financial data is required to calculate the hypothetical arm's 
length consideration. 
180 
• The CATPM imposes the tested party as if it is operating within the EU, based on ZA Case 
01 financial data and the explanatory variables of the regression. ZA Case 01 explanatory 
variables are based on the interaction of the South African market and the effect it has on 
ZA Case 01. Imposing ZA Case 01 explanatory variables in accordance with the CATPM 
equation ai=a+/3l +j32 +J3Z—+/34 +s, denved form the regression, an 
Sales Inv CL EBIT 
arm's length consideration is determined. 
• Market differences amongst the EU and South Africa exist and as such require adjustment 
(comparability requirements). In making use of the CATPM, the estimated arm's length 
consideration for ZA CASE 01, in the EU is 8.17%, which includes market forces in South 
Africa. The explanatory variables in ZA Case 01 is supply driven (liquidity and financial 
leverage) and demand driven (inventory and receivables) as well. 
The CATPM provides insight into what could be deemed to be the arm's length consideration in 
the EU as well as the relative position of ZA Case 01 within the inter-quartile range. Testing the 
CATPM provided some insight into the factors that influences profitability and consequently the 
determination of the arm's length consideration. The proposed CATPM should be considered in 
accordance with current transfer pricing practices; hence, a similar approach is followed in 
analysing ZA Case 01 in the next Chapter. 
181 
Chapter 5 The arm's length consideration: An empirical 
application in the SA automotive industry 
5.1 Introduction 
This empirical part of the research is based on an actual transfer pricing investigation and the 
information pertaining to the case is presented in a form to protect the identity of the specific 
company (see 1.4.2.2). Complete financial statement information is not disclosed to ensure 
anonymity of the specific MNE, referred to as ZA Case 01. However, information to illustrate the 
application of transfer pricing is included. 
Presentation of the findings is in accordance with accepted international practice as it pertains to 
the Guidelines of the OECD (1995:1-9) and South Africa's PN 7 (South Africa, 1999:28,37). The 
chapter follows the approach as promulgated by PN 7 whereby the transfer pricing evaluation 
focuses on the following (South Africa, 1999:12): 
• An overview of the organisation inclusive of the overall structure and nature of the 
business activities (functions) undertaken by the MNE. 
• General commercial and industry conditions affecting the MNE as well as an evaluation 
and explanation of the current business environment in which the MNE operates. 
• Direct consideration of the transaction under review, the nature and terms of the 
transaction, economic conditions and property involved in the transaction, how the product 
or service that is the subject of the controlled transaction in question flows between the 
connected parties 
• Contractual terms of the transaction(s) of the MNE. The actual contractual terms provide 
evidence about the form in which the responsibilities, risks and benefits have been assigned 
among those members of the MNE participating in the transaction. 
• The functions performed by the MNE. The relative contributions of various functions 
recognising that the number of functions performed by a particular member of an MNE is 
not decisive in determining whether that member should derive the greater share of the 
182 
profit. The importance of each function that is relevant in the determination of reward or 
profit. 
• An appraisal of risk associated with the functions performed by the MNE. In the open 
market, the assumption of increased risk is rewarded by an increase in the expected return 
(South Africa 1999:18). 
The business overview and analysis of ZA Case 01 is followed by the determination of the arm's 
length consideration. The process of determining the arm's length consideration involves a 
comparability analysis and a country risk adjustment. The analysis is further complimented by 
making use of the CATPM to determine the arm's length consideration. The results from both 
these approaches are considered. 
5.2 Industry overview: Company ZA Case 01 
In order to obtain a reasonable understanding of the operations of the companies used in this 
research in terms of applying the provisions of section 31 of the Act, the investigation relied on 
information gathered by means of the following: 
• Interviews with various personnel within the group of companies 
• Industry information as published by National Association of Automobile Manufacturers 
of South Africa (NAAMSA) 
• Statistics as published by Statistics South Africa (Stats SA) and media reports. 
• The focus of the business overview is on the South African industry and the particular 
company's position within the industry. 
5.2.1 General market overview 
South African vehicle manufacturers do not report production data, only retail and export sales. 
NAAMSA uses sales of domestically produced vehicles and export sales as a proxy for South 
African vehicle production (NAAMSA, 2001:4). Table 24 summarises domestic production, 
exports and imports for the period 1995 - 2001. 
183 
Table 24: Domestic production, exports and imports ofSA motor vehicles (Units) 
1995 1996 1997 1998 1999 2000 2001 
Sales of domestically 
produced vehicles 373 712 374 758 342 535 286 159 266 349 289 333 299 035 
Exports 15 764 11553 19 569 25 896 59 716 68 031 108 001 
Total domestic 
production 389 476 386311 362 104 312 055 326 065 357 364 407 036 
Exports as percentage of 
domestic production 4,0% 3,0% 5,4% 8,3% 18,3% 19,0% 26,5% 
Imports 22 081 46 318 56 740 65 351 59 426 66 749 85 064 
Total local market 
(including imports) 395 793 421 076 399 275 351510 325 775 356 082 384 099 
Imports as percentage of 
local market 5,5% 11,0% 14,2% 18,6% 18,2% 18,7% 22,1% 
(Source: NAAMSA, 2001: 6. Note: Domestically produced vehicles include cars, light, medium and heavy commercials) 
During 2001, exports of vehicles significantly exceeded built-up imports and total industry 
production increased commensurately. Global automotive production declined by 3.5% in 2001 to 
a level of 56.3 million units. Conversely, the South African total automotive production in 2001 
expanded by 13.9% enabling the South Africa vehicle manufacturing industry to achieve to being 
ranked 18th in the world albeit that the share in global production is minuscule, it comprises less 
than 1%. 
Over the period under consideration, imports as a per cent of the total South African market 
increased from 5.5% in 1995 to 22.1% in 2001. The significance fact is that exports as a per cent 
of domestic production increased considerably, albeit from a low base. These statistics provides 
further evidence of globalisation and South Africa becoming increasingly part thereof and the 
accompanying transfer pricing implications as discussed in the previous sections of this research. 
5.2.2 Commercial vehicle sales 
Demand-pull of the domestic market on commercial vehicles (the specific focus of this research) is 
driven by the general economic climate, estimated age of the current vehicle fleet and the road 
infrastructure. Furthermore, seen in light of this empirical investigation for transfer pricing 
purposes, commercial vehicle sales within the South African market is important. 
5.2.2.1 Some factors influencing commercial vehicle demand 
Vehicle sales are not independent of demand factors. The factors that could potentially have an 
impact on commercial vehicle sales, such as road infrastructure and vehicle age distribution are 
further investigated with specific reference to: 
184 
• Road infrastructure influences ZA Case 01 insofar as availability of service and 
maintenance as well as vehicle replacement due to the extensive distances the vehicles 
travel in a relatively short period. 
• Vehicle age is indicative of the potential demand for new vehicles if ZA Case 01 customers 
experiences favourable economic conditions. Although specific data on ZA Case 01 
customers is not available, ZA Case 01 general sales trend provides an indication. 
• Third parties do not undertake research on road infrastructure and vehicle age. Verification 
is difficult and the information from the Department of Transport is often delayed. Hence, 
reliance is placed on the information as published by NAAMSA (2001:32). 
5.2.2.1.1 Road infrastructure 
South Africa is a country with an extensive road infrastructure with approximately 80% of the 
infrastructure being unpaved roads as illustrated in Table 25. 
Table 25: Road infrastructure in the South African Economy  
Year Freeways 
(km million) 
Paved 
(km million) 
Unpaved 
(km million) 
National Roads Agency 
(including toll roads) 
(km million) 
Total 
(km million) 
1980 1,280 45,372 136,990 1,762 185,404 
1985 1,666 49,046 133,106 2,558 186,376 
1990 1,893 53,490 130,368 6,593 192,344 
1995 1,927 59,753 298,843 6,815 367,338 
1999 (latest) 2,032 61,121 300,978 7,722 371,853 
(Source: NAAMSA, 2001: 31) 
From Table 25 road infrastructure expanded considerably since 1980 with the National Roads 
Agency roads increasing nearly seven fold and unpaved roads nearly threefold. This rapid 
expansion of infrastructure is indicative of the economic expansion South Africa experienced since 
1980. The condition of the road infrastructure has a bearing on the demand for spares and 
maintenance services as well as having an effect on the economically viable life span of the 
country's automotive fleet. 
These statistics is important insofar as it is indicative of the infrastructure network and the status 
thereof. These statistics is important for ZA Case 01. ZA Case 01 is predominantly active in the 
commercial vehicle segment with a substantial intercity transport application. Due to the vast 
distances being travelled, support and maintenance of the vehicles ZA Case 01 supplies is of 
strategic importance and support their sales strategy (business strategy) . 
185 
5.2.2.2 Motor vehicle age distribution 
Estimates by NAAMSA of South Africa's motor vehicle age distribution for 2000 are as follows 
(NAAMSA, 2001: 29): 
Table 26: Median age ofSA motor vehicles 
Age in years : Less than 
1 2 3 4 s 6 7 8 9 10 More 
than 
10 
Motor vehicles* 227 430 647 891 1,134 1,353 1,520 1,685 1,837 1,997 1,920 
Per Cent* 5.8% 11.0% 16.5% 22.7% 28.9% 34.5% 38.8% 43.0% 46.9% 51.0% 49.0% 
Commercial 
vehicles* 
112 212,5 316 430 555 675 767 850 929 1,015 1,392 
Per Cent* 4.5% 8.8% 13.1% 17.8% 23.1% 28.1% 31.9% 35.3% 38.6% 42.2% 57.8% 
Note : * Represent thousand of vehicles ('000) * Expressed as a per cent of 2000 estimated vehicle population 
Source: NAAMSA (2001: 29) 
From the table it is clear that the median age for South African motor vehicles is amongst 9 and 10 
years, whereas for commercial vehicles, our focus, it is more than 10 years. However, in the 
absence of the same statistics for previous years, the only conclusion that can be drawn is that the 
median motor vehicle and commercial fleet age is relatively old and that recapitalisation sales 
could be expected in the future. 
The sales trends will largely be driven by other factors such as GDP growth rates, new entrants in 
the market, interest rates, exchange rates, tenders and general business conditions. ZA Case 01 
expects vehicle demand to increase in a favourable economic climate with potential replacement 
strategies of their major customers fuelling further demand growth. 
5.2.2.3 Commercial vehicle sales 
This transfer pricing investigation is aimed at the medium and heavy commercial vehicle segment 
of the automotive industry and the sales volumes being investigated reflects it. The sales 
information in this section is based on NAAMSA (2001:11) information distributed to its 
members. 
186 
Table 27 Different categories of vehicle sales 
Medium and Heavy 
Commercial Vehicles 
(HCV) 1995 1996 1997 1998 1999 2000 2001 2002 2003 
NAAMSA Members 
Sales Exports 11432 13685 121111 11748 10788 11679 12456 13582 14600 
Imports (Non-
NAAMSA) 950 1050 1000 1300 1500 550 630 630 630 
Total Medium 
Commercial Vehicle 
("MCV") /HCV Market 12753 14617 13759 12811 11736 12275 13323 14335 14630 
Market per cent change 14.62% -5.87% -6.89% -8.39% 4.59% 8.54% 7.60% 2.06% 
(Source: NAAMSA, 2001: 11) 
The medium and heavy commercial vehicle market experienced considerable contraction from 
1997 to 1999, as illustrated in Table 27 and it collaborates with the contraction trend evident in the 
industry employment statistics (see Table 28 and Table 29). Considerable expansion since 2000 
were experienced with total commercial vehicle market estimate for 2003 at 14 630 units, the 
highest since 1996 (NAAMSA, 2001:11). 
5.2.3 Industry Employment 
The Automotive Industry's employment statistics are not indicative of a growing economy, which 
can be characterised by sustainable labour absorption, although South Africa experience jobless 
growth due to technology driven growth, the latest globalisation wave, as illustrated in Table 28. 
Table 28: Past decade's employment in vehicle manufacturing 
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 
January 38 234 37 539 36 905 37 546 39 121 37 836 35 251 31656 32 339 33 164 
February 38 141 37 076 36 846 37 532 39 227 37 782 34 738 31705 31 105 33 156 
March 39 345 36 935 36 862 37 635 39 300 37 580 34 647 32 064 31 121 33 015 
April 39 198 37 723 37 294 38 314 38 774 37 524 33 989 31 998 31 137 32 704 
May 39 406 37 120 37 154 38 766 38 681 37 389 33 885 31 868 32 233 32 849 
June 39 785 37 117 37 378 38 637 38 791 37 091 33 619 31 958 32 239 32 698 
July 39 104 36 886 37 347 38 997 38 795 37 412 33 333 32 047 32 789 32 474 
August 38 635 36 852 37 583 39 063 38 759 37 142 33 269 32 101 32 826 32 449 
September 38 470 36 863 37 914 39 059 38 549 36 939 33 247 32 177 33 162 32 488 
October 38 396 37 179 38 024 39 307 38 009 36 457 32 909 32 132 32 809 32 485 
November 38 232 37 328 38 333 39 332 37 717 35 976 32 886 32 061 32 848 32 436 
December 37 830 37 308 38 222 39 152 37 566 35 855 32 129 32 111 32 751 32 389 
Monthly Average 
per Annum 38 731 37 160 37 489 38 612 38 607 37 082 33 658 31990 32 280 32 692 
(Source: NAAMSA 2001:11) 
Employment statistics in Table 28 indicates gradual employment losses with employment in 1992 
being 38 731 shrinking to 32 692 in 2001. Over the period 1996 to 2001, the period the research 
187 
investigated transfer pricing, employment declined from 38 607 in 1996 to 32 692 in 2001, a loss 
of 15 per cent. 
The Automotive Industry underwent considerable structural changes since South Africa's re-
emergence in the international market in 1994, employment remained stable with employment 
ranging between 37 000 and 38 000 between 1994 and 1997. Since 1997 approximately 5 000 
jobs were lost in the automotive assembly industry (see Table 28). The component industry 
experienced suffered severe job losses, losing 30 500 jobs from 1996 to 2001, shrinkage of 34.3 
per cent as illustrated in Table 29: 
Table 29: Annual Employment in the Automotive Industries 
1995 1996 1997 1998 1999 2000 2001 
Assembly Industry 38 600 38 600 37 100 33 700 32 000 32 300 32 700 
Component Industry 81 000 89 000 78 000 70 000 60 000 59 500 58 500 
Tyre Industry 11 000 10 000 9 500 9 100 9 000 8 600 8 500 
Motor Trade 178 000 180 000 180 000 170 000 175 000 175 000 180 000 
Total 308 600 317 600 304 600 282 800 276 000 275 400 279 700 
(Source: NAAMSA, 2001:7) 
The industry's employment statistics is based on monthly average employment statistics annually 
and the average annual employment according to the major sectors are illustrated in Table 29. The 
motor trade is the only sub-sector in the automotive industry that reported stable employment. 
The automotive industry's net employment decreased by 28 900 since 1995. However, since 1999 
the industry created 3 700 employment opportunities. For the year 2001 as a whole, the new 
vehicle manufacturing industry reflected net employment creation, usually attributed to strong 
demand growth. The average monthly employment level for the vehicle manufacturing industry 
for 2001 was 32 700 compared to 32 300 jobs in 2000. 
5.3 A brief company overview 
ZA Case 01 started operating in South Africa in the early seventies when the now holding 
company, ZA HOLDCO01 took over local distributors, establishing ZA Case 01, a wholly owned 
subsidiary, with an investment in a manufacturing facility situated in South Africa as illustrated in 
Figure 28. This dedicated plant assembles ZA Case 01 products to specifications set by ZA 
HOLDCO01 as illustrated in Figure 28 and Figure 31. 
188 
Figure 28: ZA Case 01 Ownership Structure 
Note: All shareholdings are 100% ULT OWNER 
Incorporated off-shore 
i ' 
ZA HOLDCO01 
Incorporated off-shore 
^ r 
ZACASE01 
Incorporated in South Africa 
Subsidiary#l 
Incorporated in South Africa 
Subsidiary#3 
Incorporated in South Africa 
i r 
Subsidiary#2 
Incorporated in South Africa 
Subsidiary#4 
Incorporated in South Africa 
(Source: own compilation) 
ZA Case 01 is incorporated in South Africa with a holding company incorporated offshore. ZA 
Case 01 's relationship with ZA Hold Co 01 and Ult Owner is that of a connected person (see 
1.6.8) and falls within the scope of section 31 of the Act (see 1.6.29) with controlled transactions 
as defined (see 1.6.9) and illustrated in more detail in Figure 31. ZA CASE 01 supply vehicles to 
the government, quasi-government organisations and the retail market and since 1997 following a 
re-organisation, concentrates on the retail market. 
5.3.1 Product expansion 
In 1996, ZA Case 01 launched new products into a South African competitive niche market. This 
was followed in 1998 and 2000 with the launch of a range of new products. ZA Case 01 acquired 
a domestic competitor in 1999 and renamed it to Subsidiary#4 (see Figure 28). Retail outlets were 
established in major centres during 2001 and record sales results were achieved in July 2002 when 
ZA Case 01 achieved a market share in excess of 30 per cent in the niche market in which they 
operate. 
5.3.2 ZA CASE 01 ' s market performance 
ZA Case 01 is one of the major players in the South African Customs Union (SACU) as illustrated 
in Figure 29. 
189 
Figure 29: ZA Case 01 SACU Market Share 
SACU Market Share 
Namibia 15-20% 
Gauteng 10-15% 
NorthWest 15-20% — 
Northern Cape 25-30% -
Western Cape 25-30% 
Botswana 15-20% 
Limpopo 30-35% 
Mpumalanga 25-30% 
Swaziland 30-35% 
waZulu Natal 30-35% 
Lesotho 45-50% 
Free State 20-25% 
Eastern Cape 25-30% 
(Source: own compilation) 
ZA Case 01 is representative in all the regions within SACU, having a substantial market share in 
each regional market. Lesotho and Swaziland is the biggest markets for ZA Case 01 outside South 
Africa. Namibia and Botswana is increasing in importance with a market share ranging from 15 
per cent to 20 per cent. In South Africa, ZA Case 01 has a market dominant position (market 
share in excess of 30 per cent) in Limpopo and KwaZulu Natal. 
Analysing ZA Case 01 's performance over the period under investigation, a picture of strong 
market share growth emerges in a market that showed signs of decline and recovery as evidenced 
in Figure 30. ZA Case 01 realised market growth in excess of 25 per cent with production unit 
volumes increasing by approximately 63 per cent from 1999 to 2001. ZA Case 01 increased their 
market share from around 18 per cent in 2001 to close to 20 per cent in 2002. In effect, ZA Case 
01's market share increased from 7.0% in 1995 to 19.7% in 2002 for all products sold in the South 
African market segment. 
190 
Figure 30: ZA Case 01 's relative market share compared to five competitors 
40.0% 
35.0% 
30.0% 
25.0% 
20.0% 
15.0% 
10.0% 
5.0% 1 
0.0% 
IZACaseOl 
-#1 
- # 2 
- * ^ # 3 
-#4 
-#5 
8.2% 
10.8% 
6.9% 
(Source: own compilation) 
Since reorganisation in 1997, ZA Case 01 's focus shifted from general freight capital equipment to 
the supply of customised products to an extended client portfolio not limited to the agriculture, 
construction, forestry, mining, food and beverage industries and Subsidiary#4 (see Figure 28) 
supplying products to the public sector. ZA Case 01 is actively involved in developing their 
export market with initial focus over the immediate short term on the geographic areas to the north 
of the SACU area and extending it to Central Africa and Mauritius with expansion further north 
being on the planning horizon (see Figure 29). 
5.3.3 Analysis of functions, risks and markets of ZA Case 01 
ZA Case 01 manufactures products sell the products into the South African and Southern African 
Customs Union (SACU) markets. In undertaking various interviews (refer to section Appendix 
5.2 for the interview schedule) with personnel of ZA Case 01 in accordance with the guidelines as 
provided in PN 7, the following broadly defined functions of ZA Case 01 were identified (South 
Africa, 1999:28): 
• Manufacturing of products 
• Distribution of products 
• Marketing and advertising 
191 
• Management of South African operations 
The affected transactions amongst ZA Case 01 and its connected parties off-shore in performing 
the abovementioned functions in terms of section 31 of the Act (see 1.6.29) is illustrated in the 
section 5.3.4. 
5.3.4 Affected transactions of ZA Case 01 
Figure 31: ZA Case 01 's connected party dealings 
(Source: own compilation) 
ZA Case 01 is incorporated in South Africa. ZA Holdco supplies ZA Case 01 of most of the 
components and parts required in the assembling (manufacturing) function ZA Case 01 performs 
in South Africa. ZA Holdco provides interest bearing and non-interest bearing financial assistance 
to ZA Case 01. ZA Holdco assumes warranty risk and pays all warranty related claims of ZA 
Case 01. The affected transactions (see 1.6.9) of ZA Case 01 are as follows: 
• Management - ZA Case 01 's head office is situated in a major city in South Africa with a 
staff compliment of more than 100. This facility houses the sales, marketing, finance and 
administration functions. The management function of the company is undertaken from its 
head office. Basic accounting functions are decentralised with a treasury function being 
centralised at the head office of ZA Case 01. Legal, auditing and taxation services are 
192 
outsourced as and when required by ZA Case 01. Inventory, sales, vehicle release to 
dealers, maintenance contracts that include monthly billing are controlled centrally. ZA 
Holdco, situated offshore, verifies substantial sales deals in excess of specific determined R 
value million. Pricing policy of ZA Case 01 's products is determined locally. ZA 
HOLDCO, situated offshore, determines the prices of the kits. The costing of 
manufacturing in South Africa as well as the effect of the exchange rate is factored in to 
obtain production cost. Competitor pricing is undertaken to determine a low-high price 
comparison. 
• Manufacturing - ZA Case 01 manufactures products at its manufacturing facilities in 
South Africa. The assembly plant is situated on approximately 33 000 m2, employing 
close to 300 employees. This facility is responsible for engineering, production and 
technical service as well as enabling ZA Case 01 to customise products to local conditions 
for the benefit of the customer. Customised build is about 60% to 65% of total build and is 
primarily based on product application. 
o Production scheduling - The process of ordering and production planning at the 
manufacturing plant can be summarized as illustrated in Figure 32 Production 
scheduling at the manufacturing plant is done on the 6th working day of each month 
as illustrated with the production planning and the sales and marketing departments 
forecasting demand for the different products per model type as well as production 
mix and customisation. 
Figure 32: Production scheduling  
Input 
6* Day of month, sales and 
marketing 
Engineering 
Document options and 
local content 
Order per PP 
Kit ex Foreign Market 
120 to 160 p month 
Order to ZA HOLDCO 
- 'Production 3* Month 
Ships to SA 4th Month 
Delivery in SA 5th Month 
Order by product 
Each product ordered 
by sales group and 
plastic bags 
Assembly / Production 
Plastic Bag 
Options for customisation add 
or take out of kit to 
specifications 
(Source: own compilation) 
o Inventory at the production facility relates to inventory needed for manufacturing in 
the form of imported kits and the "plastic bags" (refer to Figure 32). This is a 
193 
concept that allows for the manufacturing of customised vehicles in accordance 
with the customer's requirements based on product application. Finished products 
make up part of the inventory of ZA Case 01 under the auspices of the Marketing 
and Sales (MS) division of ZA Case 01. The spares and stores used in the after 
sales service of products are housed at the central part depot and are included in the 
inventory of ZA Case 01. 
• Distribution - Distribution of the finished products is undertaken by the marketing and 
sales (MS) division of ZA Case 01. ZA Case 01's dealer network comprises of 15 full 
dealerships and 20 service and parts dealerships, which are strategically situated 
throughout Southern Africa in order to provide complete support to ZA Case 01's 
customers. ZA Case 01's Customer Satisfaction Monitor (CSM) measures each 
dealership's individual performance as well as each product's performance with regard to 
sales, service and parts. A Dealer Standards Programme defines objectives and measures 
scores throughout the year culminating in a "Dealer of the Year" trophy being awarded to 
the winning dealership. 
• Marketing and advertising - Marketing and advertising (MA) is undertaken by a dedicated 
division of ZA Case 01. Media advertising is done by the MA division and is responsible 
for the launches of models, taking key clients to trade shows and it have its own budget 
allocation. Decisions are taken locally with approval of the local board. 
5.3.5 Market 
The market in which ZA Case 01 operates as well as their relative performance is discussed in 
section 5.3.2. However, ZA Case 01's performance over the period under investigation is 
noteworthy (based on interviews with ZA Case 01 and ZA Case 01 data and could be made 
accessible for moderators if they want to test authenticity of facts) and could be summarised as 
follows: 
• Market share increased from 7.7% in 1997 to 19.7% in 2002 for specific products sold in 
the Customs Union of Southern Africa. 
• The South African market has shown very little growth since 1996 but ZA Case 01 more 
than doubled its unit sales volumes, realising sales growth of 52.9% from 1996 to 2002. 
194 
• The introduction of new products in 1996 contributed nearly 400 unit sales in 2002 
allowing ZA Case 01 to obtain a 13% share of this specific market segment. 
• Another product at the high end of the market showed continual growth with annual sales 
increasing from approximately 600 units in 2000 to nearly 800 units in 2002 resulting in a 
19.1% market share in the specific market segment. 
• A local beneficiated product realised the sale of almost 450 units in an industry market of 
more than 1 000 units, nearly 40% of the total market. 
The market performance of ZA Case 01 is significant for transfer pricing purposes. In the years 
under consideration, ZA Case 01 was profitable in 1996 and 1999. ZA Case 01 incurred losses for 
tax purposes over the period 1996 to 2001 which are in contrast with ZA Case 01 market 
performance. 
5.3.6 Risk 
From a transfer pricing perspective, risk (with reference to functions performed, assets used and 
risk assumed) can be categorised as being demand related risk, supply related risk and 
transactional risk. Risk ZA Case 01 is exposed to is determined through interviews (see Appendix 
5.2) as well as an evaluation of the trial balance investigating expense items that reflects 
realisation of risk. For example, inventory risk is identified by provisions for inventory, 
obsolescence write-off and inventory losses recorded in the financial accounts. 
5.3.6.1 Demand related risk 
Demand related risks are the risks associated with market risk, inventory risk and price volatility 
of competing products or services (Brigham et ai, 1999: 187). ZA Case 01 is exposed to the 
following demand related risk: 
• Inventory - ZA Case 01 is exposed to inventory risk and the assessment is based on the 
following discernable inventory items. 
o Kit inventory items - the risk that inventory items could become obsolete is small if 
ordering of the kits is in accordance to estimated demand. In the event that product 
and model change is enacted, some items could become obsolete, especially with 
the plastic bag system that is in place. This might not be substantial because a 
195 
number of the obsolete items from an assembly point could be incorporated into 
spares and stores for after sales. This cannot be done without the accompanying 
paperwork in terms of customs regulations. 
o Finished product - these units are produced based on demand forecasts and it 
would overall not have a major risk attached to it. 
o Spares and stores - the risk associated will be primarily that of pilferage and to a 
lesser extent obsolescence and as such cannot be classified as medium or high-risk 
activities. 
o Price volatility - ZA Case 01 is exposed to the same price volatility as any of its 
competitors. All the domestic players in the industry is exposed to primarily 
foreign exchange volatility and its' impact on price volatility. Based on the facts 
the risk that ZA Case 01 is exposed to could not be classified as being high in 
comparison to the other players in the industry. 
5.3.6.2 Supply related risk 
Supply related risks are the risk associated with the presence of technological change, cost 
volatility and the potential of market entry and exit. Risk of loss associated with investment in and 
use of property, plant and equipment should be considered. The risks inherent in research and 
development to the extent that it influences the success and failure of the research and 
development projects are recorded as such. In undertaking the functional analysis of ZA Case 01 
the supply related risks that could affect ZA Case 01's operations is as follows: 
• Industry role players - It is noted that the industry has a number of players with a few 
major competitors and a number of smaller players. In an industry with 11 participants, the 
top five participants command in excess of 90% of the total market. There is some ground 
for perceived volatility in the market insofar as new entrants, however, ZA Case 01 is one 
of the major players and it should be able to withstand the threat of potential small new 
entrants hence the supply risk based on market entry is minimal. 
• Research and development - Research and development is not undertaken in South Africa 
beyond ongoing quality improvement insofar as customisation of vehicles for specific 
applications. There is the risk of breakage, downtime and performance and as such will be 
196 
assumed by ZA Case 01. However, warranties exists and in some instances defect parts 
and equipment imported from ZA Holdco will be settled by them, hence the conclusion 
reached is that the risk is not substantial from ZA Case 01 's perspective. 
• New products - The launch of the new generation product planned for 2004 poses a 
potential risk to ZA Case 01's operations. With a new product launch and the withdrawal 
of the current, well-known product, market perception and resistance could be a barrier to 
unit sales volumes over the short term. If ZA Case 01 overcomes the normal market 
apprehension and could prove the new generation product to be their product of the future 
with huge benefits to their customers, it could bolster their sales over the medium to long 
term. 
5.3.6.3 Transactional risk 
Transactional risk within the South African paradigm will be primarily the risk associated with 
foreign exchange volatility and interest rate fluctuation. Credit risk might be a further 
consideration. Culminating from the investigation, the following risk areas were evaluated and the 
following are an indication of ZA Case 01's risk exposure. 
• Foreign exchange - ZA Case 01 was exposed to foreign exchange currency risk until 
October 2002 when the billing arrangement changed to R based invoicing from ZA 
HOLDCO. Their future exposure will be associated with the relative depreciation of the R 
versus the Euro, which will affect their kit prices, a form of purchase parity price 
adjustment. In light of the South African market dynamics, ZA Case 01 will not be in an 
adverse position in comparison to their competitors because they are also exposed to 
foreign currency volatility with the importation of the final products. 
5.4 Requirements of the arm's length principle 
5.4.1 Comparability in practice 
Comparability is fundamental (see 3.2.2) to the application of the arm's length principle (South 
Africa, 1999:8). The preferred arm's length methods are based on the concept of comparing the 
prices or margins achieved by connected parties in their dealings to those achieved by independent 
entities for the same or similar dealings. In order for such comparisons to be useful, the 
197 
economically relevant characteristics of the situations being compared must be highly comparable 
(OECD, 1995:1-3 and South Africa, 1999:9). 
To be comparable means that none of the differences (if any) amongst the situations being 
compared could materially affect the condition being examined in the method (e.g. price or 
margin), or that reasonably accurate adjustments can be made to eliminate the effect of any such 
differences (OECD, 1995:1-7). If suitable adjustments cannot be made, then the dealings cannot 
be considered comparable. Since precise calculations cannot be made and the application of any 
method involves elements of judgment, there is, depending on the circumstances of the particular 
case, a need to avoid making adjustments to account for minor or marginal differences in 
comparability. 
5.4.1.1 Objective of comparability 
The objective of comparability is to always seek the highest practical degree of comparability (see 
3.2.2.3). Recognising that there will be unique situations and cases involving unique intangibles 
where it is not practicable to apply methods based on a high degree of direct comparability (South 
Africa 1999:10). The practicable standard of comparability will be determined by the amount of 
data on which comparisons with uncontrolled situations and dealings in a particular case can be 
based. Comparisons with controlled dealings by other MNE's cannot be regarded as arm's length 
comparisons. 
5.4.1.2 Assessment of comparability 
The assessment of comparability can be affected, inter alia, by (OECD, 1995:1-9): 
• The characteristics of goods and services; 
• The relative importance of functions performed; 
• The terms and conditions of relevant agreements; 
• The relative risk assumed by the MNE, connected enterprises and any independent party 
where such party is considered as a possible comparable; 
• Economic and market conditions; and 
• Business strategies. 
198 
5.4.1.3 Comparability and functions performed 
The compensation for the transfer of goods or services amongst two unconnected parties will 
usually reflect the functions that each enterprise performs, taking into account the risks assumed 
and the assets used (South Africa, 1999: 11). In determining whether two transactions are 
comparable, the functions and risks undertaken by the independent parties should be compared to 
those undertaken by the connected parties (see 3.2.2.3.2). 
5.4.2 Comparable search 
The TNMM was selected as the most appropriate method (refer to section 3.3.2.1 for the 
discussion on the method) under the circumstances based on the available information and the 
functions performed by the companies investigated, assets used and risk assumed. The entities 
being regarded as comparable to the different companies were tested on functional comparability, 
assets used and the risk assumed. 
5.4.2.1 Industrial Classification 
Standard Industrial Classification (SIC) codes classify business enterprises by their type of 
economic activity (see Appendix 2 for details). Any industrial classification system uses a 
hierarchical system, dividing economies in sectors and sub-sectors. The system used in Amadeus 
is comparable to the SIC standard and is referred to as "NACE" classification. 
The classification codes in Amadeus support searches based on the two-digit primary industry 
code as well as supporting four-digit classification. Bureau van Dijk's Amadeus Database 
contains financial and business information of approximately 1.2 million companies (refer to 
section 4.5.1.2.2 for inclusion criteria). 
5.4.3 Screening Criteria 
There are two screening criteria applied (as indicated in the previous Chapter) in undertaking a 
comparable search, the first being quantitative screening and the second being qualitative 
screening. Quantitative screening use ratios or thresholds to find companies that are similar to the 
tested party, ZA Case 01. Qualitative screening focuses on screening criteria that cannot be 
quantified. 
199 
The June 2003 version, update number 105 of the database was used for the comparable search. 
Nine screening steps, each with its own criteria are used to determine the comparable set for ZA 
Case 01. 
5.4.3.1 Quantitative screening 
5.4.3.1.1 Geographic Region 
Market conditions vary greatly amongst countries and country specific factors can influence 
profitability. Therefore, the search concentrated on a common geographic area such as the 
European Union (EU). There were 1.209 million companies identified that operates in the EU and 
the results from this step can be summarised as follow: 
Table 30: Screening Results — Geographic Region 
STEP Search Criteria Value of criteria Step Result Search Result 
1 Countries European Union 1 209 234 1 209 234 
(Source: own compilation) 
5.4.3.1.2 Independence 
Connected companies cannot be used in a comparable set due tot the fact that they might have 
transfer pricing issues of their own. The Amadeus database consists of 1.255 million companies 
that do not have subsidiaries with 544 084 of the companies in the European Union. Independent 
or dependent companies according to the search criteria of companies with no shareholders 
recorded with more than 24,9% direct or total ownership (referred to as A+, A, A-) as well as 
unknown ownership (U) resulted in 767 766 possible companies with only 624 544 companies 
being in the EU and not having any subsidiaries with the result from these steps as follow: 
Table 31: Screening Results — Independence 
STEP Search Criteria Value of criteria Step Result Search Result 
2 Independent/Dependent Co.'s. A+, A, A-.U 767 776 624 544 
3 No of subsidiaries None 1 254 960 544 084 
(Source: own compilation) 
5.4.3.1.3 Intangible assets 
Access to intangible assets such as trademarks, technological know-how, patents etc., may provide 
the owner of such intangibles the potential to earn profits in excess to that of a similar company, 
operating in the same industry without the intangibles. This poses a problem and inflates the 
results if screening is not done to exclude companies with intangible assets. In applying this 
screen, 178 985 companies on the database do not have intangible fixed assets with 70 166 of the 
200 
companies being in the EU that does not have subsidiaries and conforms to the 
independence/dependence screen. The result from this step is as follow: 
Table 32: Screening Results — Intangible Assets 
STEP Search Criteria Value of criteria Step Result Search Result 
4 Intangible Fixed Assets 2001, 2000,1999, 1998 
Max = 0 for all years 
178 985 70 166 
(Source: own compilation) 
5.4.3.1.4 Industrial classification 
By using industrial classification as search criteria, companies are selected on the grounds of their 
respective industry classification, an indication of relative comparability. The industry 
classification code being used is the NACE 1, code 34, manufacture of motor vehicles, trailers and 
semi-trailers. In making use of sub-sectors within this industry segment (see also Appendix 2), the 
following potentially comparable sub sectors were identified: 
Table 33: Industry sub-sector code description 
NACE Code Description 
3410 Manufacture of motor vehicles 
3420 Manufacture of bodies (coachwork) for motor vehicles, manufacture of trailers and semi­
trailers 
(Source: own compilation) 
The results from incorporating the abovementioned industry sub-sector code description are as 
follow: 
Table 34: Screening Results — Industrial classification 
STEP Search Criteria Value of criteria Step Result Search Result 
5 NACE1 Primary codes: 3410 and 3420 2 905 112 
(Source: own compilation) 
In applying this screen, 2 905 companies are classified under technical testing and analysis with 
112 companies being in the EU, do not have subsidiaries, conforms to the 
independence/dependence screen and do not have intangible fixed assets. 
5.4.3.2 Qualitative screening 
5.4.3.2.1 Financial item 
In order to find companies that are similar in size, based on turnover, a qualitative screen was 
applied. Companies with a turnover more than € 140 million were rejected. The results from this 
step can be summarised as follow: 
201 
Table 35: Screening Results — Financial Item 
STEP Search Criteria Value of criteria Step Result Search Result 
6 Operating revenue / turnover 
(Thousand Euro € c000) 
Last available year, Max =140 
000 for at least one year 
1 167 235 50 
(Source: own compilation) 
In applying this screen, 1 167 235 companies in the Amadeus database satisfy the financial item 
criteria with 50 companies being in the EU that do not have subsidiaries, conforms to the 
independence/dependence screen, do not have intangible fixed assets and has an operating revenue 
of more than € 140 million. 
5.4.3.2.2 Individual screening 
In applying individual screening, each company of the remaining 50 companies are screened to 
ascertain whether it operates in a comparable industry segment, is functionally broadly similar to 
the tested party and is not in a start-up phase nor closed down. Within this screen, market segment 
and data availability over the period of investigation is verified. The results from this step can be 
summarised as follow: 
Table 36: Screening Results — Individual screening; functionality and market segment 
STEP Search Criteria Value of criteria Step Result Search Result 
7 Market Companies 32 Companies deleted 18 18 
(Source: own compilation) 
The next screen that was applied was to verify that none of the potentially comparable companies 
has any shareholding that might be included in the dataset. The results from this step can be 
summarised as follow: 
Table 37: Screening Results — Individual screening; Shareholding 
STEP Search Criteria Value of criteria Step Result Search Result 
8 Market Companies 4 Companies deleted 14 14 
(Source: own compilation) 
The last screen focuses on financial information of the 14 potentially comparable companies. 
Financial information screening involves screening to ensure that at least 3 years of financial 
information is available and any discemable outliers are eliminated with the result being 
represented below: 
Table 38: Screening Results — Individual screening; Financial Information 
STEP Search Criteria Value of criteria Step Result Search Result 
9 Market Companies 5 Companies deleted 9 9 
(Source: own compilation) 
202 
The result of all the abovementioned screening steps resulted in that 9 companies can be regarded 
as reasonably functionally comparable with the tested party, ZA CASE 01. With the comparable 
companies being in the EU, which does not have subsidiaries, conforms to the 
independence/dependence screen, do not have intangible fixed assets and have operating revenue 
of not more than € 140 million with sufficient information to satisfy all of the abovementioned 
criteria (refer to Appendix 6.1 for the details on the 9 companies). 
Table 39: Summmary of Screening Results 
STEP Search Criteria Value of criteria Step Result Search Result 
1 Countries European Union 1 209 234 1 209 234 
2 Independent/Dependent Co.'s. A+, A, A-,U 767 776 624 544 
3 No of subsidiaries None 1 254 960 544 084 
4 Intangible Fixed Assets 2001,2000,1999, 1998 Max 
= 0 for all years 
178 985 70 166 
5 NACE1 Primary codes: 3410 and 
3420 
2 905 112 
6 Operating revenue / turnover (th 
Euro) 
Last available year, Max 
=140 000 for at least one 
year 
1 167 235 50 
7 Market Companies 32 Companies deleted 18 18 
8 Market Companies 4 Companies deleted 14 14 
9 Market Companies 5 Companies deleted 9 9 
(Source: own compilation) 
In order to determine the arm's length consideration, the information pertaining to the nine 
comparable companies as illustrated in Table 39 is used. The current approach in determining the 
arm's length consideration is discussed in the subsequent sections. 
5.4.4 Current approach in determination the arm's length consideration 
In any analysis or interpretation of data, a variety of descriptive measures that represents the 
inherent properties of central tendency, variation and shape may be used to describe or summarise 
the data set. The five number summary data were used as a comparable benchmark for 
determining a return consistent with the arm's length principle. 
The comparable search results were discussed in detail in section 5.4.3. Using the transactional 
net margin method (TNMM) (see 3.3.2.1) to determine the arm's length consideration, the net-
cost-plus (NCP) mark-up profit level indicator was used. The net-cost-plus results of the 
comparable search are tabled in Table 40. 
203 
Table 40: Net-cost-plus - Unadjusted results 
Company 2001 2000 1999 1998 1997 1996 Ave. Std Dev. 
JAPA MAINTENANCE 1.09% 1.43% 3.27% 6.17% 13.50% 16.23% 6.95% 0.064 
SARL ALQUIER JEUNES 2.60% 3.47% 3.82% 1.94% 1.15% 0.14% 2.19% 0.014 
UTO.ITAIRES PRO SERVICES 
UPS 5.34% 3.76% 4.80% 4.37% 4.09% 8.26% 5.10% 0.016 
DEILA 3.63% 4.64% 2.18% 2.71% 5.52% 5.13% 3.97% 0.013 
BENNES GUILLAUME SA 0.17% 1.39% 3.49% 3.83% 3.79% -0.74% 1.99% 0.020 
SUD EST REPARATION 7.80% 5.50% 3.67% 6.79% 5.02% 0.40% 4.86% 0.026 
CARROSSERIE VEHICULES 
INDUSTRIEL MELUNAJSE 12.30% 7.63% 4.81% 2.32% 8.05% 3.13% 6.37% 0.037 
ALLOY BODIES LIMITED 2.76% 4.12% 6.09% 11.84% 5.42% 3.99% 5.70% 0.032 
J. C. PAYNE LIMITED 6.23% 8.34% 0.47% 2.48% -0.20% -2.99% 2.39% 0.042 
Count 9 9 9 9 9 9 
Inter quartile range 2001 2000 1999 1998 1997 1996 Ave. Std Dev. 
Minimum 0.17% 1.39% 0.47% 1.94% -0.20% -2.99% 0.13% 0.017 
first quartile 2.60% 3.47% 3.27% 2.48% 3.79% 0.14% 2.63% 0.013 
Median 3.63% 4.12% 3.67% 3.83% 5.02% 3.13% 3.90% 0.006 
third quartile 6.23% 5.50% 4.80% 6.17% 5.52% 5.13% 5.56% 0.006 
Maximum 12.30% 8.34% 6.09% 11.84% 13.50% 16.23% 11.38% 0.036 
2001 
6 
months 
to Dec 
2000 
6 
months 
to June 
2000 1999 1998 1997 1996 Ave. Std Dev. 
Tested Party 2.38% 3.99% 3.75% 9.45% 2.19% -1.09% H.44% 4.16% 0.037 
(Source: own compilation) 
Note that the tested party, ZA Case 01 had a financial year-end change in 2000, hence the 
application of the results for 2000 to the financials accordingly. From this analysis, on a net-cost-
plus basis, apart from 1999 and 1996, ZA Case 01 does not derive a result, which can be deemed 
consistent with the arm's length principle. 
It is clear that, apart from the two years previously mentioned, that ZA Case 01 does not fall 
within the arm's length range. This is concerning from the perspective that the potentially 
comparable data is based on an EU dataset, which is clearly exposed to far less market risk if the 
bond yield rates (refer to Table 43 for more detail) is not factored into the dataset as a comparable 
adjustment. 
The challenge is to determine where one would ordinarily expect ZA Case 01 to be positioned in 
the arm's length range. Another challenge is to determine if adjustments should be made and what 
such adjustments would be. The preposition is adjustments should only be performed in relation 
to comparability insofar as it would that none of the differences amongst the situations being 
204 
compared could materially affect the condition being examined in the methodology (e.g. price or 
margin), or that reasonably accurate adjustments can be made to eliminate the effect of any such 
differences (OECD, 1995: 33). 
5.4.4.1 Transactional Net Margin Method res ults 
ZA Case 01 's positioning with regard to the inter-quartile is discussed in the previous section and 
in applying the TNMM the median is regarded as the most appropriate comparative benchmark. 
The results of applying this approach in practice yielded the results as tabled Table 41. 
Table 41: TNMM results at median 
Adjusted Net-cost-plus 2001 
6 months 
to Dec 
2000 
6 months 
to June 
2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
ZA CASE 01 Results 2.38% 3.99% 3.75% 9.45% 2.19% -1.09% 8.44% 4.16% 0.037 
Adjustment at Median 5.85% 3.44% 3.68% 0.00% 7.10% 8.70% 0.00% 
Inter quartile range 
first quartile 4.35% 5.43% 5.43% 6.09% 6.24% 5.70% 2.14% 4.99% 0.016 
Median 8.23% 7.43% 7.43% 7.18% 9.29% 7.62% 4.31% 7.34% 0.017 
third quartile 8.77% 9.84% 9.84% 8.87% 11.77% 9.76% 12.48% 10.25% 0.015 
Income Statement as reported 
Cost of Sales 
EBIT 
Net-cost-plus 
R'OOO 
-916,298 
25,395 
2.381% 
R'OOO 
-318,207 
14,568 
3.990% 
R'OOO 
-592,702 
24,980 
3.754% 
R'OOO 
-480,905 
50,625 
9.454% 
R'OOO 
-338,550 
8,397 
2.195% 
R'OOO 
-304,473 
-3,691 
-1.086% 
R'OOO 
-326,120 
30,397 
8.444% 
Adjusted Income Statement R'OOO R'OOO R'OOO R'OOO R'OOO R'OOO R'OOO 
Adjusted Cost of Sales 854,413 305,635 568,209 480,905 311,381 274,724 326,120 
EBIT 87,280 27,140 49.473 50.625 35,566 26,058 30,397 
Adjusted EBIT 87,280 27,140 49,473 50,625 35,566 26,058 30,397 
Ebit at Median 61,885 12,572 24,493 0 27,169 29,749 0 
Total Cost 996,330 352,509 641,000 535,503 355,588 312,055 359,974 
Net-cost-plus 8.248% 7.434% 7.434% 9.454% 9.292% 7.624% 8.444% 
ADJUSTMENT Total 
Tax Rate 30% 30% 30% 30% 30% 35% 35% R'OOO 
Adjusted Taxation 18,565 3,772 7,348 0 8,151 10,412 0 48,248 
STC 7,736 1,572 3,062 0 3,396 3,719 0 19,483 
Total Taxation 26,301 5,343 10,409 0 11,547 14,131 0 67,731 
(Source: own compilation) 
From Table 41 it is evident that ZA Case 01 does not derive a result, which is consistent with the 
arm's length principle hence, the position after careful consideration of all the facts at hand is to 
make an adjustment in accordance with section 31 of the Act. In addition to the application of the 
TNMM, a bond yield differential is used to test the analysis and position with regards to the arm's 
length consideration. 
205 
The adjustment is significant in monetary terms with the total adjustment being R 67 million. 
Transfer pricing adjustments is significant and requires careful consideration from business and 
tax authorities alike, as illustrated in ZA Case 01. 
The adjustment in Table 41 is based on comparable data from the EU. Adjustments to reflect the 
difference in the foreign comparables are not incorporated into the analysis. PN 7 requires 
consideration of foreign comparables and the impact of foreign comparables on the arm's length 
consideration (South Africa, 1999:26). The differences in government bond yield are considered a 
fair proxy for differences in the EU and South African market. 
5.4.5 Bond Yield adjustment to enhance comparability 
For the purposes of this research, various companies were accepted for comparative purposes. 
However, significant geographic market differences exists between South Africa the EU, on which 
the comparable datasets were based. Therefore, the financial data of the comparable EU 
companies should be adjusted by a country risk premium if the requirements of comparability are 
to be met (OECD, 1995:1-33). In order to apply the risk reward concept in practice, the approach 
followed as an alternative is broadly based on the following: 
• The bond yield rates on government long bonds (maturity 10 years and older) provides a 
fair investment benchmark for virtually risk free investments. 
• The interest rate risk is included in the price of the bond over the duration of the bond. 
Bonds with a similar coupon and the differential sensitivity to changes in interest rates are 
included. 
• Reinvestment rate risk is included, this is the risk associated with the decline of income 
attributable to a drop in interest rates. 
• Default risk is also included, however, in the case of a government bond; the default risk is 
extremely low in the specific national economy. 
• A company operating within a specific national economy would at least be satisfied with a 
return equal or bigger than the bond yield rates. 
206 
• The perceived and actual risk the company are being exposed to within a national economy 
will equate to a mark-up being added to the bond yield rate that is a fair proxy of the 
investor's expected return for accepting the "additional" risk attached to the investment. 
In an attempt to adjust for the differences amongst the two markets, a risk adjustment model was 
devised that could hypothetically impose a country risk premium on the comparable dataset. A 
simple comparison using the profitability level indicators of unadjusted EU companies would be 
incorrect since the perceived risks associated with investing capital in South Africa would not be 
recognised. Fundamentally, investment in the South Africa market is generally considered riskier 
than investment in the EU market (see Table 43 where the difference in bond yield rates can be 
seen and it supports this assumption). In order to attract global capital, South African investments 
must offer a return in excess to that of a comparable EU investment by compensating for the 
perceived higher risk (Brigham et al., 1999:190). 
This difference in risk amongst the EU market and the South African market is considered the 
country risk premium. The profitability of comparable EU companies in addition to the country 
risk premium will provide a reliable measure of arm's length result for companies conducting their 
operations in these countries. 
Quantifying the inherent risk in doing business in South Africa in a more tangible way, the ROA 
for the various companies used in the analysis were used as the profit level indicator being 
adjusted with a risk premium. The return on assets of the comparable EU dataset is tabled in 
Table 42. 
Table 42: Return on Assets - Unadjusted results of the comparable EU dataset 
Inter quartile range 2001 2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
Minimum 0.22% 3.95% 0.42% 2.45% -1.64% -11.70% -1.05% 0.056 
First quartile 5.41% 5.29% 7,95% 5.57% 5.77% -0.90% 4.85% 0.030 
Median 9.12% 10.61% 10.42% 8.86% 9.52% 5.47% 9.00% 0.019 
Third quartile 17.72% 18.03% 12.47% 14.66% 16.03% 7.71% 14.44% 0.039 
Maximum 28.66% 24.41% 14.90% 25.90% 35.03% 46.25% 29.19% 0.106 
2001 
6 
months 
to Dec 
2000 
6 
months 
to June 
2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
Tested Party 3.11% 2.65% 5.25% 11.63% 2.76% -1.65% 9.55% 4.27% 0.044 
(Source: own compilation) 
207 
With the exception of 1996 and 1999, the tested party (ZA Case 01) realised a return on assets 
lower than the first quartile and on average falls outside the inter-quartile range. The return on 
assets interquartile range is 4.85 per cent to 14.44 percent for the years 1996 to 2001. The return 
on assets of ZA Case 01 that falls outside the inter-quartile range could indicate potential transfer 
pricing exposure. 
The return on assets is used as an appropriate measure to benchmark a comparable investment 
return such as government bond yield rates, a relative risk free investment. The hypothesis is 
based on the premise that the difference in government bond yield rates is a fair estimation or 
proxy of the inherent risk of doing business in a country, risk free, thus the difference in the bond 
yields is a proxy of country risk, all other things being equal. The bond yield rates for long terms 
bonds in South Africa and the EU are tabled in Table 43. 
Table 43: Bond Yield Rate 
European Union 
EU 10 Year Government Bond Yield Annual Rate 1995 1996 1991 1998 1999 2000 2001 
8.73% 7.23% 5.96% 4.70% 4.66% 5.44% 5.03% 
South African 
Government Bonds 10 Years and older Annual Rate 14.56% 16.19% 14.14% 16.36% 13.96% 12.88% 11.63% 
Bond Yield Differential 5.83% 8.96% 8.18% 11.66% 9.30% 7.44% 6.60% 
(Source: European Central Bank, 2003: T03.02_c5 and SARB, 2003(b): KBP2003M) 
In order to apply these hypothetical country risk premiums to the comparable dataset for the years 
under investigation, the country risk premium is applied to the return on assets of all the 
comparable companies. The adjusted results are tabled in Table 44. 
In applying the bond yield to the return on assets of the comparable companies' financial data, the 
return on assets (ROA) inter-quartile range increased from 4.85 per cent to 14.44 percent to 13.54 
per cent to 23.13 per cent (average from 1996 to 2001). The adjusted ROA interquartile range 
compares well with the research ABSA published on the automotive and component industry (see 
Table 12). 
208 
Table 44: Return on Assets- Adjusted results 
Company 2001 2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
JAPA 
MAINTENANCE 9.13% 11.83% 17.26% 33.07% 43.21% 55.21% 28.28% 0.19 
SARL ALQUIER 
JEUNES 15.72% 19.41% 23.79% 21.29% 11.33% 8.06% 16.60% 0.06 
UTILITAIRES PRO 
SERVICES UPS 18.08% 16.57% 19.73% 20.52% 17.06% 24.91% 19.48% 0.03 
DEILA 12.01% 12.73% 11.50% 14.11% 13.95% 16.45% 13.46% 0.02 
BENNES 
GUILLAUME SA 6.82% 11.39% 17.52% 19.84% 17.70% 5.40% 13.11% 0.06 
SUD EST 
REPARATION 27.93% 25.47% 21.78% 26.32% 19.72% 8.96% 21.70% 0.07 
CARROSSERIE 
VEHICULES 
INDUSTRIEL 
MELUNAISE 35.26% 26.75% 20.65% 15.81% 28.69% 14.43% 23.60% 0.08 
ALLOY BODIES 
LIMITED 14.68% 18.05% 24.21% 37.56% 24.21% 16.67% 22.56% 0.08 
J. C. PAYNE 
LIMITED 24.32% 31.85% 9.73% 17.23% 6.54% -2.74% 14.49% 0.13 
Inter quartile range 2001 2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
First quartile 12.01% 12.73% 17.26% 17.23% 13.95% 8.06% 13.54% 0.035 
Median 15.72% 18.05% 19.73% 20.52% 17.70% 14.43% 17.69% 0.023 
Third quartile 24.32% 25.47% 21.78% 26.32% 24.21% 16.67% 23.13% 0.035 
2001 
6 
months 
to Dec 
2000 
6 
months 
to June 
2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
Tested Party 3.11% 2.65% 5.25% 11.63% 2.76% -1.65% 9.55% 4.27% 0.044 
(Source: own compilation) 
In order to adjust the net-cost-plus mark-up, the operating profit must be adjusted to reflect the 
adjusted net-cost-plus. The hypothesis is based on the premise that the asset base is constant and 
by applying the country risk premium, the "excess" operating profit is calculated that could equate 
as the "additional" profit required by an investor to compensate for the increased risk. Similarly, 
the operating profit so calculated applied to the net-cost-plus formula would be a fair 
approximation of the "additional" profit expected on the cost incurred when operating in a higher 
risk location. The adjusted results are tabled in Table 45. 
209 
Table 45: Net-cost-plus - Adjusted results 
Inter quartile range 2001 2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
First quartile 4.35% 5.43% 6.09% 6.24% 5.70% 2.14% 4.99% 0.016 
Median 8.23% 7.43% 7.18% 9.29% 7.62% 4.31% 7.34% 0.017 
Third quartile 8.77% 9.84% 8.87% 11.77% 9.76% 12.48% 10.25% 0.015 
2001 
6 
months 
to Dec 
2000 
6 
months 
to June 
2000 1999 1998 1997 1996 Ave. 
Std 
Dev. 
Tested Party 
Positioning 
2.38% 
< Min 
3.99% 
< 25lh Per 
3.75% 
< 25* Per 
9.45% 
>75th Per 
2.19% 
< Min 
-1.09% 
< Min 
8.44% 
< 75'" Per 
4.16% 
<Med 
0.037 
(Source: own compilation) 
From the analysis, ZA Case 01's results is volatile, during 1997 and 1998, it recorded results 
considerably lower than the inter-quartile range. During 1999 ZA Case 01 recorded a net-cost plus 
of 9.45 per cent that is higher than the 8.87 per cent, the third quartile. This net-cost-plus result 
could be considered being consistent with the arm's length consideration. 
Following on the same approach for the following two years, ZA Case 01 has returns, which are 
below the arm's length consideration, i.e. lower than the first quartile of the inter-quartile range. 
This confirms the SARS position that ZA Case 01 did not deal at arm's length in all the years 
under investigation where the adjusted net-cost-plus is below the first quartile. Hence, 
adjustments are to be made to reflect what could be considered the arm's length consideration. 
5.4.5.1 Positioning of the ZA Case 01 in the inter quartile range 
From the comparable results in the previous section it seems that the tested party, ZA Case 01 
realises returns lower than the median in most years. However, it was not yet objectively 
established if the first quartile is the appropriate position for ZA Case 01 within the comparable 
dataset. 
In order to establish ZA Case 01's position relative to the comparable dataset, the country risk 
adjustment was applied thereby positioned ZA Case 01 as if it was hypothetically operating in the 
comparable EU conditions. The results obtained from the analysis are tabled in Table 46. 
210 
Table 46: Inter quartile range positioning ofZA Case 01 
Tested Party 2001 
6 months 
to Dec 
2000 
6 months 
to June 
2000 1999 1998 1997 1996 Ave. Std Dev. 
Actual ROA 3.11% 2.65% 5.25% 11.63% 2.76% -1.65% 9.55% 4.27% 4.41% 
Differential in Bond yields 6.60% 7.44% 7.44% 9.31% 11.66% 8.18% 8.96% 
Adjusted ROA -3.49% -4.79% -2.19% 2.32% -8.89% -9.83% 0.59% 
Inter quartile range 
Minimum 0.22% 3.95% 3.95% 0.42% 2.45% -1.64% -11.70% -1.05% 0.056 
First quartile 5.41% 5.29% 5.29% 7.95% 5.57% 5.77% •0.90% 4.85% 0.030 
Median 9.12% 10.61% 10.61% 10.42% 8.86% 9.52% 5.47% 9.00% 0.019 
Third quartile 17.72% 18.03% 18.03% 12.47% 14.66% 16.03% 7.71% 14.44% 0.039 
Maximum 28.66% 24.41% 24.41% 14.90% 25.90% 35.03% 46.25% 29.19% 0.106 
(Source: own compilation) 
From this analysis in Table 46 ZA Case 01 falls above the median in the 1996 and 1999 years of 
assessment. In applying the arm's length principle, a reward consistent with the arm's length 
standard could arguably be the median or the mid point of the comparable arm's length range 
(South Africa 1999:27). 
This view is consistent with the view expressed in the functional analysis with regards to ZA Case 
01 's risk profile (see 5.3.6). Any material change to either functions performed, assets used or risk 
assumed in the connected party dealings would be considered and as such would be incorporated 
into the positioning of ZA Case 01 in the inter quartile range. The CATPM, in the proposed 
positioning analysis is expected to provide further evidence what ZA Case 01 position should be 
within the arm's length range (refer to sections 4.4.3 where it is discussed and Appendix 7.2 where 
it is disclosed). 
5.4.5.2 Government bond yield benchmark 
In order to apply the risk-reward concept in practice, the approach followed as an alternative to the 
current practice is broadly based on the fact that bond yield rates on government long bonds 
(maturity 10 years and older) provides a fair investment benchmark for virtually risk free 
investments. Furthermore, the interest rate risk is included in the price of the bond over the 
duration of the bond. Bonds with a similar coupon and the differential sensitivity to changes in 
interest rates are included. 
The perceived and actual risk a company are being exposed to within a national economy will 
equate to a mark-up being added to the bond yield rate that is a fair proxy of the investor's 
expected return for accepting the "additional" risk attached to the investment. In the analysis, the 
211 
bond yield rate of South Africa is applied to the asset base of the tested party and a return of at 
least equal to the bond yield rate (conservative stance) is determined as tabled in Table 43. 
Table 47: Bond Yield Adjustment 
2001 6 months 
to Dec 
2000 
6 months 
to June 
2000 
1999 1998 1997 1996 
R'000 R'000 R'000 R'000 R'000 R'000 R'000 
Total Assets 815,444 549,130 476,206 435,329 303,852 223,317 318,343 
RSA Long Bond Yield 11.63% 12.88% 12.88% 16.36% 14.14% 16.19% 14.56% 
Return on total assets 0.823% 3.114% 2.653% 5.246% 11.629% 2.764% -1.653% 
Expected EBIT 94,836 35,364 30,668 71,220 42,965 36,155 46,351 
Income Statement as reported R'000 R'000 R'000 R'000 R'000 R'000 R'000 
Cost of Sales -916,298 -318,207 -592,702 -480,905 -338,550 -304,473 -326,120 
Operating Costs -150,458 -46,874 -72,791 -54,598 -44,077 -35,246 -33,854 
EBIT 25,395 14,568 24,980 50,625 8,397 -3,691 30,397 
Net-cost-plus 2.381% 3.990% 3.754% 9.454% 2.195% -1.086% 8.444% 
Adjusted Income Statement R'000 R'000 R'000 R'000 R'000 R'000 R'000 
Adjusted Cost of Sales -846,857 -297,411 -587,014 -460,310 -303,982 -264,627 -310,166 
Operating Costs -150,458 -46,874 -72,791 -54,598 -44,077 -35,246 -33,854 
EBIT 94,836 35,364 30,668 71,220 42,965 36,155 46,351 
Adj. Result to Cost of Sales -69,441 -20,796 -5,688 -20,595 -34,568 -39,846 -15,954 
Adjusted Net-cost-plus 9.509% 10.272% 4.648% 13.832% 12.344% 12.057% 13.473% 
Gross Profit per cent 21.85% 21.66% 14.98% 21.47% 22.29% 21.73% 20.55% 
ADJUSTMENT Total 
Tax Rate 30% 30% 30% 30% 30% 35% 35% R'000 
Adjusted Taxation 20,832 6,239 1,706 6,178 10,370 13,946 5,584 64,856 
STC 8,680 2,599 711 2,574 4,321 4,981 1,994 25,861 
Total Taxation 29,512 8,838 2,417 8,753 14,691 18,927 7,578 90,717 
(Source: own compilation) 
In undertaking the abovementioned analysis in Table 47 the following should be noted: 
• The transfer pricing adjustment increased from R 67 million to R 90 million, inclusive of 
Secondary Taxation on Companies (deemed dividend provision in the Act). The 
significance of the transfer pricing adjustment in monetary terms underlines the importance 
for business and tax authorities to ensure accurate application of transfer pricing. 
• The turnover figure represents the tested party dealings with the domestic market and is a 
fair representation of unconnected party dealings. Although not disclosed, it could be 
verified. 
• The operating costs disclosed in the financial statements are costs the tested party incurs 
and does not form part of any connected party dealings. 
212 
• The abovementioned facts substantiate that the adjustment is made at the cost of sales line, 
the connected party transaction where transfer might occur. 
• The analysis treats the tested party on par with the risk profile of a government bond yield. 
In reality, the tested party's risk profile is not equal to that of a government bond and one 
would expect it to attract a margin for perceived higher risk. 
• This margin for risk cannot be objectively allocated in circumstances where the company's 
credit rating is not known, hence the conservative approach to determine the minimum 
benchmark. The analysis is based on the following underlying assumptions: 
o The South African long government bond yield rates (long bond) are a fair proxy 
for a relative risk free investment in South Africa. 
o Usually an investor would expect a return on assets (or the investment) of at least 
equal to the government bond yield rates. Investors usually add a margin to the 
risk free rate to compensate them for increased risk in any other investment 
(Brigham et al, 1999:178). It is very difficult to calculate this mark-up or 
premium objectively in the absence of published company credit ratings, in this 
instance ZA Case 01. This prompted the use of the bond yield benchmark as an 
indication of the minimum (at least be satisfied with a risk free return) return an 
investor would be satisfied with for investing in South Africa. 
• Earnings before interest and tax (EBIT) are the return the investor earns on assets 
(investment). Using EBIT as the most appropriate benchmark for the return on the 
investment is based on (Brigham et al., 1999: 180): 
o Expenditure items such as interest and tax could differ substantially from one 
company to the next, as well as from one year to the next. 
o Interest expense is based on financing structure that could vary greatly amongst 
companies and over time within the same company. 
o Taxation expense, is influenced by financial performance of previous years, and 
can distort the return calculations. 
213 
o Adjustment to EBIT is made with respect to the difference amongst expected 
return on assets (bond yield benchmark) and realised return (ZA Case 01) as 
measured by return on assets. 
o The adjustment is applied to the income statement to effect the adjustment to the 
line item where connected party transactions take place, in this specific instance, 
the cost of sales line. 
In the determination of the arm's length consideration under the current approach, ZA Case 01 
does not derive a result that is consistent with the arm's length consideration for the years 1997 
through to 2002, excluding 1999. The analysis does not provides any indication of the risk 
identified in the functional analysis of ZA Case 01 (refer to section 5.3.6 for the analysis) that 
could be influential in the relative level of profitability ZA Case 01 realised. 
The Comparability Adjustment Transfer Pricing Model (CATPM) makes use of a variety of 
factors (refer to section 4.4.1 and 4.5.2.1) that measures risk insofar as it is significant in the 
estimation of profitability and consequently the arm's length consideration. Applying the CATPM 
to the data concerning ZA Case 01 and making use of explanatory variables (factors that impact on 
profitability) in determining the response variable (profit level indicator, net-cost-plus "NCP"), the 
arm's length consideration is a function of functions performed, assets used and risk assumed with 
risk assumed being objectively determined. 
5.5 A Comparability Adjustment Transfer Pricing Model 
The CATPM, which is the focus of this research, has been described in detail in section 4.4. 
Uncertainty exists in transfer pricing insofar as adjustments to comparable data is necessary and in 
the event that a tested party is found to be in contravention of the arm's length consideration, what 
the adjustment position in the arm's length range should be. In determining the arm's length 
consideration, the OECD Guidelines (OECD 1995:1-7,1-17,1-19,1-25) as well as the South African 
PN (South Africa, 1999: 9) requires adjustments to be made in order to enhance comparability. 
In following the current approach as described in section 5.4.4, the results is not conclusive 
whether adjustments is required in order to enhance comparability. This is due to the inexact 
nature of transfer pricing (OECD, 1995:1-5 and South Africa, 1999:27) and the practice of 
determining a range of profit level indicators with the adjustment usually enacted at the 
214 
mid-point (South Africa, 1999:27), or median of the range. Hence, the CATPM is used for ZA 
CASE 01 to shed some light on the noted uncertainties, in accordance with the objectives of the 
research (refer to section 1.2). 
5.5.1 Comparable Analysis results under the CATPM 
In practice, information constraints make the application of the traditional methods (refer to 
section 3.2.2.4 for a detailed discussion) not viable mainly due to the lack of publicly available 
information on comparable uncontrolled transactions or gross margins. In an attempt to overcome 
these information constraints, it is often necessary to resort to the transactional profits methods 
(refer to section 3.3.2 for a detailed discussion). 
The comparable search results for the CATPM were discussed in section 4.5.1. In order to apply 
the CATPM to ZA Case 01, the dataset was extended to include information for the financial years 
1996 through to 2002, the period over which the tested party, ZA Case 01 is analysed. The 
summary statistics of the dataset under consideration is tabled in Table 48. 
Table 48: CATPM Summary Statistics for 1996 through 2002 
Summary measures for selected variables 
CATPM 
Inv Risk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
Net-
cost-
plus 
Observations 262.000 262.000 262.000 262.000 262.000 262.000 262.000 262.000 
Mean 0.256 8.046 1.576 2.077 114.205 0.857 0.853 0.078 
Median 0.120 1.505 1.346 2.033 6.586 0.937 0.704 0.036 
Standard 
deviation 0.965 32.305 1.170 0.847 883.324 0.695 2.109 0.310 
First quartile 0.056 0.798 1.064 1.513 2.283 0.675 0.632 0.019 
Third quartile 0.178 3.532 1.737 2.598 16.756 1.013 0.999 0.069 
(Source: own compilation) 
From the statistical summary, in Table 48 a NCP arm's length consideration range (the inter­
quartile range) between 1.9 per cent, the lower end of the range, to 6.9 per cent, the higher end of 
the range, with a median NCP of 3.6 per cent (read off the last column marked Net-cost-plus). In 
the event that the tested party, ZA Case 01, falls outside this range, and adjustment would 
ordinarily be made to the financials statements, in particular the earnings before interest and tax 
("EBIT"). The same approach is followed if any of the other profit level indicators are used. 
The arm's length NCP range, 1.9 per cent to 6.9 per cent, in Table 48 (inter-quartile) does not 
provide insight into what factors from the 262 observations are significant insofar as the 
215 
determination of the boundaries of the arm's length NCP range. Making use of the population of 
comparable companies (determination of the population is discussed in section 4.5.1) in 
comparison to the sample as determined under the current approach (refer to section 5.4.4) the 
arm's length NCP range is deemed to be between 2.63 per cent and 5.56 per cent (refer to Table 40 
for the NCP results). 
The median of the current approach is 3.9 per cent whilst the median under the CATPM is 3.6 per 
cent (according to the summary statistics in Table 48). The median NCP arm's length 
consideration differs slightly, albeit that the spread of the data under the current approach (2.63 per 
cent to 5.56 per cent) is tighter than under the CATPM approach (1.9 per cent to 6.9 per cent). 
The smaller spread of data is as a result of individual screening that minimise the potential 
comparable companies (9 companies over 6 years that equates to 54 observations) compared to 
262 observations used in the CATPM. 
The sample, as tabled in Table 39, current approach's determination is subjective and can be seen 
as ambiguous because of the qualitative screening in the comparability analysis. The quality of 
qualitative screening is dependent on the analytical ability and experience of the analyst 
undertaking the analysis. In order to minimise potential ambiguity, the objectives of this research 
in section 1.2 clearly states that by using multiple regression in the CATPM, the aim is to enhance 
comparability analysis by estimating weights that determine the quantitative impact of mutually 
exclusive and collectively exhaustive ("MECE") ratios on profitability. 
Ambiguity and subjectivity is further limited by the CATPM where the total population 
conforming to the quantitative screening criteria is used. Substantial differences in the median is 
not expected, (evidenced by 3.6 per cent compared to 3.9 per cent) however, the significant 
contribution of the CATPM is the determination of the arm's length range (the interquartile range) 
lower and upper limits that has an impact on whether an adjustment is made or not. Substantial 
differences exist with the arm's length range under the current approach being 2.63 per cent to 
5.56 per cent and the CATPM being 1.9 per cent to 6.9 per cent. 
In accordance with the current approach, if the tested party falls outside the 2.63 to 5.56 per cent 
range, an adjustment to profitability (NCP) in the case of ZA Case 01, the mid-point, 3.6 per cent 
is made. According to the CATPM, if the tested party falls outside the 1.9 to 6.9 per cent range, 
an adjustment is made to 3.9 per cent. The difference in the thresholds according to the arm's 
216 
length range is significant (1.9 per cent compared to 2.63 per cent and 6.9 per cent compared to 
5.56 per cent) especially if the determination of these thresholds is model driven rather than 
analyst interpretation. In addressing potential material tax consequences for an MNE, an approach 
that does not rely on possible subjective analysis to determine whether an adjustment is to be made 
or not, is clearly more attractive. 
5.5.2 CATPM results 
The regression aim to predict Y, (profitability) = Net-cost-plus from a set of X variables (the 
CATPM factors), which are the empirical mutually exclusive and collectively exhaustive 
("MECE") risks and leverages. Data used for the CATPM model is the 262 observations 
comparable to ZA Case 01 for the financial years 1996 through to 2002. Although all seven 
variables are theoretically essential to the CATPM, removing one or several can reduce or 
eliminate multicollinearity (nearly a linear relationship among a set of explanatory variables 
(Albright et al., 2003:635) while maintaining the MECE requirement. In order to achieve the 
elimination of multicollinearity whilst maintaining the MECE, a correlation matrix for the seven 
variables was calculated as illustrated Table 49. 
Table 49: Correlation Matrix CATPM factors 1996 to 2002 
CATPM Inv 
Risk 
CATPM Rec 
Risk 
CATPM Liq 
Risk 
CATPM 
Activity Risk 
CATPM Sol 
Risk 
CATPM Fin 
Lev 
CATPM Tax 
Lev 
CATPM Inv 
Risk 1.000 
CATPM Rec 
Risk -0.060 1.000 
CATPM Liq 
Risk 0,537 0.048 1.000 
CATPM 
Activity Risk -0.338 -0.086 -0.166 1.000 
CATPM Sol 
Risk -0.005 -0.024 -0.014 -0.080 1.000 
CATPM Fin 
Lev -0.049 0.037 0.029 0.054 0.030 1.000 
CATPM Tax 
Lev 0.013 -0.018 -0.019 -0.103 -0.003 -0.086 1.000 
(Source: own compilation) 
The correlation matrix indicates that liquidity and inventory are somewhat correlated; with the 
coefficient of correlation 0.537 which means that one of the two factors could be excluded from 
the regression. There is no established threshold for elimination or no rule for determining which 
217 
one of the pair should be eliminated, therefore for the purposes of this regression both are 
accepted. 
Table 50: Net-cost-plus regression results 
Summary measures Change % Change 
Multiple R 0.8551 0.0054 0.6% 
R-Square 0.7313 0.0092 1.3% 
Adj R-Square 0.7282 0.0082 1.1% 
StErrofBst 0.1617 -0.0024 -1.5% 
ANOVA Table 
Source df SS MS F p-value 
Explained 3 18.3631 6.1210 234.0341 2.640E-73 
Unexplained 258 6.7479 0.0262 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit Upper limit 
Constant -0.1738 0.0177 -9.8264 1.455E-19 -0.2086 -0.1389 
CATPM Liq Risk 0.1302 0.0102 12.7867 2.506E-29 0.1102 0.1503 
CATPM Inv Risk 0.1539 0.0124 12.4469 3.608E-28 0.1295 0.1782 
CATPM RecRisk 0.0009 0.0003 2.9742 3.215E-03 0.0003 0.0015 
(Source: own compilation) 
5.5.3 Interpretation of regression results 
5.5.3.1 Coefficient of determination 
The outputs to be considered are tabulated in Table 50. R Square, or R2, the coefficient of 
determination is a measure of goodness of linear fit (Berenson and Levine, 1999:749). R2 always 
has a value between 0 and 1 and the coefficient of determination can be interpreted as the fraction 
of variation of the response variable (NCP) explained by the regression line (as defined by the 
CATPM factors) Albright et at, (2003:571). R Square, in Table 50 (Step 3 of the multiple 
stepwise regression, see Appendix 7.3) indicates that inventory, receivable and liquidity explain 
73% of variation in NCP. Alternatively, 27% of the variation of NCP is not explained by the 
CATPM, in particular the inventory, receivable and liquidity leverage factors, commonly referred 
to as explanatory variables. 
5.5.3.2 Standard error 
The standard error of estimate, as provided in the regression output in Table 50, is the standard 
deviation (is a measure of variation, how values fluctuate around the mean or average) around the 
line of regression (Berenson and Levine, 1999:749) The standard error of estimate is equal to 
0,1617. Generally, the standard error of estimate indicates the level of accuracy of the predictions 
made from the regression equation. 
218 
The smaller the value, the more accurate predictions ought to be (Albright et al, 2003:570). The 
standard error or estimate of 0.1617 of the regression in Table 50 indicates the typical error likely 
when the fitted value (CATPM factors) based on the regression line to predict or estimate NCP. In 
order to determine the acceptability of the accuracy and the expected error, a comparison with the 
standard deviation of the factors under consideration, as tabled in Table 48 is made. 
One measure of comparison is the standard deviation of the NCP, 0.31 as tabled in Table 48. The 
value of 0.31 is the standard deviation of the residuals around a horizontal line positioned at the 
mean value, 0.078 of NCP. The mean value would be the relevant regression line if no 
explanatory variables such as inventory, receivables, liquidity and financial leverage were used. 
The standard deviation of NCP is a measure of the estimate error (0.31) if the mean is used to 
estimate NCP for all the comparables in the dataset. The standard error of estimate of 0.1617 of 
the regression is considerably smaller than the standard deviation of NCP that implies a significant 
improvement in reducing the estimate error (Albright et al., 2003:570). 
5.5.3.3 Test for overall fit 
In analysing the test for overall fit, the ANOVA table illustrated in Table 50 are considered. The 
R square value is acceptable (value of 0.7313); the standard error of estimate of 0.1617 is 
significantly smaller than the standard deviation of the NCP. Furthermore, the F-ratio 234.034 is 
high (if it is large, then the explained variation is large relative to the unexplained variation, thus is 
has explanatory value) and its significance F (P-value) test is very small 2.640" . According to 
Albright et al (2003:632) if the P-value is less than 0.05 in combination with a large F-ratio, then 
the explanatory variables such as inventory, receivable and liquidity has some explanatory value of 
NCP. 
Another consideration with regards to the regression output is t- values. The lvalues for the 
regression coefficients indicates which of the potential explanatory variables (CATPM factors) are 
useful in explaining NCP, the response variable. A lvalue measures the ratio of estimated 
coefficient to its standard error, it is an indicator of how many standard errors the regression 
coefficient is from 0 Albright et al, (2003:632). A £-value can be used to determine if any 
particular explanatory variable of the CATPM should be included in the CATPM regression 
equation. In the event that an explanatory variable's coefficient equals 0, it is pointless to include 
such a variable in the CATPM equation, the 0 coefficient will cancel its effect on the response 
219 
variable, NCP. Table 50 does not indicates a t- value of 0 for any of the explanatory variables, 
hence none of them are excluded from the CATPM equation (refer to section 4.4.2 for a 
j - \ i n Inv r> R e c o CA a Sales 0 Debt „ EBT n NP r™ j - ^ . J 
dlscusslon) *=a+A^+*l^+Aa+fi*^+fi>c^+fi<mr+Awr+s' ^ ^ 
pattern of the data, in particular the CATPM factor (MECE ratio) liquidity is illustrated in Figure 
33. 
Figure 33: Liquidity fitted values 
3.0 -I ♦ 
2.4 
♦ 
1.8 
♦ 
3 1.2 
♦ 
0.6 
♦ 
0.0 ■ * * * * " ^ 
0.0 2.5 5.0 7.5 10.0 
CATPM Ulq Risk 
12.5 15.0 17.5 
(Source: own compilation) 
The linear trend from the liquidity fitted value scatter plot is clearly visible, as illustrated in Figure 
33. Outliers are present in the data with outliers being indicated by points outside the majority of 
the fitted values. In analysing and interpreting the results obtained from the CATPM, and in 
particular, the regression, the following emerges: 
• Inventory, receivables and liquidity is significant explanatory variables in estimating the 
response variable (NCP) 
• The estimation of the response variable the coefficient of determination, R square explains 
73% of variation in NCP 
• The ANOVA table illustrated in Table 50 indicates a high F - ratio 234.034 (if it is large, 
then the explained variation is large relative to the unexplained variation, thus is has 
explanatory value) and its significance F (P-value) being very small 2.640"73. The 
220 
explanatory variables with a p-value less than 0.05 in combination with a large F—ratio, 
then the explanatory variables such as inventory, receivable and liquidity has explanatory 
power of NCP (Albright et al, 2003:632). 
• The regression analysis indicates that in using the coefficients determined with the 
CATPM that the arm's length consideration a' can be formulated as 
al=a + Pl-^+p2—+P3 —+£ & = -0.1738 + 0 .1302-^+0.1539— + 0.0009— Sales Inv CL o r Sales Inv CL 
5.5.3.4 Application of the CATPM regression output 
In order to determine the arm's length consideration with the CATPM, the explanatory variables 
inventory, receivable and liquidity is used to estimate the arm's length consideration. In order to 
estimate the arm's length consideration, the following approach is followed: 
• Determine the explanatory variables (CATPM factors or risk indicators) for the tested party 
(refer to Appendix 7.1 where ZA Case 01 explanatory variables as well as the respondent 
variables are disclosed). 
• Use the estimated significant weights or coefficients determined by the regression analysis 
(inventory, receivables and liquidity) to estimate the arm's length consideration. The arm's 
length consideration is in accordance with Paragraph 1 of Article 9 of the OECD Model 
Tax Convention (OECD, 1995: 1-3) "...conditions are made or imposed amongst... two 
[associated] enterprises in their commercial or financial relations ... which would have 
been made amongst independent enterprises (unconnectedparties) ...". 
• The basis of the estimation of the NCP arm's length consideration is the sum of the product 
of the estimated significant weights and the tested party's explanatory variables. The 
explanatory variables are only the ones indicated as significant (inventory, receivables and 
liquidity) by the multiple regression, including that of the intercept, as tabled in Table 51. 
221 
Table 51: CATPM Result 1996 to 2002 
Regress ion N C P for the period 1996to 2002 
Estimation of the Arm's 
length consideration 
Tested Party Hypothetical first quartile Company 
Tested Party 
Ratio's 
(Median) 
Regression 
Output 
Coefficients 
or weights 
Weights x 
Tested Ratio's 
first quartile 
Ratio's 
Regression 
Output 
Coefficients 
or weights 
Weights x 
Median 
Ratio's 
Intercept 1.000 -0.1738 -0.1738 1.0000 -0.1738 -0.1738 
Inventory Risk 0.407 0.1539 0.0626 0.0557 0.1539 0.0086 
Receivable Risk 0.557 0.0009 0.0005 0.7977 0.0009 0.0007 
Liquidity Risk 1.716 0.1302 0.2234 1.0643 0.1302 0.1386 
Sum 11.28% -2.59% 
Difference amongst Tested 
Party and Comparable Data 
Sample 13.86% 
Tested Party Profit Level Indicator 3.68% 3.68% 
Source: own compilation 
The tested party, ZA Case 01 financial information in terms of the CATPM equation is provided in 
the part of Table 51, marked Tested Party. The coefficients of the explanatory variables that 
provide an R2 of 0.7313 is provided (refer to Table 50 for the regression output). For instance, 
liquidity risk for the tested party have a value of 1.716 and the coefficient as determined by the 
regression analysis is 0.1302, resulting in a CATPM factor of 0.2234. The sum of all these 
CATPM factors is 11.28%. According to the proposition of the CATPM, should ZA Case 01 earn 
a NCP of 11.28 % in the EU, given its risk factors or explanatory variables? The tested party 
realised a NCP of 3.68%, clearly not indicative of what the estimation of the arm's length 
consideration purport to be. 
Positioning analysis with regards to the output from the CATPM is significant. The South African 
PN (South Africa, 1999:27) reiterates that in the event an adjustment is made (when the tested 
party falls outside the arm's length range), the midpoint is appropriate. This research, in the 
context of ZA Case 01 indicates that the arm's length NCP consideration is higher than the median 
or mid-point. The median arm's length consideration, according to the CATPM is 2.13%, 
considerably lower than 11.28%, the estimated NCP. The position of ZA Case 01 within the arm's 
length range is above the third quartile of the arm's length range (refer to Appendix 7.2 where the 
third quartile is included in the analysis.) 
222 
5.6 Conclusion 
From the investigation, ZA Case 01 did not derive a result consistent with the arm's length 
consideration for the years under consideration; irrespective if the current (see Table 41 and Table 
45) or CATPM approach (see Table 51 and Appendix 7.2) was followed. The arm's length test 
was performed by making use of the TNMM method in conjunction with the bond yield model, 
which came to the same conclusion. Although the research does not focus on the provision of 
financial assistance, in the investigation financial assistance as contemplated in section 31 was 
identified and an adjustment for thin capitalisation was made. This tax adjustment amounts to R 
18 million for the period under consideration which is indicative of the materiality of transfer 
pricing adjustments. 
The adjustment for the transfer pricing of goods amounts to an adjustment of R 68 million for a 
total taxation adjustment of R 86 million. By making use of the bond yield model, the adjustment 
amounts to R 90 million. The difference in results amongst the bond yield model and the 
calculations under the TNMM is less than 5 per cent. The OECD Guidelines and PN 7 states that 
transfer pricing are not an exact science. The conversion of the bond yield model with the TNMM 
in this specific case is significant. 
The total adjustment to taxable income of ZA CASE 01 is approximately R 300 million. The 
management of MNE's such as ZA Case 01 faces substantial challenges in determining their 
transfer prices and ensuring that they mitigate the risk of an adjustment in the advent of an 
investigation. The magnitude of the adjustments based on the dealings of connected parties is 
significant in ensuring effective administration of the arm's length principle. 
In order to further test this approach, the CATPM was designed to crystallise comparability insofar 
as risk identified by using regression analysis to estimate the arm's length consideration. In 
addition to the hypothetical arm's length consideration, it is used to determine the position of the 
tested party within the constraints of the arm's length range. 
A consideration from the CATPM output follows that ZACase 01 should earn an estimated NCP 
of 11.28 per cent. This is a significant observation seen in light that when applying the bond yield 
as an indicator for the difference in market risk, the bond yield adjusted NCP (refer to Table 45 for 
details) amounts to 10.25 per cent at the third quartile, the position of ZA Case 01 according to the 
223 
positioning analysis (refer to Appendix 7.2 where the third quartile is disclosed). When applying 
the Bond yield as an indicator, the conservative assumption is that a comparable company would 
at least earn return equal to the bond yield over time. Usually, companies are exposed to more risk 
than a bond yield; hence, one would expect returns in excess of the bond yield. Applying the 
CATPM, the excess or premium over the bond yield is (11.28 % less 10.25%) 1.03%, which 
seems reasonable in the circumstances. 
Although, transfer pricing is regarded as a non-exact science, its outcomes are material in 
monetary terms. For business management and tax authorities alike, it is essential to apply 
theoretical approaches and research methodologies in the determination of the arm's length 
consideration, which could remove substantial subjective conclusions. Consequently, the most 
relevant research findings are considered in the next chapter. 
224 
Chapter 6 Conclusions and recommendations 
6.1 Conclusions 
In concluding on the findings of this research, the overriding concept that transfer pricing is not an 
exact science but results in an exact exposure in terms of tax is concerning. Substantial work has 
been undertaken by the OECD and tax authorities such as the SARS in clarifying the concept of 
transfer pricing and provide some certainty to business on transfer pricing application. 
The South African economy is becoming increasingly open (refer to 2.2.1.1 for the discussion) and 
is increasingly participating in global trade. The increase in the openness of the South African 
economy (see 2.2.1.1) is indicative of globalisation as well as emphasising the importance of 
transfer pricing in strategic business decisions as well as securing the South African tax base. In 
order to effectively deal with transfer pricing, it is essential that South African information be used 
in the determination of the arm's length consideration. Currently South African data pertaining to 
unconnected parties is not available forcing MNE's, professional advisors and the SARS to make 
use of foreign databases. 
The determination of the arm's length consideration presupposes a profitability comparison 
amongst connected and unconnected parties. At best, transfer pricing results in an approximation 
of an arm's length consideration, hence the use of the arm's length range (see 1.6.2 and 3.2.2). In 
the event that a tested party's results falls with the arm's length range, it is deemed to be 
transacting according to the arm's length principle. 
It is apparent from the research that MNE's management missed the following related 
opportunities: 
• Out of 22 countries that was surveyed, only in Germany, more than half of the respondents 
include transfer pricing as part of their corporate strategic planning process (refer to Table 
6 for more detail) 
• MNE's are missing shareholder value building opportunities by not integrating transfer 
pricing up front in strategic business such as mergers, acquisitions, divestures, e-commerce 
and intellectual property management (see Table 6) with Germany (67 per cent) and Korea 
225 
(88 per cent) being the only countries that charge (in significant instances) intellectual 
property for tax and management purposes. 
• Two thirds of parent and half of subsidiaries have not considered the transfer pricing issues 
around their e-commerce activities (see Table 5). 
• Only eighteen per cent of MNE's that were involved in a recent merger used the 
opportunity to re-examine overall transfer pricing policies (see Table 5). Re-examination 
of transfer pricing policies provides opportunities to co-ordinate and ensure tax efficient 
transfer pricing policies 
The proposition of a comparable approach and specifically a CATPM based on the arm's length 
principle has tremendous value, and in particular for the: 
• management of multinational enterprises, 
• professional advisory firms and 
• tax authorities. 
Transfer pricing is by nature non-exact. By virtue of accepting the non-exact nature of transfer 
pricing, ambiguity and subjective analysis are argued away with reference to the acceptance of the 
non-exact nature of transfer pricing. The proposition put forward by the CATPM (see section 4.4) 
unveils the true dynamics of transfer pricing, albeit that the arm's length principle (refer to 1.6.1 
for a definition) is based on what would have been amongst connected and unconnected parties. 
The first proposition of the arm's length principle, "what would have been" is where the CATPM 
provides significant insight. In determining the degree of comparability, including the adjustments 
required to establish it, an understanding of how unrelated companies evaluate potential 
transactions is required. The "what would have been" hypothesis is based on unconnected parties, 
when evaluating the terms of a potential transaction, will compare the transaction to the other 
options realistically available to them (such as profit maximisation or loss minimisation), and they 
will only enter into the transaction if they see no alternative that is clearly more attractive. 
The arm's length consideration is equal to the consideration an unconnected party receives from a 
transaction that it derives the utmost benefit from. The determination of the arm's length 
consideration is in effect the determination of the utmost benefit (measured by profitability) 
226 
unconnected parties receive and extrapolate it to the transaction amongst connected parties. In the 
determination of the arm's length consideration under the current approach, ZA Case 01 does not 
derive a result (see 5.4.4.1) that is consistent with the arm's length consideration for the years 
1997 through to 2002 (excluding 1999). The analysis does not provides any indication of the risk 
identified in the functional analysis of ZA Case 01 (refer to section 5.3.6 for the analysis) that 
could be influential in the relative level of profitability ZA Case 01 realised. 
The adjustment for the transfer pricing of goods amounts according to the current approach results 
in an adjustment of R 68 million for a total taxation adjustment of R 86 million (inclusive of the 
adjustment for financial assistance which falls outside the scope of this research). By making use 
of bond yields, to reflect country or market differences, the transfer pricing adjustment amounts to 
R 90 million (see section 5.4.5.2). 
The current approach lacks in objectively determining the positioning of the transfer pricing 
adjustment (see section 5.4.5.1). In imposing the bond yield differential to ZA Case 01, at a 
minimum (risk free rate is appropriate return without any premium on increased risk) ZA Case 01 
can be viewed with reference to the EU comparable dataset (refer to Table 46 ). This positioning 
is based on the premise that an investor would at least expect ZA Case 01 to return equal or bigger 
than the bond yield rate. The more than or bigger is unquantifiable, hence the minimum return is 
determined and positioning in the arm's length range so determined. 
The CATPM approach make use of a variety of factors (refer to section 4.4.1 and 4.5.2.1) that 
measures risk insofar as it is significant in the estimation of profitability, the arm's length 
consideration. Applying the CATPM to the data concerning ZA Case 01 and making use of 
explanatory variables (factors that impact on profitability) in determining the response variable 
(profit level indicator, NCP), the arm's length consideration is a function of functions performed, 
assets used and risk assumed. 
In order to further test this approach, the CATPM was designed to conceptualise comparability 
insofar as risk identified by using regression analysis to estimate the arm's length consideration. 
In addition to the hypothetical arm's length consideration, the CATPM is used to determine the 
position of the tested party within the constraints of the arm's length range (see section Appendix 
7.2). 
227 
An arm's length consideration according to the CATPM estimates that ZA Case 01 should earn an 
estimated NCP of 11.28 per cent (see Appendix 7.2). This is a significant observation seen in light 
that when applying the bond yield as an indicator for the difference in market risk (country risk 
premium), the bond yield adjusted NCP (refer to Table 45 for details) amounts to 10.25 per cent at 
the third quartile, the position of ZA Case 01 according to the positioning analysis (refer to 
Appendix 7.2 where the third quartile calculations is disclosed). 
When applying the bond yield as an indicator, the conservative assumption is that a comparable 
company would at least earn return (profit) equal to the bond yield over time. Usually, companies 
are exposed to more risk than a bond yield; hence, one would expect returns in excess of the bond 
yield. Applying the CATPM, the premium over the bond yield is (11.28 % less 10.25%) 1.03%, 
which seems reasonable in the circumstances. 
Another contribution of the CATPM is that objectively, ZA Case 01 should not be adjusted to the 
mid-point of the inter-quartile (arm's length range) as suggested by the South African PN 7. In 
making use of the explanatory variables (inventory, receivables and liquidity), an estimation of the 
response variable (NCP) is possible. In applying the coefficients determined by a multiple 
regression model to the explanatory variables of ZA Case 01, it is established that ZA Case 
position within the arm's length range is at the third quartile (refer to Appendix 7.2 for details). 
6.1.1 Specific conclusions on arm's length consideration 
The current approach is based on determining comparable companies to ZA Case 01. The basis of 
comparability is the interpretation of the facts established by the functional analysis. The 
functional analysis (see section 5.3.3) identifies the significant functions, assets and risk assumed 
by ZA Case 01. Quantification of the functions performed, assets used and risk assumed is based 
on a combination of qualitative and quantitative factors (see sections 5.4.3.1 and 5.4.3.2). 
In determining the arm's length consideration according to the current approach, subjectivity in the 
selection of the comparables of ZA Case 01, and in particular the comparability analysis steps 
tabled in Table 36 through to Table 38 is dependent on the experience of the analyst. The 
interpretation of the most significant functions in the MNE's operations that would entitle the 
member of the MNE that performs the significant functions should be entitled to the major share 
228 
of the profit emphasises further consideration to what is significant and to what extent significance 
influences profitability and comparability. 
Management of MNE's, professional advisors and tax administrations are expected to exercise 
judgment and discretion, which give, rise to subjectivity and ambiguity. Furthermore, the 
adjustment to transactions of MNE's is not ambiguous (see sections 5.4.4.1 and 5.4.5.2). It is not 
surprisingly that a concerted effort should be made to clarify subjectivity and ambiguity. In this 
regard, the CATPM is based on a comparable dataset without any analyst interpretation of 
qualitative inclusion criteria (see section 5.4.3.2). The CATPM provides an alternative objective 
approach with specific outcomes such as: 
• Improving the comparability analysis by using ratio analysis. Ratios or the relevant profit 
level indicators provides measures of functions, assets and risks, to use the information 
contained in financial statements and to guide the analysis of comparables; even in the 
absence of industry comparables (see section 4.4.1). 
• Enhancing comparability analysis by estimating weights that determine the quantitative 
impact of mutually exclusive and collectively exhaustive ("MECE") ratios on profitability 
(see sections 4.5.2 and 5.5.3.4). 
• Enhancing the comparability analysis through providing an objective measure based on 
regression techniques to produce point estimates of the arm's length consideration relative 
to the inter-quartile range (see and Appendix 7.2 ). 
Working capital adjustments (refer to section 4.3.3) in conjunction with the CATPM provides a 
measure to enhance comparability to factors that influences profitability. In the event that the 
CATPM indicates that inventory, receivables or payables are significant explanatory variables in 
estimating the response variable (profitability), adjustments to reflect the time value of money on 
either the price of goods (sales) or cost (cost of sales) is imperative. Currently, adjustments are 
made without any substantiating evidence on the actual reasons behind the adjustments. 
6.2 Recommendations 
The unavailability of comparable information on which a South African transfer pricing analysis is 
based is well known. Comparability analyses in South Africa are based on information obtained 
229 
from foreign sourced databases, such as Amadeus that is used in this research. In order to 
overcome the data constraints experienced, the following is recommended: 
• Change the Company Act that makes it a statutory requirement for companies to file their 
financial statements publicly, on a unconsolidated as well as a consolidated basis, 
irrespective if it is a private or public company 
• Establish a South African database that contains information on South African companies 
covering at least the following information: 
o Company name 
o Industry classification 
o Trade description 
o Activities undertaken 
o Complete financial statements on an unconsolidated and consolidated basis 
o Management information such as directors, ownership, auditors 
o If listed, share price information, sector on the securities exchange, primary and 
secondary listing particulars 
• Recall PN 7 and PN 2 that provides guidelines and safe harbours that are vague and 
contributes to ambiguity 
• Legislate transfer pricing documentation (at least the policy) and make it a statutory record 
requirement 
6.2.1 Recommendation for further research 
6.2.1.1 Establishment of CATPM database 
In order to minimise uncertainty and ambiguity currently experienced in transfer pricing 
administration, the CATPM can be used to provide clarity on the following: 
• Categorisation of the South African economy on a functional basis, i.e., manufacturing, 
logistics, services, wholesale, retail, etc. 
• Determination of sectors and sub-sectors, i.e., manufacturing, pharmaceutical, ethical, etc. 
230 
• Determination of thresholds or norms with respect to entity characterisation, i.e., 
manufacturing, fully fledged manufacturer to a toll manufacturer 
• Determine explanatory variables for different sectors, entities,etc. 
6.2.1.2 Market forms 
One shortcoming in the application of the arm's length principle is that the reward consistent with 
the arm's length standard is based on a comparison of unconnected party dealings in a competitive 
market model. However, MNE's operate in various markets structuresand adjustments to emulate 
the forces of competition on pricing or profits are not performed. 
Transfer pricing under less than perfect competitive structures such as monopolistic and 
oligopolistic market conditions is not considered in this research. The impact of the prevalence of 
these market conditions on transfer pricing has not been explored. 
6.2.1.3 Levels of Economic Development 
Consideration of transfer pricing in developed and developing economies is another field of 
research that has not been undertaken. The only exception to this criticism with regards to the lack 
of competition measurement in transfer pricing insofar as prices is by applying the comparable 
uncontrolled price and the comparable uncontrolled transaction methods. 
6.2.1.4 Impact of tax havens on MNE's effective tax rate 
The impact of harmful tax competition or tax havens is not investigated in this research. However, 
international business structures involving these tax havens are common; all MNE's does cite 
business reasons for the establishment and continuous business dealings through it. 
This investigation does not explore the commerciality thereof. An empirical investigation aimed 
at identifying the commercial benefits tax havens provides to the MNE's in the advent of greater 
tax harmonisation and equalisation of corporate tax rates will add tremendous value to current 
literature. 
6.2.1.5 Profit split transfer pricing methodology 
Uncertainty with regards to the profit split method or the lack of use (refer to Figure 17 and Table 
10 where the profit split is compared to the other methodologies) should not deter research on the 
231 
appropriateness of the method. International trade transactions are increasing and the lack of 
objective measures to separate transactions would increase the potential use of the profit split. The 
aim of this research is not to find possible alternative profit split applications, however cognisance 
of alternative approaches with the approaches that is discussed in Appendix 7.3 is worthwhile 
researching. 
6.2.1.6 Ethical Dimension 
In conclusion, the ethical dimensions from a managerial point of view also warrant further 
research. Ultimately, a type of code of good conduct in the field of transfer rpcing is needed. 
232 
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Appendix 1. Branches of foreign entities operating in South 
Africa 
Company Name Domicile Industry 
1st Floor The Gabba Bryanston Services 
ABN AMRO Bank NV Johannesburg Banking/Finance 
ACNieisen SA BV and Nielsen Media Research Southdale Services 
Action Equipment Company Edenglen Services 
Actis Saxonwold Banking/Finance 
Africa X-Ray Industrial & Medical (AXIM) Halfway House Services 
African Bank Ltd Halfway House Banking/Finance 
A.qence Francaise De Development AFD Sandton Bankinq/Finance 
AHl Menlo Park Bankinq/Finance 
AH I Menlo Park Services 
ATIC Services Westhoven Services 
Babcock Plant & Equipment Bloemfontein Services 
Banca di Roma Sandton Bankinq/Finance 
Banco Espirito Santo Bruma Bankinq/Finance 
Bandaq Inc South Africa Edenvale Services 
Bank of Baroda Durban Bankinq/Finance 
Bank of Tokyo-Mitsubishi Ltd, The Sandton Banking/Finance 
Barra International Ltd Newlands Bankinq/Finance 
Belqolaise Bank Benmore Bankinq/Finance 
Bell Dewar & Hall Inc Houghton Services 
Bisset Boehmke McBIain Attorneys Cape Town Services 
Buchanan Boyes Smith Tabata Attorneys bb Cape Town Services 
Byers Auto Glass Kenwyn Services 
Bytes Specialised Solutions Johannesburg Services 
Canadian High Commission Trade Office Parklands Services 
Daewoo International Corporation Johannesburg Branch Sandton Services 
Deneys Reitz Inc Sandton Services 
Det Norske Veritas Roggebaai Services 
Dresdner Kieinwort Wasserstein Johannesburg Bankinq/Finance 
Emerging Markets Partnership - Southern Africa Braamfontein Banking/Finance 
Fintrex Craiqhall Services 
Forge Ahead Gautenq Services 
Forklift Specialities Pinetown Services 
French South African Trade Development Corporation Cc-
FRANSA Craiqhall Services 
Fujitsu Services Johannesburg Services 
Goldman Judin Maisels Inc Sandton Services 
Goldman Sachs International Benmore Banking/Finance 
Habib Overseas Bank Ltd Marshalltown Banking/Finance 
Hahn & Hahn Inc Hatfield Services 
HBZ Bank Ltd Qualbert Banking/Finance 
Hentrich Bergs & Associates Johannesburg Services 
IIR - Institute for International Research Parklands Services 
IMS Health International Johannesburg Services 
ING South Africa Benmore Banking/Finance 
239 
Company Name Domicile Industry 
Interlink Translation Services Roosevelt Park Services 
JP Morgan Chase Johannesburg Banking/Finance 
JP Morgan Chase Johannesburg Services 
KLM Royal Dutch Airlines Johannesburg Services 
Leaders Unlimited Korn/Ferry International Sandton Services 
Lowe Bull Bryanston Services 
Maison Francaise Du Cap - French Business Centre Gardens Services 
Mitsubishi Corporation Sandton Banking/Finance 
Nets oft Inc 
Umhlanga 
Rocks Services 
Ogilvy Durban Services 
Only The Best Cresta Services 
Open Trade Training Centre Dersley Services 
P&H MinePro Services Johannesburg Services 
Regus International Gallo Manor Services 
Reg us International Durban Services 
Relocation Africa Claremont Services 
Rennie Murray & Co Pty Ltd Durban Banking/Finance 
Rentokil Initial Clareinch Services 
Safcor Panalpina Johannesburg Services 
Saitex Cresta Services 
Search Partners International Johannesburg Services 
SITAINC Johannesburg Services 
Sofema Centurion Services 
South African Bank of Athens Ltd Johannesburg Banking/Finance 
Standard Chartered Bank SA Sandton Banking/Finance 
State Bank of India Rosebank Banking/Finance 
Stewart Scott International Sandton Services 
Sumitomo Mitsui Banking Corporation Bryanston Banking/Finance 
Top Reizen North riding Services 
Travel Insurance Consultants Cramerview Services 
UCB Braamfontein Services 
WestLB AG Johannesburg Banking/Finance 
Wolff Neuhaus & Co 
Highlands 
North Banking/Finance 
Wolff Neuhaus & Co 
Highlands 
North Services 
Young & Rubicam Woodmead Services 
Appendix 2. Industry classification 
Appendix 2.1. Industry classification on Amadeus database 
Bureau van Dijk Electronic Publishing (BvDEP) has developed a detailed cross-reference system 
linking multiple national and international industry classification systems from around the world. 
This unique cross-referencing system provides BvDEP databases with the most accurate cross-
border industry searching and analysis possible. 
Each country uses one industrial classification system as its national system for cataloguing the 
industries of the companies filing accounts with the official registries. All company accounts 
filed in a given country, therefore, indicate the company's activities with this national code, 
whether it is a code unique to that country or a widely used international code. The national 
codes relevant for companies on the AMADEUS databases are listed in the table below, along 
with the three international codes (NACE 1.1, US SIC, NAICS) used in the cross-reference 
system. 
Table 52: Amadeus database industiy classification sources 
Code Description Countries covered 
M a x No. 
of digits 
NACE Rev 
1.1 
Nomenclature statistique des activites 
economiques dans la Communaute 
europeenne 23 European countries 4 
US SIC Standard Industrial Classification 
International Code and National Code 
for: USA & 145 non European 
countries 4 
NAICS 2002 
North American Industry Classification 
System (2002) 
International Code and National Code 
for USA listed companies 6 
UK SIC 2003 Standard Industrial Classification United Kingdom 5 
NAF Nomenclature d'Activites Franchises France 4 
WZ 2003 
Klassifikation der Wirtschaftszweige 
vom Statistischen Bundesamt aus der 
Revision von 2003 Germany/Austria 51 
ATECO 2002 
Classificazione delle attivita 
economiche (2002) Italy 5 
CNAE 
Clasificacion Nacional de Actividades 
Economicas Spain/Portugal 4 
BIK 
Bedrijfsindeling Kamers van 
Koophandel Netherlands 6 
NACE-BEL 
Nomenclature generate des Activites 
economiques en Belgique Belgium 5 
SNI-SE Svensk Naringsgrenslndelning Sweden 5 
(Source: Bureau van Dijk, :2003 Amadeus Database No. 105) 
241 
Appendix 2.2. NACE Revision 1.1 Industry classification 
All the national industry codes used on the database are cross linked together using the 
international NACE- revsion 1.1 codifications as a reference. Any individual national code 
selected will search the whole database and will not be limited to those companies which have 
been assigned that code. The comprehensive list of the NACE Rev. 1.1 codifications used in thes 
research is as tabled in 
Table 53: NACE Revision 1.1 Codes 
NACE Rev 
1.1 Code Definition 
01 Agriculture, hunting and related service activities 
Oil Growing of crops; market gardening; horticulture 
0111 Growing of cereals and other crops not elsewhere specified 
0112 Growing of vegetables, horticultural specialties and nursery products 
0113 Growing of fruits, nuts, beverage and spice crops 
012 Farming of livestock 
0121 Farming of cattle, sheep, goats, horses, asses, mules and hinnies; dairy farming 
0122 Other livestock farming; production of animal products not elsewhere specified 
013 Growing of crops combined with farming of livestock (mixed farming) 
014 Agricultural and animal husbandry service activities, except veterinary activities 
015 Hunting, trapping and game propagation including related service activities 
02 Forestry, logging and related service activities 
05 Fishing, operation offish hatcheries and fish farms; service activities incidental to fishing 
10 Mining of coal and lignite; extraction of peat 
101 Mining and agglomeration of hard coal 
102 Mining and agglomeration of lignite 
103 Extraction and agglomeration of peat 
11 
Extraction of crude petroleum and natural gas; service activities incidental to oil and gas 
extraction excluding surveying 
111 Extraction of crude petroleum and natural gas 
112 Service activities incidental to oil and gas extraction excluding surveying 
12 Mining of uranium and thorium ores 
13 Mining of metal ores 
131 Mining of iron ores 
132 Mining of non-ferrous metal ores, except uranium and thorium ores 
14 Other mining and quarrying 
141 Quarrying of stone, sand and clay 
142 Mining and quarrying not elsewhere specified 
1421 Mining of chemical and fertilizer minerals 
1422 Extraction of salt 
1429 Other mining and quarrying not elsewhere specified 
15 Manufacture of food products and beverages 
151 Production, processing and preservation of meat fish, fruit, vegetables, oils and fats 
1511 Production of meat and meat products 
1512 Processing and preserving of fish and fish products 
242 
NACE Rev 
1.1 Code Definition 
1513 Processing of fruit and vegetables 
1514 Manufacture of vegetable and animal oils and fats 
152 Manufacture of dairy products 
153 
Manufacture of grain mill products, starches and starch products, and prepared animal 
feeds 
1531 Manufacture of grain mill products 
1532 Manufacture of starches and starch products 
1533 Manufacture of prepared animal feeds 
154 Manufacture of other food products 
1541 Manufacture of bakery products 
1542 Manufacture of sugar 
1543 Manufacture of cocoa, chocolate and sugar confectionery 
1544 Manufacture of macaroni, noodles, couscous and similar farinaceous products 
1549 Manufacture of other food products not elsewhere specified 
155 Manufacture of beverages 
1551 
Distilling, rectifying and blending of spirits; ethyl alcohol production from fermented 
materials 
1552 Manufacture of wines 
1553 Manufacture of malt liquors and malt 
1554 Manufacture of soft drinks; bottling of mineral waters 
16 Manufacture of tobacco products 
17 Manufacture of textiles 
171 Spinning, weaving and finishing of textiles 
1711 Preparation and spinning of textiles fibres; weaving of textiles 
1712 Finishing of textiles 
172 Manufacture of other textiles 
1721 Manufacture of made-up textile articles, except apparel 
1722 Manufacture of carpets and rugs 
1723 Manufacture of cordage, rope; twine and netting 
1729 Manufacture of other textiles not elsewhere specified 
173 Manufacture of knitted and crocheted fabrics and articles 
18 Manufacture of wearing apparel; dressing and dyeing of fur 
181 Manufacture of wearing apparel, except fur apparel 
182 Dressing and dyeing of fur; manufacture of articles of fur 
19 
Tanning and dressing of leather; manufacture of luggage, handbags, saddlery, harness 
and footwear 
191 Tanning and dressing of leather; manufacture of luggage, handbags and harness 
1911 Tanning and dressing of leather 
1912 Manufacture of luggage, handbags and the like, saddlery and harness 
192 Manufacture of footwear 
20 
Manufacture of wood and of products of wood and cork, except furniture; manufacture of 
articles of straw and plaiting materials 
201 Sawmilling and planing of wood 
202 Manufacture of products of woods, cork straw and plaiting materials 
2021 
Manufacture of veneer sheets; manufacture of plywood, laminatedboard, particle board 
and other panels and boards 
243 
NACE Rev 
1.1 Code Definition 
2022 Manufacture of builders' carpentry and joinery 
2023 Manufacture of wooden containers 
2029 
Manufacture of other products of wood; manufacture of articles of cork, straw and 
plaiting materials 
21 Manufacture of paper and paper products 
2101 Manufacture of pulp, paper and paperboard 
2102 
Manufacture of corrugated paper and paperboard and of containers of paper and 
paperboard 
2109 Manufacture of other articles of paper and paperboard 
22 Publishing, printing and reproduction of recorded media 
221 Publishing 
2211 Publishing of books, brochures, musical books and other publications 
2212 Publishing of newspapers, journals and periodicals 
2213 Publishing of recorded media 
2219 Other publishing 
222 Printing and service activities related to printing 
2221 Printing 
2222 Service activities related to printing 
223 Reproduction of recorded media 
23 Manufacture of coke, refined petroleum products and nuclear fuel 
231 Manufacture of coke oven products 
232 Manufacture of refined petroleum products 
233 Processing of nuclear fuel 
24 Manufacture of chemicals and chemical products 
241 Manufacture of basic chemicals 
2411 Manufacture of basic chemicals, except fertilizers and nitrogen compounds 
2412 Manufacture of fertilizers and nitrogen compounds 
2413 Manufacture of plastics in primary forms and of synthetic rubber 
242 Manufacture of other chemical products 
2421 Manufacture of pesticides and other agro-chemical products 
2422 Manufacture of paints, varnishes and similar coatings, printing ink and mastics 
2423 Manufacture of pharmaceuticals, medicinal chemicals and botanical products 
2424 
Manufacture of soap and detergents, cleaning and polishing preparations, perfumes and 
toilet preparations 
2429 Manufacture of other chemical products not elsewhere specified 
243 Manufacture of man-made fibers 
25 Manufacture of rubber and plastic products 
251 Manufacture of rubber products 
2511 Manufacture of rubber tyres and tubes; retreading and rebuildling of rubber tyres 
2519 Manufacture of other rubber products 
252 Manufacture of plastic products 
26 Manufacture of other non-metallic mineral products 
261 Manufacture of glass and glass products 
269 Manufacture of non-metallic mineral products not elsewhere specified 
2691 Manufacture of non-structural non-refractory ceramic ware 
2692 Manufacture of refractory ceramic products 
244 
NACE Rev 
1.1 Code Definition 
2693 Manufacture of structural non-refractory clay products 
2694 Manufacture of cement, lime and plaster 
2695 Manufacture of articles of concrete, cement and plaster 
2696 Cutting, shaping and finishing of stone 
2699 Manufacture of other non-metallic mineral products not elsewhere specified 
27 Manufacture of basic metals 
271 Manufacture of basic iron and steel 
272 Manufacture of basic precious and non-ferrous metals 
273 Casting of metals 
2731 Casting of iron and steel 
2732 Casting of non-ferrous metals 
28 Manufacture of fabricated metal products except machinery and equipment 
281 Manufacture of structural metal products, tanks reservoirs and steam generators 
2811 Manufacture of structural metal products 
2812 Manufacture of tanks, reservoirs and containers of metal 
2813 Manufacture of steam generators, except central heating hot water boilers 
289 
Manufacture of other fabricated metal products; service activities to producers of 
fabricated metal products 
2891 Forging, pressing, stamping and roll-forming of metal; powder metallurgy 
2892 Treatment and coating of metals; general mechanical engineering on fee or contract basis 
2893 Manufacture of cutlery, hand tools and general hardware 
2899 Manufacture of other fabricated metal products not elsewhere specified 
29 Manufacture of machinery and equipment not elsewhere specified 
291 Manufacture of general purpose machinery 
2911 Manufacture of engines and turbines, except aircraft, vehicle and cycle engines 
2912 Manufacture of pumps, compressors, taps and valves 
2913 Manufacture of bearings, gears, gearing and driving elements 
2914 Manufacture of ovens, furnaces and furnace burners 
2915 Manufacture of lifting and handling equipment 
2919 Manufacture of other general purpose machinery 
292 Manufacture of special purpose machinery 
2921 Manufacture of agricultural and forestry machinery 
2922 Manufacture of machine-tools 
2923 Manufacture of machinery for metallurgy 
2924 Manufacture of machinery for mining, quarrying and construction 
2925 Manufacture of machinery for food, beverage and tobacco processing 
2926 Manufacture of machinery for textile, apparel and leather production 
2927 Manufacture of weapons and ammunition 
2929 Manufacture of other special purpose machinery 
293 Manufacture of domestic appliances not elsewhere specified 
30 Manufacture of office, accounting and computing machinery 
31 Manufacture of electrical machinery and apparatus not elsewhere specified 
311 Manufacture of electric motors, generators and transformers 
312 Manufacture of electricity distribution and control apparatus 
313 Manufacture of insulated wire and cable 
314 Manufacture of accumulators, primary cells and primary batteries 
245 
NACE Rev 
1.1 Code Definition 
315 Manufacture of electric lamps 
319 Manufacture of other electrical equipment not elsewhere specified 
32 Manufacture of radio, television and communication equipment and apparatus 
321 Manufacture of electronic valves and tubes and other electronic components 
322 
Manufacture of television and radio transmitters and apparatus for line telephony and line 
telegraphy 
323 Manufacture of television and radio receivers and associated consumer goods 
33 Manufacture of medical, precision and optical instruments, watches and clocks 
331 
Manufacture of medical appliances and instruments and appliances for measuring, 
checking, testing, navigation and other purposes, except optical instruments 
3311 Manufacture of medical and surgical equipment and othopaedic appliances 
3312 
Manufacture of instruments and appliances for measuring, checking, testing, navigation 
and other purposes, except industrial process control equipment 
3313 Manufacture of industrial process control equipment 
332 Manufacture of optical instruments and photographic equipment 
333 Manufacture of watches and clocks 
34 Manufacture of motor vehicles, trailers and semi-trailers 
341 Manufacture of motor vehicles 
342 
Manufacture of bodies (coachwork) for motor vehicles; manufacture of trailers and semi­
trailers 
343 Manufacture of parts and accessories for motor vehicles and their engines 
35 Manufacture of other transport equipment 
351 Building and repairing of ships and boats 
3511 Building and repairing of ships 
3512 building and repairing of pleasure and sporting boats 
352 Manufacture of railways and tramway licomotives and rolling stock 
353 Manufacture of aircraft and spacecraft 
359 Manufacture of transport equipment not elsewhere specified 
3591 Manufacture of motorcycles 
3592 Manufacture of bicycles and invalid carriages 
3599 Manufacture of other transport equipment not elsewhere specified 
36 Manufacture of furniture; manufacturing not elsewhere specified 
361 Manufacturing of furniture 
369 Manufacturing not elsewhere specified 
3691 Manufacture of jewellery and related articles 
3692 Manufacture of musical instruments 
3693 Manufacture of sport goods 
3694 Manufacture of games and toys 
3699 Other manufacturing not elsewhere specified 
37 Recycling 
371 Recycling of metal waste and scrap 
372 Recycling of non-metal waste and scrap 
40 Electricity, gas, steam and hot water supply 
401 Production, collection and distribution of electricity 
402 Manufacture of gas; distribution of gaseous fuels through mains 
403 Steam and hot water supply 
246 
NACE Rev 
1.1 Code Definition 
41 Collection, purification and distribution of water 
45 Construction 
451 Site preparation 
452 Building of complete constructions or parts thereof; civil engineering 
453 Building installation 
454 Building completion 
455 Renting of construction or demolition equipment with operator 
50 
Sale, maintenance and repair of motor vehicles and motorcycles; retail sale of automotive 
fuel 
501 Sale of motor vehicles 
502 Maintenance and repair of motor vehicles 
503 Sale of motor vehicle parts and accessories 
504 Sale, maintenance and repair of motorcycles and related parts and accessories 
505 Retail sale of automotive fuel 
51 Wholesale trade and commission trade, except of motor vehicles and motorcycles 
511 Wholesale on a fee or contract basis 
512 Wholesale of agricultural raw materials, live animals, food, beverages and tobacco 
5121 Wholesale of agricultural raw materials and live animals 
5122 Wholesale of food, beverages and tobacco 
513 Wholesale of household goods 
5131 Wholesale of textiles, clothing and footwear 
5139 Wholesale of other household goods 
514 Wholesale of non-agricultural intermediate products, waste and scrap 
5141 Wholesale of solid, liquid and gaseous fuels and related products 
5142 Wholesale of metals and metal ores 
5143 
Wholesales of construction materials, hardware, plumbing and heating equipment and 
supplies 
5149 Wholesale of other intermediate products, waste and scrap 
515 Wholesale of machinery, equipment and supplies 
519 Other wholesale 
52 
Retail trade, except of motor vehicles and motorcycles; repair of personal and household 
goods 
521 Non-specialized retail trade 
5211 Retail sale in non-specialized stores with food beverages or tobacco predominating 
5219 Other retail sale in non-specialized stores 
522 Retail sale of food, beverages and tobacco in specialized stores 
523 Other retail trade of new goods in specialialized stores 
5231 Retail sale of pharmaceutical and medical goods cosmetic and toilet articles 
5232 Retail sale of textiles, clothing, footwear and leather goods 
5233 Retail sale of household appliances, articles and equipment 
5234 Retail sale of hardware, paints and glass 
5239 Other retail sale in specialized stores 
524 Retail sale of second-hand goods in stores 
525 Retail trade not in stores 
5251 retail sale via mail order house 
5252 Retail sale via stalls and markets 
247 
NACE Rev 
1.1 Code Definition 
5259 Other non-store retail sales 
526 Repair of personal and household goods 
55 Hotels and restaurants 
551 Hotels; camping sites and other provision of short-stay accommodation 
552 Restaurants, bars and canteens 
60 Lands transport; transport via pipelines 
601 Transport via railways 
602 Other land transport 
6021 Other scheduled passenger land transport 
6022 Other non-scheduled passenger land transport 
6023 Freight transport by road 
603 Transport via pipelines 
61 Water transport 
611 Sea and coastal water transport 
612 Inland water transport 
62 Air transport 
621 Scheduled air transport 
622 Non-scheduled air transport 
63 Supporting and auxiliary transport activities; activities of travel agencies 
6301 Cargo handling 
6302 Storage and warehousing 
6303 Other supporting transport activities 
6304 Activities of travel agencies, tour operators and tourist guides 
6309 Activities of other transport agencies 
64 Post and telecommunication 
641 Post and courier activities 
6411 National post activities 
6412 Courier activities other than national post activities 
642 Telecommunication 
65 Financial intermediation, except insurance and pension funding 
651 Monetary intermediation 
6511 Central banking 
6519 Other monetary intermediation 
659 Other financial intermediation 
6591 Financial leasing 
6592 Other credit granting 
6599 Other financial intermediation not elsewhere specified 
66 Insurance and pension funding, except compulsory social security 
6601 Life insurance 
6602 Pension 
6603 Non-life insurance 
67 Activities auxiliary to financial intermediation 
671 Activities auxiliary to financial intermediation except insurance and pension funding 
6711 Administration of financial markets 
6712 Security dealind activities 
6719 Activities auxiliary to financial intermediation not elsewhere specified 
248 
NACE Rev 
1.1 Code Definition 
672 Activities auxiliary to insurance and pension funding 
70 Real estate activities 
701 Real estate activities with own or leased property 
702 Real estate activities on a fee or contract basis 
71 
Renting of machinery and equipment without operator and of personal and household 
goods 
711 Renting of transport equipment 
7111 Renting of land transport equipment 
7112 Renting of water transport equipment 
7113 Renting of air transport equipment 
712 Renting of other machinery and equipment 
7121 Renting of agricultural machinery and equipment 
7122 Renting of construction and civil engineering machinery and equipment 
7123 Renting of office machinery and equipment (including computer) 
7129 Renting of other machinery and equipment not elsewhere specified 
713 Renting of personal and household goods not elsewhere specified 
72 Computer and related activities 
721 Hardware consultancy 
722 Software consultancy and supply 
723 Data processing 
724 Data base activities 
725 Maintenance and repair of office, accounting and computing machinery 
729 Other computer related activities 
73 Research and development 
731 Research and development on natural sciences 
732 Research and development on social sciences and humanities 
74 Other business activities 
741 
Legal, accounting, book-keeping and auditing activities; tax consultancy; market research 
and public opinion polling; business and management consultancy 
7411 Legal activities 
7412 Accounting, book-keeping and auditing activities; tax consultancy 
7413 Market research and public opinion polling 
7414 Business and management consultancy activities 
742 Architectural, engineering and other technical activities 
7421 Architectural and engineering activities and related technical consultancy 
7422 Technical testing and analysis 
743 Advertising 
749 Business activities not elsewhere specified 
7491 Labour recruitment and provision of personnel 
7492 Investigation and security activities 
7493 Building-cleaning activities 
7494 Photographic activities 
7495 Packaging activities 
7499 Other business activities not elsewhere specified 
75 Public administration and defense; compulsory social security 
751 Administration of the state and the economic and social policy of the community 
249 
NACE Rev 
1.1 Code Definition 
7511 General (Over-all) public service activities 
7512 
Regulation of the activities of agencies that provide health care, education, cultural 
services and other social services excluding social security 
7513 Regulation of and contribution to more efficient operation of business 
7514 Ancillary service activities for the government as a whole 
752 Provision of services to the community as a whole 
7521 Foreign affairs 
7522 Defense activities 
7523 Public order and safety activities 
753 Compulsory social security activities 
80 Education 
801 Primary education 
802 Secondary education 
8021 General secondary education 
8022 Technical and vocational secondary education 
803 Higher education 
809 Adult and other education 
85 Health and social work 
851 Human health activities 
8511 Hospital activities 
8512 Medical and dental practice activities 
8519 Other human health activities 
852 Veterinary activities 
853 Social work activities 
8531 Social work with accommodation 
8532 Social work without accommodation 
90 Sewage and refuse disposal, sanitation and similar activities 
91 Activities of membership organizations not elsewhere specified 
911 Activities of business, employers and professional organizations 
9111 Activities of business and employers organizations 
9112 Activities of professional organizations 
912 Activities of trade unions 
919 Activities of other membership organizations 
9191 Activities of religious organizations 
9192 Activities of political organizations 
9199 Activities of other membership organizations not elsewhere specified 
92 Recreational, cultural and sporting activities 
921 Motion picture, radio and television and other entertainment activities 
9211 Motion picture and video production and distribution 
9212 Motion picture projection 
9213 Radio and television activities 
9214 Dramatic arts, music and other arts activities 
9219 Other entertainment activities not elsewhere specified 
922 News agency activities 
923 Libraries, archives, museums and other cultural activities 
9231 Libraries and archives activities 
250 
NACE Rev 
1.1 Code Definition 
9232 Museums activities and preservation of historical sites and buildings 
9233 Botanical and zoological gardens and nature reserves activities 
924 Sporting and other recreational activities 
9241 Sporting activities 
9249 Other recreational activities 
93 Other service activities 
9301 Washing, cleaning and dyeing of textile and fur products 
9302 Hairdressing and other beauty treatment 
9303 Funeral and related activities 
9309 Other service activities not elsewhere specified 
95 Private households with employed persons 
99 Extra-territorial organization and bodies 
(Source: Bureau van Dijk, :2003 Amadeus Database No. 105) 
251 
Appendix 3. Comparability Adjustment Transfer Pricing Model 
Appendix 3.1. CATPM origin 
Any hypothesis based on experience in transfer pricing, expertise in management or knowledge 
of economics can be tested using data from financial statements for companies that are 
comparables to a given tested party. The CAPM as documented in Brigham et al (1999: 155 -
234), transfer pricing principles as documented in the OECD Guidelines (1995: 1-1 - 111-24) and 
PN 7 (South Africa 1999: 9 - 32) and the CATPM model's fundamentals are summarised in 
Table 54. 
The CAPM distinguishes amongst market or idiosyncratic risk and systematic or diversifiable 
risk with beta coefficient being the systematic risk measurement (refer to section 4.3.5.2 where 
the beta coefficient concept has been discussed). Market risk is measured by variables such as 
bond yields and no consideration to what influences such market risk is provided (Brigham et al 
1999: 185, 187). Measurement errors could influence the results, with the errors originating from 
errors in return measurement, beta coefficient calculations and market indices which can be used 
to determine the market risk and its commensurate return. 
It could be argued that the CAPM's ability to predict the returns of a company by virtue of the 
diversifiable or systematic risk it is exposed to by the beta coefficient measure, is sufficient to 
identify and quantify risk for transfer pricing purposes. Transfer pricing, and the arm's length 
principle, which is founded on comparability requires that the conditions of the affected 
transaction and the conditions it is being compared to must be comparable, in essence the same. 
In order to achieve this objective, total risk must be measured rather than the sole reliance on 
systematic or diversifiable risk, as measured by beta coefficient. In undertaking a comparability 
analysis, data on which such an analysis is based can vary across geographical markets hence, 
market or idiosyncratic risk becomes material in the determination of the arm's length principle. 
This need of measuring total risk, decomposed in its identifiable, separate components is what the 
CATPM aims to achieve. 
The fundamentals of the various approaches are summarised according to the basis of the 
methodology, data use, model equation in mathematic notation, model description and 
classification of risk. The portfolio concept of the CAPM (Brigham et al 1999: 183) is included 
252 
in the summary due to fact the CAPM is measuring profitability in terms of risk. Risk according 
to the CAPM consists of market and diversifiable risk with market risk being treated as a constant 
and diversifiable risk as a variable indicative of profitability (Brigham et al 1999: 186). In 
contrast to the CAPM, transfer pricing is concerned with risk based on functionality and the 
CATPM with total risk that influences profitability. 
Table 54: Transfer pricing model comparison 
Capital Asset Pricing 
Model 
Transfer Pricing International 
Standard 
Comparability Adjustment 
Transfer Pricing Model 
Basis of the 
methodolog 
y 
Determine the expected 
return on assets. Not 
restricted to connected 
parties 
Determine the arm's length 
consideration for transactions 
amongst connected parties, based 
on functions performed, assets 
used and risk assumed. 
Determine the arm's length 
consideration for transactions 
amongst connected parties, 
incorporating functionality, asset 
use and risk assumed albeit that 
the premise is that price is the 
difference amongst cost and 
market prices. 
Data Quantitative Quantitative and qualitative Quantitative and qualitative 
Model 
Equation 
*?=**+(*:-**)#+£, ALC? = pli° which is a 
function of 
foxAf)(AxA?)(tfxA?)) 
af=P,ql-Cl 
Model 
description 
Determine the expected 
return k°e as the sum of the 
risk free return k i in the i 
industry and the market risk 
premium [k'm - f c ^ J f t , 
where fc° is the market 
return in industry i and j3. 
is the beta coefficient value 
of the industry in which the 
company a operates (market 
volatility) with £. being an 
adjustment factor. 
The arm's length consideration 
ALC? is the profit level 
indicator pli; which can be based 
on an inter quartile range or an 
uncontrolled comparable price 
which is determined by the 
functions performed Ft and 
comparability adjustment A(. , 
assets used A,- and comparability 
A A 
adjustment A . and risk assumed 
Rj and comparability adjustment 
The transfer pricing model 
determines the arm's length 
consideration CX? as the 
difference amongst the cost 
C. and the product amongst the 
price P. and quantity q; of 
products sold. 
Classificatio 
n of risk 
Risk is measured by 
variance, which is in turn 
classified according to 
market or systematic risk 
and unsystematic risk. 
Systematic or market risk is 
associated with the variation 
in the market whilst on the 
other hand unsystematic risk 
is independent of the 
market, often referred to 
idiosyncratic risk 
Risk could be measured in terms 
of variance. In general, 
adjustments are made only to 
affect comparability. No 
adjustment examples are made; 
reference is made that 
adjustments could be based on 
adjusting for characteristics in 
terms of the transactions, 
functions, contractual terms, 
economic conditions and 
business strategies. 
Risk is measured in terms of its 
variance. Risk is generally 
referred to in terms of total 
transactional risk, the risk 
involved in engaging in a specific 
transaction. Variance in price 
and quantity and cost provides a 
measure of market and 
idiosyncratic risk, similar to the 
CAPM model. Market risk is 
associated with variations in 
prices whilst idiosyncratic risk is 
independent of the market as a 
whole. 
253 
Capital Asset Pricing 
Model 
Transfer Pricing International 
Standard 
Comparability Adjustment 
Transfer Pricing Model 
Impact on 
market risk 
Diversification can lead to 
an averaging of systematic 
or market risk 
Market risk is adjusted for 
insofar as it can be identified and 
accurate adjustment is made to 
comparables to reflect it. 
Hence it could reduce it but not 
eliminate or be regarded as an 
average "risk". The efficient 
market hypothesis is not 
appropriate for all transactions. 
Impact on 
idiosyncrati 
c risk 
Diversification can reduce 
unsystematic risk or 
idiosyncratic risk to near 
zero. 
Can be adjusted insofar as being 
identified and accurate 
adjustments can be made to 
comparables to reflect it. 
Diversification can reduce 
unsystematic risk or idiosyncratic 
risk to near zero 
Value of 
application 
Focus is on systematic risk 
rather than total risk. 
Risk to be adjusted for is only 
appropriate insofar as to enhance 
comparability and accurate 
adjustments can be made 
Concern to systematic (market) 
as well as unsystematic 
(idiosyncratic)risk 
Source: Brigham et al (1999:155 - 234), OECD (1995: hi -111-24), South Africa (1999: 9 - 32) and own compilation 
254 
Appendix 4. CATPM Results 
Appendix 4.1. CATPM comparable PLI data NACE 341 and 342 
Year Company Name 
Net-cost-
plus 
EBIT 
Margin 
Return on 
total assets 
2002 ALSACE CONSTRUCTIONS CARROSSERTE 1.13% -1.74% -0.91% 
2002 ANDREOLIRIMORCHI 18.81% 24.90% 18.74% 
2002 ATRANSAB 3.47% 8.22% 3.00% 
2002 BALEIKE S.L. 8.71% 17.26% 8.81% 
2002 BASCULANTES PEPLN SA 0.97% 3.48% 1.51% 
2002 BOBO CAB SWEDEN AB 1.33% 2.17% 0.61% 
2002 CARROCERIAS DASAN SA 1.13% 1.19% 0.38% 
2002 CARROCERIAS FRANCISCO CASTELLO BROSETA SA 2.58% 5.16% 2.63% 
2002 CARROCERIAS SELNHNOS. S.L. 6.17% 17.33% 6.70% 
2002 
CARROSSERIE VEHICULES LNDUSTRIEL 
MELUNAISE 10.09% 29.42% 9.84% 
2002 CARROZZERIA OFFICINE S.MARCO 2.05% 3.63% 2.05% 
2002 ' CCC CONSTRUCTEUR 0.98% 3.01% 2.65% 
2002 CORBIN -14.23% -19.84% -15.98% 
2002 DALA LAMLNAT AB 6.97% 10.27% 5.27% 
2002 ETABLISSEMENT KOLLE 1.42% 3.14% 1.58% 
2002 ETS LEROUGE -1.90% -5.59% -1.97% 
2002 EUROLLFT SARL 2.32% 3.61% 2.39% 
2002 GROTHKAROSS AB -7.40% -38.04% -7.52% 
2002 HARSH LIMITED -1.30% -2.41% -1.93% 
2002 HERMANNS LBERICA SA 0.96% 2.57% 0.94% 
2002 M.D.M. INDUSTRIE 4.99% 8.84% 4.11% 
2002 MEKAUTOAB -0.27% -2.42% -0.56% 
2002 MOBIL BAGES SAL 9.65% 20.36% 9.17% 
2002 NOGE BUS FRANCE 4.26% 3.66% 3.32% 
2002 NORRLANDS VAGNAR AB 7.21% 18.32% 6.94% 
2002 OY LNNSOL AB 10.19% 29.72% 9.60% 
2002 PETIT LOCATION 27.40% 30.83% 28.49% 
2002 REKO TRAILER AB 9.78% 18.52% 8.53% 
2002 REMOLQUES HERMANOS GARCIA S.L. 4.38% 3.90% 3.74% 
2002 ROUERGUE CARROSSERIE INDUSTRIELLE 2.80% 3.18% 1.32% 
2002 SARL D'EXPLOITATTON DU GARAGE BERTA 3.36% 5.55% 3.36% 
2002 SARL HUWER HYDROVIDE 11.09% 14.85% 10.82% 
2002 SARL IFOR WILLIAMS FRANCE 0.16% 0.22% 0.10% 
2002 SOC COMMERCIALE PROMOTION DISTRIBUTION 9.04% 16.16% 6.80% 
2002 
STEINDUSTRIELLES DE VENTES ECHANGES 
LOCATIONS -2.76% -5.89% -3.67% 
255 
Year Company Name 
Net-cost-
plus 
EBIT 
Margin 
Return on 
total assets 
2002 STE ORNAISE DE CHAUDRONNERIE CAROSSERIE 4.78% 6.56% 4.46% 
2002 STE TECHNIQUE INDUSTRIELLE MERIDIONALE 4.63% 10.64% 4.92% 
2002 THERMOCON OY ELEMENT 20.32% 17.90% 19.41% 
2002 THIERRY -3.11% -10.07% -3.61% 
2002 UNICAR FURGONATURE S.P.A. 2.13% 2.41% 1.79% 
2002 UTILITAIRES PRO SERVICES UPS 5.07% 13.11% 4.98% 
2002 VEHICULES rNDUSTRLELS TRACTES 4.63% 1.02%; 1.36% 
2001 ALSACE CONSTRUCTIONS CARROSSERIE 6.87% 9.04% 4.85% 
2001 
AMENAGEMENT CARROSSERIE EQUIPEMENT DE 
VEHICULES -2.37% -8.22% -5.05% 
2001 ANDREOLIRIMORCHI 14.40% 22.07% 14.44% 
2001 ATRANS AB 4.40% 7.88% 3.64% 
2001 BALEIKE S.L. 9.10% 20.23% 9.15% 
2001 BASCULANTES PEPLN SA 0.33% 3.24% 1.28% 
2001 BOBO CAB SWEDEN AB 1.39% 2.66% 0.65% 
2001 CARROCERIAS DASAN SA 0.94% 1.11% 0.39% 
2001 CARROCERIAS FRANCISCO CASTELLO BROSETA SA 2.37% 3.26% 2.64% 
2001 CARROCERIAS LA JUNQUERA S.L. 3.54% 7.68% 2.39% 
2001 CARROCERIAS SEIN HNOS. S.L. 9.62% 32.21% 9.79% 
2001 
CARROSSERIE VEHICULES INDUSTRIEL 
MELUNAISE 10.95% 28.66% 10.57% 
2001 CARROZZERIA OFFICLNE S.MARCO 2.81% 6.79% 2.32% 
2001 CCC CONSTRUCTEUR 2.08% 4.30% 3.02% 
2001 CONSTRUCTIE VERGAUWE 12.23% 15.50% 12.23% 
2001 CORBLN 8.96% 5.50% 6.51% 
2001 DALA LAMLNAT AB 4.82% 9.37% 3.46% 
2001 ETABLISSEMENT KOLLE 7.09% 17.31% 7.25% 
2001 ETS LEROUGE 2.92% 6.71% 3.06% 
2001 EUROLIFT SARL 1.52% 3.52% 1.52% 
2001 FOKOR OY 1.08% 0.32% 0.18% 
2001 HARSH LIMITED 8.67% 12.56% 8.29% 
2001 M.D.M. INDUSTRIE -1.24% -4.35% -2.55% 
2001 MOBIL BAGES SAL 9.36% 38.38% 9.16% 
2001 NOGE BUS FRANCE 3.10% 0.53% 3.10% 
2001 NORRLANDSVAGNAR AB 6.46% 19.72% 6.12% 
2001 OYLNNSOLAB 6.47% 17.37% 5.77% 
2001 PETIT LOCATION 26.65% 34.46% 27.00% 
2001 RAPID CONTAINER SERVICES 0.16% 1.20% 0.49% 
2001 REKO TRAILER AB 10.39% 19.72% 9.42% 
2001 REMOLQUES HERMANOS GARCIA S.L. 4.50% 4.83% 4.37% 
2001 ROUERGUE CARROSSERIE INDUSTRIELLE 4.87% 8.15% 3.13% 
256 
Year Company Name 
Net-cost-
plus 
EBIT 
Margin 
Return on 
total assets 
2001 SARL D'EXPLOITATTON DU GARAGE BERTA 2.54% 10.22% 2.54% 
2001 SARL HUWER HYDRO VIDE 7.93% 9.32% 7.89% 
2001 SARL IFOR WILLIAMS FRANCE -4.14% -9.17% -4.34% 
2001 SOC COMMERCIALE PROMOTION DISTRIBUTION 5.60% 9.30% 3.30% 
2001 
STE INDUSTRIELLES DE VENTES ECHANGES 
LOCATIONS 4.39% 5.23% 3.31% 
2001 STE ORNAISE DE CHAUDRONNERIE CAROSSERIE 14.44% 36.80% 13.52% 
2001 STE TECHNIQUE INDUSTRTELLE MERIDIONALE 3.02% 8.35% 3.06% 
2001 THERMOCON OY ELEMENT 18.59% 15.45% 18.01% 
2001 UNICAR FURGONATURE S.P.A. -4.61% -6.97% -7.05% 
2001 UTILITAIRES PRO SERVICES UPS 5.07% 11.48% 4.96% 
2001 VEHICULES INDUSTRIELS TRACTES 2.99% 0.86% 1.05% 
2001 VOLQUETES FELICES SL 11.35% 21.79% 10.85% 
2000 ALSACE CONSTRUCTIONS CARROSSERIE 5.73% 6.69% 4.43% 
2000 
AMENAGEMENT CARROSSERIE EQUIPEMENT DE 
VEHICULES 3.95% 3.19% 1.56% 
2000 ANDREOLI RIMORCHI 7.17% 12.74% 7.03% 
2000 ATRANS AB 1.55% 1.36% 0.65% 
2000 AUSSA CONTAINERS - SOCIETA' A RESP 35.10% 3.84% 34.84% 
2000 BALEIKE S.L. 8.40% 16.68% 8.43% 
2000 BASCULANTES PEPIN SA 3.56% 10.94% 4.64% 
2000 BOBO CAB SWEDEN AB 0.73% 1.05% 0.27% 
2000 CARROCERIAS DASAN SA 2.69% 5.54% 2.09% 
2000 CARROCERIAS FRANCISCO CASTELLO BROSETA SA 2.75% 5.72% 2.89% 
2000 
CARROSSERIE VEHICULES INDUSTRIEL 
MELUNAISE 7.09% 19.31% 6.60% 
2000 CARROZZERIA OEFICINE S.MARCO 2.00% 5.50% 1.79% 
2000 CCC CONSTRUCTEUR 2.52% 4.60% 3.21% 
2000 CONSTRUCTIE VERGAUWE 3.17% 3.57% 3.17% 
2000 DALA LAMINAT AB 4.47% 7.37% 2.81% 
2000 ETABLISSEMENT KOLLE 4.76% 11.90% 4.86% 
2000 ETS LEROUGE 5.69% 12.38% 5.44% 
2000 EUROLIFT SARL 1.84% 2.75% 1.69% 
2000 FOKOR OY -0.94% -4.19% -1.98% 
2000 GROTHKAROSS AB 4.15% 17.12% 3.90% 
2000 HERMANNS IBERICA SA 2.98% 10.30% 3.14% 
2000 M.D.M. INDUSTRIE 2.66% 4.52% 1.96% 
2000 MOBIL BAGES SAL 6.24% 29.40% 5.77% 
2000 NORRLANDSVAGNAR AB 8.57% 24.36% 8.05% 
Year Company Name 
Net-cost-
plus 
EBIT 
Margin 
Return on 
total assets 
2000 OY TNNSOL AB 4.72% 7.82% 3.67% 
2000 PETIT LOCATION 26.02% 35.78% 26.37% 
2000 RAPID CONTAINER SERVICES 0.94% 2.50% 1.21% 
2000 REKO TRAILER AB 9.00% 20.82% 7.96% 
2000 ROUERGUE CARROSSERIE INDUSTRIELLE 2.88% 3.18% 1.51% 
2000 SARL D'EXPLOITATTON DU GARAGE BERTA 0.62% 1.69% 0.62% 
2000 SARL HUWER HYDRO VIDE 9.71% 10.95% 10.12% 
2000 SARL IFOR WILLIAMS FRANCE -3.32% -6.62% -3.69% 
2000 SOC COMMERCIALE PROMOTION DISTRIBUTION 4.65% 7.42% 2.62% 
2000 
STE TNDUSTRIELLES DE VENTES ECHANGES 
LOCATIONS 1.85% 1.32% 0.78% 
2000 STE TECHNIQUE INDUSTRIELLE MERTDIONALE 3.49% 8.23% 3.59% 
2000 UNICAR FURGONATURE S.P.A. 2.40% -0.04% -0.04% 
2000 UTILITAIRES PRO SERVICES UPS 3.62% 9.13% 3.52% 
2000 VEHICULES INDUSTRIELS TRACTES 4.85% 2.31% 2.68% 
2000 VOLQUETES FELICES SL 6.06% 14.13% 5.52% 
1999 ALSACE CONSTRUCTIONS CARROSSERIE 7.02% 7.16% 5.25% 
1999 
AMENAGEMENT CARROSSERIE EQUIPEMENT DE 
VEHICULES 3.53% 4.31% 1.56% 
1999 ANDREOLIRIMORCHI 3.01% 5.11% 2.80% 
1999 ATRANSAB 4.86% 8.19% 4.01% 
1999 AUSSA CONTAINERS - SOCffiTA' A RESP 68.38% 4.89% 69.92% 
1999 BALEIKE S.L. 8.01% 21.02% 7.79% 
1999 BOBO CAB SWEDEN AB 2.60% 9.90% 2.04% 
1999 CARROCERIAS DASAN SA 2.82% 5.01% 1.88% 
1999 CARROCERIAS FRANCISCO CASTELLO BROSETA SA 2.38% 4.38% 2.25% 
1999 
CARROSSERIE VEHICULES INDUSTRIEL 
MELUNAISE 4.59% 11.34% 3.84% 
1999 CARROZZERIA OFFICINE S.MARCO 1.96% 6.10% 1.40% 
1999 CCC CONSTRUCTEUR 4.62% 8.13% 5.18% 
1999 CONSTRUCTIE VERGAUWE 5.42% 7.12% 5.42% 
1999 CORBIN 7.93% 8.70% 6.96% 
1999 DALA LAMINAT AB 4.45% 4.57% 2.23% 
1999 ETABLISSEMENT KOLLE 2.09% 5.45% 2.40% 
1999 ETS LEROUGE 7.06% 15.94% 6.80% 
1999 EUROLIFT SARL 2.37% 4.05% 2.37% 
1999 FOKOR OY 10.63% 22.30% 10.12% 
1999 GROTHKAROSS AB 0.70% 1.79% 0.56% 
1999 HERMANNS IBERICA SA 4.11% 9.61% 4.09% 
258 
Year Company Name 
Net-cost-
plus 
EBIT 
Margin 
Return on 
total assets 
1999 M.D.M. INDUSTRIE 0.94% -0.50% -0.26% 
1999 MOBIL BAGES SAL 6.04% 16.86% 5.23% 
1999 PETIT LOCATION 22.19% 25.33% 22.43% 
1999 RAPID CONTAINER SERVICES 0.55% 1.80% 0.69% 
1999 REKO TRAILER AB 11.69% 24.10% 10.97% 
1999 ROUERGUE CARROSSERIE INDUSTRIELLE 3.46% 4.27% 2.33% 
1999 SARL D'EXPLOITATION DU GARAGE BERTA 3.50% 6.89% 3.79% 
1999 SARL HUWER HYDRO VIDE 11.71% 19.38% 11.90% 
1999 SARL IFOR WILLIAMS FRANCE 0.43% 0.55% 0.29% 
1999 SOC COMMERCIALE PROMOTION DISTRIBUTION 5.24% 7.32% 2.86% 
1999 
STEINDUSTRTELLES DE VENTES ECHANGES 
LOCATIONS 3.71% 5.20% 2.94% 
1999 STE TECHNIQUE INDUSTRIELLE MERTDIONALE 2.66% 6.19% 2.73% 
1999 UNICAR FURGONATURE S.P.A. 2.32% -0.75% -0.68% 
1999 UmnATRES PRO SERVICES UPS 4.58% 10.42% 4.47% 
1999 VEHICULES INDUSTRTELS TRACTES 4.76% 0.73% 1.15% 
1998 ALSACE CONSTRUCTIONS CARROSSERIE 5.34% 7.71% 3.93% 
1998 
AMENAGEMENT CARROSSERIE EQUIPEMENT DE 
VEHICULES 3.82% 2.53% 1.44% 
1998 ANDREOLIRIMORCHI 1.90% 2.42% 1.20% 
1998 ATRANS AB 1.79% 0.14% 0.06% 
1998 AUSSA CONTAINERS - SOCffiTA' A RESP 81.60% 8.44% 88.89% 
1998 BASCULANTES PEPIN SA 1.99% 5.40% 2.29% 
1998 CARROCERIAS DASAN SA 2.92% 5.87% 2.13% 
1998 CARROCERIAS FRANCISCO CASTELLO BROSETA SA 1.54% 2.54% 1.33% 
1998 CARROCERIES ES-MI S.L. 12.38% 18.72% 12.62% 
1998 
CARROSSERIE VEHICULES INDUSTRIEL 
MELUNAISE 2.26% 4.15% 1.33% 
1998 CASADEI 2.27% 0.23% 0.17% 
1998 CCC CONSTRUCTEUR 2.71% 5.02% 3.35% 
1998 CONSTRUCTIE VERGAUWE 1.34% 1.59% 1.34% 
1998 DALA LAMTNAT AB 8.07% 16.09% 5.70% 
1998 ETABLISSEMENT KOLLE 2.68% 7.43% 2.89% 
1998 ETS LEROUGE 3.17% 7.01% 2.84% 
1998 EUROLIFT SARL -2.20% -5.19% -2.20% 
1998 FOKOR OY 6.64% 13.96% 6.14% 
1998 GROTHKAROSS AB 2.35% 10.09% 2.27% 
1998 HERMANNS TBERICA SA 2.96% 4.38% 1.99% 
1998 M.D.M. INDUSTRIE 1.73% 0.59% 0.39% 
259 
Year Company Name 
Net-cost-
plus 
EBIT 
Margin 
Return on 
total assets 
1998 MOBIL BAGES SAL 2.91% 9.16% 2.43% 
1998 PETIT LOCATION 25.03% 30.58% 25.03% 
1998 RAPID CONTAINER SERVICES -0.62% -3.13% -1.19% 
1998 REKO TRAILER AB 8.54% 19.69% 7.38% 
1998 ROUERGUE CARROSSERIEINDUSTRTELLE 7.35% 11.90% 5.98% 
1998 SARL DEXPLOITATION DU GARAGE BERTA 5.09% 9.75% 5.09% 
1998 SARL HUWER HYDROVIDE 8.55% 13.31% 8.52% 
1998 SARL IFOR WILLIAMS FRANCE 0.70% 1.06% 0.47% 
1998 SOC COMMERCIALE PROMOTION DISTRIBUTION 5.53% 5.15% 2.47% 
1998 
STE INDUSTRIELLES DE VENTES ECHANGES 
LOCATIONS 1.33% 1.32% 0.78% 
1998 STE TECHNIQUE INDUSTRIELLE MERIDIONALE 2.96% 6.43% 2.88% 
1998 SUPERCAR ALLESTLMENTI 2.81% 5.83% 2.81% 
1998 UNICAR FURGONATURE S.P.A. -3.70% -9.00% -8.73% 
1998 UTTLITAIRES PRO SERVICES UPS 4.19% 8.86% 4.25% 
1998 VEHICULES INDUSTRIELS TRACTES -34.32% -27.97% -48.59% 
Appendix 4.2. CATPM comparable ratios data NACE 341 and 342 
Year Company Name 
CATPM 
InvRisk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
2002 
ALSACE 
CONSTRUCTIONS 
CARROSSERIE 14.93 110.07 95.81 190.78 854 -80.95 111.76 
2002 ANDREOLI RIMORCHI 6.21 725.25 161.97 132.86 39470 99.63 82.48 
2002 ATRANS AB 14.56 67.1 155.31 273.7 329.6 86.62 92.28 
2002 BALEIKE S.L. 2.29 1286.96 173.08 195.99 73.83 101.13 71.68 
2002 
BASCULANTES PEPIN 
SA 12.41 69.27 224.31 230.24 5.9 155.87 68.96 
2002 BOBO CAB SWEDEN AB 9.38 166.93 129.64 353.67 1065.25 46.03 78.16 
2002 
CARROCERIAS DASAN 
SA 14.14 61.91 127.37 313.34 51.6 33.65 36.69 
2002 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 10.62 259.99 169.33 196.34 7.38 102.05 69.5 
2002 
CARROCERIAS SEIN 
HNOS. SX. 6.99 104.4 220.41 258.6 666.67 108.54 81 
2002 
CARROSSERIE 
VEHICULES 
INDUSTRIEL 
MELUNAISE 1.06 1418.42 136.51 299 370.18 97.51 67.42 
2002 
CARROZZERIA 
OEFICINE S. MARCO 10.04 145.5 374.24 177.68 2600 100 11.63 
260 
Year Company Name 
CATPM 
InvRisk 
CATPM 
RecKisk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
2002 CCC CONSTRUCTEUR 10.51 352.52 172.67 113.87 108.64 269.23 85.71 
2002 CORBIN 4.06 653.45 58.3 124.19 254.67 112.32 100 
2002 DALALAMINATAB 16.13 89.38 165.5 194.87 3871 75.57 92.4 
2002 ETABLISSEMENT KOLLE 7.31 278.95 277.48 199 227.36 110.81 48.78 
2002 ETS LEROUGE 7.46 285.85 117.51 283.43 2887.5 103.7 100 
2002 EUROLIFT SARL 9.29 382.64 111.12 151.22 595 102.78 83.78 
2002 GROTHKAROSS AB 5.33 196.92 124.81 505.66 1102 101.6 100 
2002 HARSH LIMITED 28.3 72.15 135.69 124.94 863482 148.38 93.17 
2002 HERMANNS IBERICA SA 12.07 125.98 115.73 272.51 269.45 98.43 65.27 
2002 M.D.M. INDUSTRIE 20.96 93.07 135.86 214.76 414.29 82.52 85.88 
2002 MEKAUTO AB 7.08 163.75 191.78 430.09 999 210.71 100 
2002 MOBIL BAGES SAL 6.63 105.03 67.24 222.03 0.59 95.02 68.91 
2002 NOGE BUS FRANCE 68.19 20.27 173.9 110.27 4928.33 77.91 100 
2002 
NORRLANDSVAGNAR 
AB 8.5 142.73 131.33 264.01 420 96.23 80.31 
2002 OYINNSOL AB 2.94 300.78 161.37 309.73 1948.36 94.13 70.55 
2002 PETIT LOCATION 0.06 33100 . 281.21 108.2 105.65 103.98 59.68 
2002 REKO TRAILER AB 16.41 108.56 241.41 217.19 1943.6 87.19 73.96 
2002 
REMOLQUES 
HERMANOS GARCIA S.L. 22.47 63.96 107.74 104.31 1758.57 85.43 69.76 
2002 
ROUERGUE 
CARROSSERIE 
INDUSTRIELLE 14.79 27.35 108.67 241.61 900 47.02 67.61 
2002 
SARL D'EXPLOITATION 
DU GARAGE BERTA 5.09 656.06 118.68 165.41 2468.09 100 68.97 
2002 
SARL HUWER 
HYDROVIDE 9.57 293.2 202.53 137.22 299.11 97.56 66.17 
2002 
SARL IFOR WILLIAMS 
FRANCE 7.63 404.55 102.45 209.56 1842.5 66.67 100 
2002 
SOC COMMERCIALE 
PROMOTION 
DISTRIBUTION 22.33 73.1 181.39 237.81 113 75.17 71.43 
2002 
STEINDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 17.58 146.73 100.21 160.29 469.03 133.33 104.17 
2002 
STE ORNAISE DE 
CHAUDRONNERIE 
CAROSSERIE 5.04 626.58 109.67 146.95 1408.7 93.33 98.57 
2002 
STE TECHNIQUE 
INDUSTRIELLE 
MERIDIONALE 2.73 661.54 143.22 216.18 1022.95 106.36 71.79 
2002 
THERMOCON OY 
ELEMENT 10.35 216.13 277.92 92.2 3000.01 95.51 71 
261 
Year Company Name 
CATPM 
InvRisk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
2002 THERRY 6.47 298.08 87 279.17 596.67 116 100 
2002 
UNICAR FURGONATURE 
S.P.A. 16.63 99.4 102.46 134.8 803.96 83.83 40.35 
2002 
UTILITAIRES PRO 
SERVICES UPS 26.27 15.52 345.41 263.17 280.39 98.21 70.91 
2002 
VEfflCULES 
INDUSTRIELS TRACTES 61.34 35.5 88.01 75.07 212.36 29.41 20 
2001 
ALSACE 
CONSTRUCTIONS 
CARROSSERJE 19.06 72.91 111.28 186.49 878 70.54 61.54 
2001 
AMENAGEMENT 
CARROSSERJE 
EQUIPEMENT DE 
VEfflCULES 32.58 19.2 100.88 162.75 549.67 213.04 100 
2001 ANDREOLIRMORCHI 5.09 742.74 149.25 152.85 39680 100.29 54.58 
2001 ATRANS AB 16.03 114.89 133.27 216.3 321.82 82.7 100 
2001 BALEIKE S.L. 1.37 1614.57 174.44 221.13 126.99 100.52 69.18 
2001 
BASCULANTES PEPIN 
SA 12.66 54.09 232.27 252.6 10.62 385.34 50.96 
2001 BOBO CAB SWEDEN AB 12.37 73.61 138.31 407.89 603.75 47.08 77.37 
2001 
CARROCERIAS DASAN 
SA 13.43 87 123.24 284.48 63.08 41.6 35.02 
2001 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 3.35 243.83 134.63 123.47 96.2 111.34 62.95 
2001 
CARROCERIAS LA 
JUNQUERAS.L. 7.41 127.2 66.59 320.98 48.94 67.56 68.81 
2001 
CARROCERIAS SEIN 
HNOS. S.L. 5.39 158.55 221.62 328.88 666.67 101.76 77.69 
2001 
CARROSSERffi 
VEfflCULES 
INDUSTREL 
MELUNAISE 1.68 947.54 103.94 271.19 622.81 96.48 64.58 
2001 
CARROZZERIA 
OFFICINES.MARCO 7.73 137.86 104.53 292.73 4830 82.35 19.05 
2001 CCC CONSTRUCTEUR 2.27 1319.44 174.44 142.08 161 145.45 70.83 
2001 
CONSTRUCTS 
VERGAUWE 24 120.62 242.21 126.75 577.42 100 100 
2001 CORBIN 29.34 122.83 87.97 84.53 417.33 72.63 91.3 
2001 DALA LAMINAT AB 15.94 57.12 148.57 270.93 2358 71.78 76.88 
2001 ETABLISSEMENT KOLLE 5.41 246.47 275.5 238.72 221.7 102.24 60.96 
2001 ETS LEROUGE 7.92 365.79 141.07 219.36 2212.5 104.76 100 
2001 EUROLIFT SARL 5.75 198.04 105.92 230.86 2433.33 100 70.37 
2001 FOKOR OY 21.56 71.57 134.55 181.95 2577.69 16.35 79.07 
2001 HARSH LIMITED 24.05 79.71 186.63 151.57 631516 95.57 75.13 
2001 M.D.M. INDUSTRE 26.18 91.11 132.27 170.81 365.55 205.88 142.86 
262 
Year Company Name 
CATPM 
InvRisk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
2001 MOBIL BAGES SAL 12.33 54.49 154.01 418.78 7.44 97.93 70.63 
2001 NOGE BUS FRANCE 491,8 16.3 102.02 17.18 5151.67 100 100 
2001 
NORRLANDSVAGNAR 
AB 8.22 137.12 179.63 322.3 751.79 94.65 78.88 
2001 OYINNSOL AB 0.09 10811.9 141.11 301.05 1086.56 89.19 71.21 
2001 PETIT LOCATION 0.07 22400 309.86 127.62 38.26 101.31 66.24 
2001 
RAPID CONTAINER 
SERVICES 3.94 573.1 216.1 244.41 46.67 300 100 
2001 REKO TRAILER AB 17.32 97.53 250.31 209.44 1662.4 90.66 74.92 
2001 
REMOLQUES 
HERMANOS GARCIA S.L. 17.96 111.06 173.1 110.57 1758.57 97.08 69.77 
2001 
ROUERGUE 
CARROSSERIE 
INDUSTRIELLE 14.33 37.72 106.01 260.8 1344.44 64.26 66.23 
2001 
SARL D'EXPLOITATION 
DU GARAGE BERTA 6.42 105.19 145.13 401.51 772.34 100 63.93 
2001 
SARL HUWER 
HYDROVIDE 13.52 224.88 184.76 118.07 613.74 99.59 65.57 
2001 
SARL IFOR WILLIAMS 
FRANCE 7.88 357.14 101.03 211.44 1705 104.82 101.67 
2001 
SOC COMMERCIALS 
PROMOTION 
DISTRIBUTION 19.68 72.78 199.64 281.75 86 58.89 60.38 
2001 
STE MDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 14.51 142.81 95.82 158.04 569.03 75.41 100 
2001 
STEORNAISEDE 
CHAUDRONNERIE 
CAROSSERIE 2.29 766.67 177.53 272.14 1000 93.65 100 
2001 
STE TECHNIQUE 
INDUSTRIELLE 
MERIDIONALE 2.1 1064 143.37 272.54 780.33 101.39 71.23 
2001 
THERMOCON OY 
ELEMENT 8.72 229.91 303.54 85.76 2788.02 96.89 71.03 
2001 
UNICAR FURGONATURE 
S.P.A. 17.81 63.6 106.39 98.84 454.33 153.07 126.45 
2001 
UTILITAIRES PRO 
SERVICES UPS 29.1 11.69 349.75 231.48 266.67 97.8 67.42 
2001 
VEHICULES 
INDUSTREELS TRACTES 51.58 45.83 82.91 81.69 185.92 35.29 25 
2001 VOLQUETES FELICES SL 5.95 348.17 276.02 200.83 1.45 95.66 68.09 
2000 
ALSACE 
CONSTRUCTIONS 
CARROSSERIE 18.1 159.31 105.51 151.05 1780 77.31 60.87 
263 
Year Company Name 
CATPM 
InvRisk 
CATPM 
RecRisk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
2000 
AMENAGEMENT 
CARROSSERIE 
EQUIPEMENT DE 
VEHICULES 18.13 89.61 99.3 203.99 848.51 39.64 77.27 
2000 ANDREOLIRIMORCHI 2.87 1098.31 107.58 181.22 31150 98.13 49.48 
2000 ATRANSAB 15.13 141.17 130.11 209.25 468.38 42.14 100 
2000 
AUSSA CONTAINERS -
SOCIETA' A RESP 689.91 0.12 161.47 11.03 297.87 99.26 95.17 
2000 BALEIKES.L. 1 3586.2 122.7 197.96 178.33 100.36 76.82 
2000 
BASCULANTES PEPIN 
SA 12.5 74.97 204.79 235.63 15.35 130.47 65 
2000 BOBO CAB SWEDEN AB 9.24 126.91 117.42 388.1 700.5 37.08 68.18 
2000 
CARROCERIAS DASAN 
SA 14.72 73.73 133.06 264.67 73.71 77.84 59.23 
2000 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 0.74 2862.07 166.48 197.95 231.62 104.99 65 
2000 
CARROSSERIE 
VEHICULES 
INDUSTRIEL 
MELUNAISE 1.43 1250 96.11 292.67 673.74 93.12 62.07 
2000 
CARROZZERIA 
OFFICINE S. MARCO 2.58 665.31 115.23 307.61 4580 89.47 8.82 
2000 CCC CONSTRUCTEUR 5.24 568 180.41 143.1 116 127.78 63.04 
2000 
CONSTRUCTIE 
VERGAUWE 21.16 110.63 236.84 112.5 1006.25 100 100 
2000 DALALAMINATAB 17.69 38.78 135.07 262.07 2456 62.95 75.31 
2000 ETABLISSEMENT KOLLE 6.72 269.86 224.58 245.07 272.12 102.03 45.03 
2000 ETS LEROUGE 11.19 235.75 148.39 227.6 3037.5 95.6 100 
2000 EUROLIFT SARL 12.27 135.63 102.28 162.8 2786.67 91.67 63.64 
2000 FOKOR OY 15.49 79.35 145.35 211.89 2179.98 210.98 100.56 
2000 GROTHKAROSS AB 8.97 129.48 162.96 438.74 1158 94.05 73.21 
2000 HERMANNS IBERICA SA 7.73 221.53 127.09 327.76 15.81 105.31 63.95 
2000 M.D.M. INDUSTRIE 18.17 87.29 114.29 230.82 426.89 73.58 64.1 
2000 MOBIL BAGES SAL 12.07 20.02 123.88 509.54 19.4 92.54 70.51 
2000 
NORRLANDSVAGNAR 
AB 6.51 184.96 155.84 302.42 862.56 94.02 78.56 
2000 OYMNSOLAB 0.79 932.48 147.46 212.86 293.3 77.77 71.41 
2000 PETIT LOCATION 0.07 23900 161.82 135.68 456.67 101.35 65.69 
2000 
RAPID CONTAINER 
SERVICES 4.29 486.79 178.81 206.06 80.69 128.57 100 
2000 REKO TRAILER AB 15.2 108.57 204.75 261.42 1881.2 88.48 71.52 
2000 
ROUERGUE 
CARROSSERTE 
INDUSTRIELLE 17.31 95.72 108.42 210.57 1282.72 52.48 64.15 
264 
Year Company Name 
CATPM 
InvRisk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
2000 
SARL D'EXPLOITATION 
DU GARAGE BERTA 16.55 24.69 139.89 271.94 1608.7 100 22.22 
2000 
SARLHUWER 
HYDROVIDE 12.77 271.88 246.18 108.21 430.53 104.2 64.52 
2000 
SARL IFOR WILLIAMS 
FRANCE 9.2 383.21 109.15 179.6 2112.28 111.11 100 
2000 
SOC COMMERCIALE 
PROMOTION 
DISTRIBUTION 22.29 49.2 184.39 282.97 141.45 56.41 54.55 
2000 
STE INDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 7.43 246.8 68.68 170.21 485.81 41.89 -116.13 
2000 
STE TECHNIQUE 
INDUSTRELLE 
MERIDIONALE 3.7 647.95 131.83 228.85 878.69 102.9 69.01 
2000 
UNICAR FURGONATURE 
S.P.A. 18.22 141.79 109.48 103.71 583.17 -1.53 3433.33 
2000 
UTILITAIRES PRO 
SERVICES UPS 24.01 13.63 345.77 259.06 282.61 97.22 55.71 
2000 
VEHICULES 
INDUSTRIELS TRACTES 43.65 55.56 84.92 86.17 197.13 55.17 100 
2000 VOLQUETES FELICES SL 4.99 288.02 235.79 255.97 0.64 91.1 67.28 
1999 
ALSACE 
CONSTRUCTIONS 
CARROSSERIE 30.96 67.49 105.9 136.49 1108 74.7 62.9 
1999 
AMENAGEMENT 
CARROSSERIE 
EQUIPEMENTDE 
VEHICULES 18.18 48.57 114.29 276.41 785.45 44.21 66.67 
1999 ANDREOLIRIMORCHI 1.74 2261.11 105.48 182.16 30380 93.12 33.5 
1999 ATRANSAB 13.83 164.11 145.91 203.97 538.28 82.6 100 
1999 
AUSSA CONTAINERS -
SOCIETA' A RESP 1049.72 21.69 451.64 7 1206.4 102.25 95.26 
1999 BALEIKE S.L. 1.11 1588.35 106.8 . 269.8 227.9 97.23 70.25 
1999 BOBO CAB SWEDEN AB 7.12 146.96 120.51 486.02 508.25 78.46 70.91 
1999 
CARROCERIAS DASAN 
SA 13.99 72.92 132.97 266.29 92.38 66.63 52.24 
1999 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 1.28 1368.96 132.32 194.63 401.9 94.65 67.59 
1999 
CARROSSERIE 
VEHICULES 
INDUSTRIEL 
MELUNAISE 1.53 1120.51 93.07 295.02 660.71 83.76 58.16 
1999 
CARROZZERIA 
OFFICINE S.MARCO 3.92 200 127.68 435.67 1680 71.43 -65 
1999 CCC CONSTRUCTEUR 4.69 541.18 182.72 156.99 133.55 111.94 66.67 
265 
Year Company Name 
CATPM 
InvRisk 
CATPM 
RecRisk 
CATPM 
Liq Risk 
CATPM 
Activity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
1999 
CONSTRUCTS 
VERGAUWE 17.61 127.97 190.66 131.39 875 100 100 
1999 CORBIN 23.79 23.58 94.64 124.88 633.33 87.8 100 
1999 DALALAMINATAB 15.94 104.18 126.27 204.69 2458 50.17 86.81 
1999 ETABLISSEMENT KOLLE 6.48 356.08 168.8 227.08 330.77 114.75 45.71 
1999 ETS LEROUGE 9.89 235.71 143.49 234.58 1687.5 96.25 100 
1999 EUROLIFT SARL 4.84 342.55 102.04 171.13 2420 100 86.96 
1999 FOKOR OY 11.74 126.24 139.98 220.34 2614.47 95.22 84.88 
1999 GROTHKAROSS AB 7.02 305.2 138.47 316.64 2237 80.65 61.33 
1999 HERMANNS IBERICA SA 13.69 176.19 115.87 234.63 38.19 99.7 64.88 
1999 MX>.M. INDUSTRIE 16 138.76 106.54 190.57 513.45 -27.78 100 
1999 MOBIL BAGES SAL 8.94 203.17 166.38 322.67 28.13 86.49 73.25 
1999 PETTT LOCATION 0.17 15200 140.62 112.9 1153.33 101.12 63.84 
1999 
RAPID CONTAINER 
SERVICES 4.07 578.95 185.79 260.59 77.5 126.09 100 
1999 REKO TRAILER AB 19.15J 97.31 165.59 219.65 2399.6 93.84 77.99 
1999 
ROUERGUE 
CARROSSERIE 
INDUSTRXELLE 11.5 236.33 120.12 182.99 888.89 67.53 65.38 
1999 
SARL D'EXPLOITATION 
DU GARAGE BERTA 27.77 24.13 130.6 181.98 1865.22 108.33 66.67 
1999 
SARL HUWER 
HYDROVLDE 8.48 353.49 250 162.79 339.69 101.69 63.54 
1999 
SARL IFOR WILLIAMS 
FRANCE 5.49 642.11 113.85 190.42 2428.07 67.74 61.9 
1999 
SOC COMMERCIALS 
PROMOTION 
DISTRIBUTION 23.81 48.85 162.73 255.76 195.39 54.65 61.7 
1999 
STEINDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 5.71 221.5 52.82 177.06 7955.56 79.23 67.96 
1999 
STE TECHNIQUE 
INDUSTRXELLE 
MERIDIONALE 4.67 588.89 129.48 227.29 580.33 102.44 64.29 
1999 
UNICAR FURGONATURE 
S.P.A. 16.07 177.01 99.14 110.11 624.5 -29.25 338.71 
1999 
UTILITALRES PRO 
SERVICES UPS 23.94 20.5 316.52 233.04 323.91 97.62 60.98 
1999 
VEHICULES 
INDUSTRXELS TRACTES 44.24 58.31 60.19 62.98 116.09 24.24 100 
1998 
ALSACE 
CONSTRUCTIONS 
CARROSSERIE 15.17 127.78 92.79 195.96 2360 73.68 42.86 
266 
Year Company Name 
CATPM 
InyRisk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Actiyity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Ley 
CATPM 
Tax Ley 
1998 
AMENAGEMENT 
CARROSSERIE 
EQUIPEMENT DE 
VEHICULES 21.14 143.57 106.32 175.56 2665.63 37.78 76.47 
1998 ANDREOLIRMORCHI 3.77 355.72 102.43 202.65 27710 62.77 9.3 
1998 ATRANSAB 17.87 65.08 137 221.8 518.38 3.56 100 
1998 
AUSSA CONTAINERS -
SOCIETA' A RESP 766.81 21.86 1518.2 9.5 29.29 108.94 95.9 
1998 
BASCULANTES PEPIN 
SA 12.24 94.85 209.66 235.79 32.04 114.89 60.85 
1998 
CARROCERIAS DASAN 
SA 11.63 100.4 130.38 276.34 101.67 72.79 67.59 
1998 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 7.03 232.53 140.88 190.76 209.68 86.79 85.5 
1998 
CARROCERIES ES-MI 
S.L. 10.69 118.57 219.59 148.28 3.1 102 70 
1998 
CARROSSERIE 
VEHICULES 
INDUSTREL 
MELUNAISE 2.09 802.13 94.72 311.62 561.9 58.82 86.67 
1998 CASADEI 12.38 322.56 91.24 134.44 21640 7.59 100 
1998 CCC CONSTRUCTEUR 5.56 638.46 161.5 149.73 118.42 123.68 68.09 
1998 
CONSTRUCTIE 
VERGAUWE 19.92 120.81 153.39 119.3 1031.25 100 100 
1998 DALA LAMINAT AB 17.33 60.08 152.95 282.1 1549 70.69 97.87 
1998 ETABLISSEMENT KOLLE 8.82 174.09 201.31 256.97 . 239.42 108 67.9 
1998 ETS LEROUGE 12.25 154.46 125.1 246.36 2200 89.66 100 
1998 EUROLIFT SARL 2.2 1321.43 98.48 235.93 1113.33 100 100 
1998 FOKOR OY 10.62 152.53 158.99 227.49 2702.47 92.44 71.37 
1998 GROTHKAROSS AB 7.1 183.8 147.69 445.18 1318 96.32 83.33 
1998 HERMANNS IBERICA SA 4.9 722.76 114.05 220.05 96.54 67.32 72.61 
1998 M.D.M. INDUSTRIE 22.43 148.51 112.29 150.71 656.3 22.58 57.14 
1998 MOBIL BAGES SAL 9.3 137.49 192.84 376.67 8.79 83.47 76.36 
1998 PETIT LOCATION 0.89 1900 209.23 122.19 633.33 100 64.16 
1998 
RAPID CONTAINER 
SERVICES 5.14 443.48 176.37 262.56 51.46 192 100 
1998 REKO TRAILER AB 13.52 118.65 158.96 266.73 1913.6 86.4 79.97 
1998 
ROUERGUE 
CARROSSERIE 
INDUSTRIELLE 8.66 311.11 99.09 199.04 1943.48 81.31 67.82 
1998 
SARL D'EXPLOITATION 
DU GARAGE BERTA 14.56 72.73 114.86 191.42 1373.91 100 64 
1998 
SARL HUWER 
HYDROVIDE 11.9 208.44 222.8 156.25 1026.09 99.57 62.45 
267 
Year Company Name 
CATPM 
InvRisk 
CATPM 
Rec Risk 
CATPM 
Liq Risk 
CATPM 
Acti-vity 
Risk 
CATPM 
Sol Risk 
CATPM 
Fin Lev 
CATPM 
Tax Lev 
1998 
SARL IFOR WILLIAMS 
FRANCE 7.33 317.29 118.66 225.36 1447.37 67.44 62.07 
1998 
SOC COMMERCIALS 
PROMOTION 
DISTRIBUTION 31.8 30.61 143.33 208.91 276.97 44.58 62.16 
1998 
STE INDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 7.02 187.12 57.45 168.91 8055.56 59.09 15.38 
1998 
STE TECHNIQUE 
INDUSTRIELLE 
MERXDIONALE 4.55 673.33 127.27 223.18 719.57 97.44 65.79 
1998 
SUPERCAR 
ALLESTMENTI 5.61 221.3 119.05 207.78 1196.08 100 -9.26 
1998 
UNICAR FURGONATURE 
S.P.A. 17.54 156.09 85.51 103.15 734.51 235.59 112.23 
1998 
UTLLITAIRES PRO 
SERVICES UPS 27.47 16.17 348.97 208.47 276.09 101.52 61.19 
1998 
VEHICULES 
INDUSTRIELS TRACTES 44.43 40.13 52.75 57.57 195.4 141.56 100 
268 
Appendix 4.3. CATPM net-cost-plus stepwise regression 
Results of stepwise regression for Net-cost-plus 
Step 1 - Entering variable: CATPM Liq Risk 
Summary measures 
Multiple R 0.8513 
R-Square 0.7247 
Adj R-Square 0.7233 
StErrofEst 0.1865 
ANOVA Table 
Source df SS MS F p-value 
Explained 1 17.8460 17.8460 5.13E+02 1.63E-56 
Unexplained 195 6.7804 0.0348 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit 
Upper 
limit 
Constant -0.3267 0.0226 -14.4565 1.13E-32 -3.71E-01 -0.2821 
CATPM Liq Risk 0.2587 0.0114 22.6548 0.00E+00 2.36E-01 0.2812 
Step 2 - Entering variable: CATPM Inv Risk 
% 
Summary measures Change Change 
Multiple R 0.9252 0.0740 8.7% 
R-Square 0.8560 0.1314 18.1% 
Adj R-Square 0.8546 0.1313 18.2% 
StErrofEst 0.1352 -0.0513 -27.5% 
ANOVA Table 
Source df SS MS F p-value 
Explained 2 21.0813 10.5407 5.77E+02 2.23E-82 
Unexplained 194 3.5452 0.0183 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit 
Upper 
limit 
Constant -0.2570 0.0172 -14.9410 4.28E-34 -2.91E-01 -0.2230 
CATPM Liq Risk 0.1913 0.0097 19.7134 0.00E+00 1.72E-01 0.2104 
CATPM Inv Risk 0.1387 0.0104 13.3057 3.97E-29 1.18E-01 0.1593 
Step 3 - Entering variable: CATPM Fin Lev 
Summary measures 
Multiple R 0.9300 
Change 
0.0048 
7o 
Change 
0.5% 
R-Square 0.8649 0.0089 1.0% 
Adj R-Square 0.8628 0.0083 1.0% 
StErrofEst 0.1313 -0.0039 -2.9% 
ANOVA Table 
Source df SS MS F p-value 
Explained 3 21.3005 7.1002 4.12E+02 1.29E-83 
Unexplained 193 3.3260 0.0172 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit 
Upper 
limit 
Constant -0.1994 0.0232 -8.5873 2.96E-15 -2.45E-01 -0.1536 
CATPM Liq Risk 0.1973 0.0096 20.6110 0.00E+00 1.78E-01 0.2162 
CATPM Inv Risk 0.1358 0.0102 13.3725 2.72E-29 1.16E-01 0.1559 
CATPM Fin Lev -0.0717 0.0201 -3.5665 4.56E-04 -1.11E-01 -0.0320 
Step 4 - Entering variable: CATPM Rec Risk 
% 
Summary measures 
Multiple R 0.9331 
Change 
0.0031 
Change 
0.3% 
R-Square 0.8707 0.0057 0.7% 
Adj R-Square 0.8680 0.0051 0.6% 
StErrofEst 0.1288 -0.0025 -1.9% 
ANOVA Table 
Source df SS MS F p-value 
Explained 4 21.4413 5.3603 3.23E+02 4.50E-84 
Unexplained 192 3.1851 0.0166 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit 
Upper 
limit 
Constant -0.2007 0.0228 -8.8086 7.48E-16 -2.46E-01 -0.1558 
CATPM Liq Risk 0.1941 0.0095 20.5334 0.00E+00 1.75E-01 0.2128 
CATPM Inv Risk 0.1390 0.0100 13.8658 9.57E-31 1.19E-01 0.1588 
CATPM Fin Lev -0.0728 0.0197 -3.6907 2.91E-04 -1.12E-01 -0.0339 
CATPM Rec Risk 0.0008 0.0003 2.9137 4.00E-03 2.48E-04 0.0013 
Appendix 4.4. CATPM comparable ratios data with fitted and residual values 
Company Name 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
Liq Risk 
CATP 
MFin 
Lev 
Nel-cosl-
plu-
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
Fin Lev 
Fitted 
Values 
Fin Lev 
Residuals 
ALSACE CONSTRUCTIONS 
CARROSSERIE 0.1517 1.2778 0.9279 0.7368 00564 2.061 0.101 -0.0867 0.1431 0.0571 -0.0007 0.0571 -0.0007 57.381 10.999 
AMENAGEMENT 
CARROSSERIE 
EQUIPEMENT DE 
VEHICULES 0.2114 1.4357 1.0632 0.3778 0.0397 3.733 0.702 -0.0517 0.0914 0.0718 -0.0321 0.0718 -0.0321 84.828 -3.228 
ANDREOLI RIMORCHI 0.0377 3.5572 1.0243 0.6277 0.0194 1.000 -0.459 -0.0617 0.0811 0.0290 -0.0096 0.0290 -0.0096 31.914 3.186 
ATRANS AB 0.1787 0.6508 1.37 0.0356 0.0182 0.608 -0.576 0.0277 -0.0095 0.0637 -0.0455 0.0637 -0.0455 21.544 -18.444 
AUSSA CONTAINERS -
SOCEETA' A RESP 7.6681 0.2186 15.182 1.0894 4.4352 0.175 -0.131 3.6004 0.8348 1.9061 2.5291 1.9061 2.5291 7.338 -3.078 
BASCULANTES PEPIN SA 0.1224 0.9485 2.0966 1.1489 O.02O3 0.034 0.014 0.2157 -0.1954 0.0499 -0.0296 0.0499 -0.0296 5.251 -0.621 
CARROCERIAS DASAN SA 0.1163 1.004 1.3038 0.7279 0.0301 0.007 0.024 0.0106 0.0195 0.0484 -0.0183 0.0484 -0.0183 4.506 -1.516 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 0.0703 2.3253 1.4088 0.8679 0.0156 -0.139 -0.116 0.0377 -0.0221 0.0371 -0.0215 0.0371 -0.0215 0.141 -34.461 
CARROCERIES ES-MI S.L. 0.1069 1.1857 2.1959 1.02 0.1412 -0.040 0.090 0.2413 -0.1001 0.0461 0.0951 0.0461 0.0951 3.683 1.077 
CARROSSERIE VEHICULES 
INDUSTRIEL MELUNAISE 0.0209 8.0213 0.9472 0.5882 0.0232 -0.015 0.066 -0.0817 0.1049 0.0249 -0.0017 0.0249 -0.0017 3.708 1.142 
CASADEI 0.1238 3.2256 0.9124 0.0759 0.0233 -0.115 0.091 -0.0907 0.1140 0.0502 -0.0269 0.0502 -0.0269 -0.578 -1.792 
CCC CONSTRUCTEUR 0.0556 6.3846 1.615 1.2368 0.0278 0.089 -0.031 0.0911 -0.0633 0.0334 -0.0056 0.0334 -0.0056 5.646 -0.116 
CONSTRUCTS 
VERGAUWE 0.1992 1.2081 1.5339 1 0.0136 -0.006 0.082 0.0701 -0.0565 0.0688 -0.0552 0.0688 -0.0552 3.424 3.596 
DALA LAMDMAT AB 0.1733 0.6008 1.5295 0.7069 0.0877 -0.041 0.140 0.0690 0.0187 0.0624 0.0253 0.0624 0.0253 2.798 6.162 
ETABLISSEMENT KOLLE 0.0882 1.7409 2.0131 1.08 0.0275 0.448 -0.394 0.1941 -0.1666 0.0415 -0.0140 0.0415 -0.0140 11.646 -6.576 
ETS LEROUGE 0.1225 1.5446 1.251 0.8966 0.0328 -0.005 -0.007 -0.0031 0.0359 0.0499 -0.0171 0.0499 -0.0171 2.368 -3.668 
EUROLIFTSARL 0.022 13.2143 0.9848 1 -0,0215 0.013 0.024 -0.0719 0.0504 0.0252 -0.0467 0.0252 -0.0467 3.233 0.267 
FOKOR OY 0.1062 1.5253 1.5899 0.9244 0.0711 0.441 -0.397 0.0846 -0.0135 0.0459 0.0252 0.0459 0.0252 11.450 -7.260 
GROTHKAROSS AB 0.071 1.838 1.4769 0.9632 0.0241 0.435 -0.381 0.0554 -0.0313 0.0372 -0.0131 0.0372 -0.0131 11.361 -6.291 
HERMANNS IBERICA SA 0.049 7.2276 1.1405 0.6732 0.0305 -0.057 0.045 -0.0317 0.0622 0.0318 -0.0013 0.0318 -0.0013 0.571 -1.811 
M.D.M. INDUSTRIE 0.2243 1.4851 1.1229 0.2258 00176 0.126 -0.031 -0.0362 0.0538 0.0749 -0.0573 0.0749 -0.0573 5.544 3.126 
MOBIL BAGES SAL 0.093 1.3749 1.9284 0.8347 0.03 0.433 -0.396 0.1721 -0.1421 0.0426 -0.0126 0.0426 -0.0126 11.307 -7.687 
PETIT LOCATION 0.0089 19 2.092.3 1 0.3338 0.231 -0.092 0.2145 0.1193 0.0219 0.3119 0.0219 0.3119 7.499 4.731 
RAPID CONTAINER 
SERVICES 0.0514 4.4348 1.7637 1.92 -0.0062 0.376 -0.328 0.1295 -0.1357 0.0324 -0.0386 0.0324 -0.0386 10.221 -5.641 
REKO TRAILER AB 0.1352 1.1865 1.5896 0.864 0.0934 0.109 -0.054 0.0845 0.0089 0.0530 0.0404 0.0530 0.0404 5.766 -0.526 
ROUERGUE CARROSSERIE 
INDUSTRIELLE 0.0866 3.1111 0.9909 0.8131 00794 -0.048 0.134 -0.0704 0.1498 0.0411 0.0383 0.0411 0.0383 2.314 5.616 
271 
Company Name 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
Liq Risk 
CATP 
M Fin 
Lev 
Net-cost-
pi us 
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
III Fin Lev Residuals 
SARL SEXPLOITATION 
DU GARAGE BERTA 0.1456 0.7273 1.1486 1 0.0536 -0.022 0.068 -0.0296 0.0832 0.0556 -0.0020 0.0556 -0.0020 2.841 1.539 
SARL HUWER 
HYDROVIDE 0.119 2.0844 2.228 0.9957 0.0935 0.033 -0.016 0.2496 -0.1561 0.0490 0.0445 0.0490 0.0445 4.821 -3.091 
SARL IFOR WILLIAMS 
FRANCE 0.0733 3.1729 1.1866 0.6744 0 007 0.128 -0.029 -0.0197 0.0267 0.0378 -0.0308 0.0378 -0.0308 5.841 3.199 
SOCCOMMERCIALE 
PROMOTION 
DISTRIBUTION 0.318 0.3061 1.4333 0.4458 0.05 S6 0.147 -0.099 0.0441 0.0145 0.0980 -0.0394 0.0980 -0.0394 6.453 -1.803 
STEINDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 0.0702 1.8712 0.5745 0.5909 0.0134 0.079 -0.068 -0.1781 0.1915 0.0370 -0.0236 0.0370 -0.0236 5.717 -4.637 
STE TECHNIQUE 
INDUSTRIELLE 
MERIDIONALE 0.0455 6.7333 1.2727 0.9744 0.0305 0.216 -0.184 0.0025 0.0280 0.0310 -0.0005 0.0310 -0.0005 7.176 -4.006 
SUPERCAR 
ALLESTIMENTI 0.0561 2.213 1.1905 1 0.02S9 0.009 0.031 -0.0187 0.0476 0.0336 -0.0047 0.0336 -0.0047 4.122 -0.302 
UNICAR FURGONATURE 
S.P.A. 0.1754 1.5609 0.8551 2.3559 -0.0357 0.033 0.020 -0.1055 0.0698 0.0629 -0.0986 0.0629 -0.0986 3.919 1.071 
UTILITAIRES PRO 
SERVICES UPS 0.2747 0.1617 3.4897 1.0152 j 0,0437 0.053 -0.039 0.5760 -0.5323 0.0873 -0.0436 0.0873 -0.0436 4.058 -2.718 
VEHICULES INDUSTRIELS 
TRACTES 0.4443 0.4013 0.5275 1.4156 -0.2555 0.172 -0.112 -0.1902 -0.0653 0.1291 -0.3846 0.1291 -0.3846 6.857 -1.257 
ALSACE CONSTRUCTIONS 
CARROSSERIE 0.3096 0.6749 1.059 0.747 0.0755 0.080 0.053 -0.0527 0.1282 0.0959 -0.0204 0.0959 -0.0204 4.628 7.062 
AMENAGEMENT 
CARROSSERIE 
EQUIPEMENT DE 
VEHICULES 0.1818 0.4857 1.1429 0.4421 0.0365 -0.009 0.083 -0.0310 0.0675 0.0645 -0.0280 0.0645 -0.0280 3.251 3.619 
ANDREOLI RIMORCHI 0.0174 22.6111 1.0548 0.9312 0.031 0.039 -0.015 -0.0538 0.0848 0.0240 0.0070 0.0240 0.0070 5.209 -2.809 
ATRANSAB 0.1383 1.6411 1.4591 0.826 0.0511 0.015 0.022 0.0508 0.0003 0.0538 -0.0027 0.0538 -0.0027 4.039 -0.509 
AUSSA CONTAINERS -
SOCIETA' A RESP 10.4972 0.2169 4.5164 1.0225 2.1622 -0.007 0.034 0.8416 1.3206 2.6021 -0.4399 2.6021 -0.4399 3.253 -0.593 
BALEIKES.L. 0.0111 15.8835 1.068 0.9723 0.0371 -0.011 0.052 -0.0504 0.1375 0.0225 0.0646 0.0225 0.0646 3.644 0.306 
BOBO CAB SWEDEN AB 0.0712 1.4696 1.2051 0.7846 0.0267 -0.026 0.087 -0.0150 0.0417 0.0373 -0.0106 0.0373 -0.0106 2.880 2.850 
CARROCERIAS DASAN SA 0.1399 0.7292 1.3297 0.6663 0.0291 0.090 -0.043 0.0173 0.0118 0.0542 -0.0251 0.0542 -0.0251 4.777 -0.277 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 0.0128 13.6896 1.3232 0.9465 0.0243 0.088 -0.070 0.0156 0.0087 0.0229 0.0014 0.0229 0.0014 6.006 -4.216 
CARROSSERIE VEHICULES 
INDUSTRIEL MELUNAISE 0.0153 11.2051 0.9307 0.8376 0.0481 -0.080 0.036 -0.0859 0.1340 0.0235 0.0246 0.0235 0.0246 0.718 -5.328 
272 
Company Name 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
Liq Risk 
CATP 
MFin 
Lev 
Net-cost-
plus 
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
Fin Lev 
Fitted 
Values 
Fin Lev 
Residuals 
CARROZZERIA OFFICINE 
S.MARCO 0.0392 2 1.2768 0.7143 0.02 0.041 0.006 0.0036 0.0164 0.0294 -0.0094 0.0294 -0.0094 4.255 0.215 
CCC CONSTRUCTEUR 0.0469 5.4118 1.8272 1.1194 0.0485 0.122 -0.065 0.1460 -0.0975 0.0313 0.0172 0.0313 0.0172 5.342 0.078 
CONSTRUCTS 
VERGAUWE 0.1761 1.2797 1.9066 1 0.0573 -0.078 0.051 0.1665 -0.1092 0.0631 -0.0058 0.0631 -0.0058 1.096 -3.856 
CORBIN 0.2379 0.2358 0.9464 0.878 0.0861 -0.181 0.145 -0.0819 0.1680 0.0783 0.0078 0.0783 0.0078 -2.282 -1.418 
DALA LAMINAT AB 0.1594 1.0418 1.2627 0.5017 0,0465 0.069 0.018 -0.0001 0.0466 0.0590 -0.0125 0.0590 -0.0125 4.701 3.369 
ETABLISSEMENT KOLLE 0.0648 3.5608 1.688 1.1475 0,0214 0.244 -0.128 0.1100 -0.0886 0.0357 -0.0143 0.0357 -0.0143 7.763 2.627 
ETS LEROUGE 0.0989 2.3571 1.4349 0.9625 0.076 -0.004 0.033 0.0445 0.0315 0.0441 0.0319 0.0441 0.0319 3.594 -0.714 
EUROLIFT SARL 0.0484 3.4255 1.0204 1 0.0242 -0.039 0.061 -0.0627 0.0869 0.0317 -0.0075 0.0317 -0.0075 2.478 -0.348 
FOKOR OY 0.1174 1.2624 1.3998 0.9522 0.1189 0.021 -0.015 0.0354 0.0835 0.0486 0.0703 0.0486 0.0703 3.345 -2.725 
GROTHKAROSS AB 0.0702 3.052 1.3847 0.8065 0.0071 0.228 -0.120 0.0315 -0.0244 0.0370 -0.0299 0.0370 -0.0299 7.503 2.277 
HERMANNS IBER1CA SA 0.1369 1.7619 1.1587 0.997 0.0428 0.089 -0.014 -0.0270 0.0698 0.0534 -0.0106 0.0534 -0.0106 5.002 1.968 
M.D.M. INDUSTRIE 0.16 1.3876 1.0654 -0.2778 0.0095 0.037 -0.013 -0.0511 0.0606 0.0591 -0.0496 0.0591 -0.0496 5.538 -3.218 
MOBIL BAGES SAL 0.0894 2.0317 1.6638 0.8649 0.0643 0.021 0.025 0.1037 -0.0394 0.0418 0.0225 0.0418 0.0225 3.632 0.768 
PETIT LOCATION 0.0017 152 1.4062 1.0112 02851 0.050 -0.040 0.0371 0.2480 0.0202 0.2649 0.0202 0.2649 5.736 ^.796 
RAPID CONTAINER 
SERVICES 0.0407 5.7895 1.8579 1.2609 0.0055 0.058 -0.007 0.1539 -0.1484 0.0298 -0.0243 0.0298 -0.0243 4.450 0.370 
REKO TRAILER AB 0.1915 0.9731 1.6559 0.9384 0.1324 0.031 0.016 0.1017 0.0307 0.0669 0.0655 0.0669 0.0655 4.266 0.184 
ROUERGUE CARROSSERIE 
INDUSTRIELLE 0.115 2.3633 1.2012 0.6753 0.0358 -0.050 0.041 -0.0160 0.0518 0.0480 -0.0122 0.0480 -0.0122 0.461 -1.401 
SARL DEXPLOITATION 
DU GARAGE BERTA 0.2777 0.2413 1.306 1.0833 0.0362 0.154 -0.055 0.0111 0.0251 0.0881 -0.0519 0.0881 -0.0519 6.066 2.934 
SARL HUWER 
HYDROVIDE 0.0848 3.5349 2.5 1.0169 0.1326 -0.052 0.109 0.3200 -0.1874 0.0406 0.0920 0.0406 0.0920 2.366 2.974 
SARL IFOR WILLIAMS 
FRANCE 0.0549 6.4211 1.1385 0.6774 0.0043 0.043 -0.028 -0.0322 0.0365 0.0333 -0.0290 0.0333 -0.0290 4.627 -3.077 
SOC COMMERCIALE 
PROMOTION 
DISTRIBUTION 0.2381 0.4885 1.6273 0.5465 0.0553 0.066 -0.054 0.0943 -0.0390 0.0783 -0.0230 0.0783 -0.0230 6.752 -5.622 
STEINDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 0.0571 2.215 0.5282 0.7923 0.0385 -0.003 0.032 -0.1900 0.2285 0.0338 0.0047 0.0338 0.0047 3.597 -0.797 
STE TECHNIQUE 
INDUSTRIELLE 
MERIDIONALE 0.0467 5.8889 1.2948 1.0244 0.0273 0.022 0.006 0.0083 0.0190 0.0312 -0.0039 0.0312 -0.0039 3.673 -0.983 
UNICAR FURGONATURE 
S.P.A. 0.1607 1.7701 0.9914 -0.2925 0.0237 0.058 -0.023 -0.0702 0.0939 0.0593 -0.0356 0.0593 -0.0356 4.237 -0.767 
UTILITAIRES PRO 
SERVICES UPS 0.2394 0.205 3.1652 0.9762 0.048 -0.030 0.083 0.4921 -0.4441 0.0787 -0.0307 0.0787 -0.0307 2.379 2.711 
273 
Company Name 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
Liq Risk 
CATP 
MFin 
Lev 
Net-cost-
plus 
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
Fin Lev 
Fitted 
Values 
Fin Lev 
Residuals 
VEHICULES [NDUSTRELS 
TRACTES 0.4424 0.5831 0.6019 0.2424 0,0499 -0.048 0.094 -0.1710 0.2209 0.1286 -0.0787 0.1286 -0.0787 2.415 1.975 
ALSACE CONSTRUCTIONS 
CARROSSERIE 0.181 1.5931 1.0551 0.7731 0.0608 -0.022 0.073 -0.0538 0.1146 0.0643 -0.0035 0.0643 -0.0035 3.009 1.861 
AMENAGEMENT 
CARROSSERIE 
EQUIPEMENT DE 
VEHICULES 0.1813 0.8961 0.993 0.3964 0.0411 0.042 -0.031 -0.0698 0.1109 0.0644 -0.0233 0.0644 -0.0233 4.658 -3.528 
ANDREOLI RIMORCHI 0.0287 10.9831 1.0758 0.9813 0.0772 0.029 0.000 -0.0484 0.1256 0.0268 0.0504 0.0268 0.0504 3.950 -1.130 
ATRANS AB 0.1513 1.4117 1.3011 0.4214 0.0157 0.043 0.008 0.0099 0.0058 0.0570 -0.0413 0.0570 -0.0413 4.049 0.811 
AUSSA CONTAINERS -
SOCIETA' A RESP 6.8991 0.0012 1.6147 0.9926 0.5409 -0.028 0.071 0.0910 0.4499 1.7170 -1.1761 1.7170 -1.1761 2.471 1.639 
BALEIKE S.L. 0.01 35.862 1.227 1.0036 0.0917 0.065 0.029 -0.0093 0.1010 0.0222 0.0695 0.0222 0.0695 5.045 2.885 
BASCULANTES PEPIN SA 0.125 0.7497 2.0479 1.3047 0.0369 0.106 -0.020 0.2031 -0.1662 0.0505 -0.0136 0.0505 -0.0136 4.376 4.164 
BOBO CAB SWEDEN AB 0.0924 1.2691 1.1742 0.3708 0.0073 0.028 -0.018 -0.0229 0.0302 0.0425 -0.0352 0.0425 -0.0352 4.276 -3.336 
CARROCERIAS DASAN SA 0.1472 0.7373 1.3306 0.7784 0.0276 0.221 -0.114 0.0175 0.0101 0.0560 -0.0284 0.0560 -0.0284 7.186 2.524 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 0.0074 28.6207 1.6648 1.0499 0.0283 -0.012 0.016 0.1040 -0.0757 0.0216 0.0067 0.0216 0.0067 -1.319 1.649 
CARROSSERIE VEHICULES 
INDUSTRIEL MELUNAISE 0.0143 12.5 0.9611 0.9312 0.0763 0.120 -0.083 -0.0781 0.1544 0.0233 0.0530 0.0233 0.0530 4.762 -1.202 
CARROZZERIA OFFICINE 
S.MARCO 0.0258 6.6531 1.1523 0.8947 0.0204 0.139 -0.129 -0.0286 0.0490 0.0261 -0.0057 0.0261 -0.0057 4.767 -3.797 
CCC CONSTRUCTEUR 0.0524 5.68 1.8041 1.2778 0.0258 -0.009 0.033 0.1400 -0.1142 0.0327 -0.0069 0.0327 -0.0069 4.187 -1.917 
CONSTRUCTIE 
VERGAUWE 0.2116 1.1063 2.3684 1 0.032& 0.051 -0.037 0.2860 -0.2532 0.0718 -0.0390 0.0718 -0.0390 4.624 -3.234 
DALALAMINATAB 0.1769 0.3878 1.3507 0.6295 0.0467 0.044 0.059 0.0227 0.0240 0.0633 -0.0166 0.0633 -0.0166 3.772 5.588 
ETABLISSEMENT KOLLE 0.0672 2.6986 2.2458 1.0203 0 05 -0.051 0.070 0.2542 -0.2042 0.0363 0.0137 0.0363 0.0137 2.103 -0.263 
ETS LEROUGE 0.1119 2.3575 1.4839 0.956 0.0603 -0.005 0.038 0.0572 0.0031 0.0473 0.0130 0.0473 0.0130 3.014 0.156 
EUROLIFT SARL 0.1227 1.3563 1.0228 0.9167 0.0188 0.140 -0.120 -0.0621 0.0809 0.0499 -0.0311 0.0499 -0.0311 5.380 -3.390 
FOKOR OY 0.1549 0.7935 1.4535 2.1098 -0.0093 -0.030 0.040 0.0493 -0.0586 0.0579 -0.0672 0.0579 -0.0672 2.394 -1.434 
GROTHKAROSS AB 0.0897 1.2948 1.6296 0.9405 0.0433 -0.011 0.077 0.0949 -0.0516 0.0418 0.0015 0.0418 0.0015 2.774 3.466 
HERMANNS IBERICA SA 0.0773 2.2153 1.2709 1.0531 0.0308 0.177 -0.084 0.0021 0.0287 0.0388 -0.0080 0.0388 -0.0080 6.367 2.183 
M.D.M. INDUSTRIE 0.1817 0.8729 1.1429 0.7358 0.0273 0.019 0.100 -0.0310 0.0583 0.0645 -0.0372 0.0645 -0.0372 3.364 7.266 
MOBIL BAGES SAL 0.1207 0.2002 1.2388 0.9254 0.O665 0.016 0.014 -0.0062 0.0727 0.0495 0.0170 0.0495 0.0170 3.608 -0.688 
NORRLANDSVAGNAR AB 0.0651 1.8496 1.5584 0.9402 0,0937 0.001 0.035 0.0764 0.0173 0.0358 0.0579 0.0358 0.0579 3.480 -0.020 
OY INNSOL AB 0.0079 9.3248 1.4746 0.7777 0.O496 0.035 0.025 0.0548 -0.0052 0.0217 0.0279 0.0217 0.0279 3.728 1.962 
PETIT LOCATION 0.0007 239 1.6182 1.0135 0.3517 0.167 -0.026 0.0919 0.2598 0.0199 0.3318 0.0199 0.3318 6.059 6.321 
RAPID CONTAINER 
SERVICES 0.0429 4.8679 1.7881 1.2857 0.0095 0.070 -0.044 0.1359 -0.1264 0.0303 -0.0208 0.0303 -0.0208 4.316 -1.736 
274 
C o m p a n y N a m e 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
Liq Risk 
CATP 
MFin 
Lev 
Net-cost-
plus 
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
Fin Lev 
Fitted 
Values 
Fin Lev 
Residuals 
REKO TRAILER AB 0.152 1.0857 2.0475 0.8848 0.09S9 0.057 0.015 0.2030 -0.1041 0.0572 0.0417 0.0572 0.0417 4.116 2.524 
ROUERGUE CARROSSERIE 
INDUSTRIELLE 0.1731 0.9572 1.0842 0.5248 0.0297 -0.044 0.054 -0.0462 0.0759 0.0623 -0.0326 0.0623 -0.0326 -0.138 1.118 
SARL DEXPLOITATION 
DU G A R A G E BERT A 0.1655 0.2469 1.3989 1 0.0063 0.285 -0.030 0.0352 -0.0289 0.0605 -0.0542 0.0605 -0.0542 8.453 11.867 
S A R L H U W E R 
H Y D R O V I D E 0.1277 2.7188 2.4618 1.042 0.1075 0.468 -0.447 0.3101 -0.2026 0.0512 0.0563 0.0512 0.0563 11.808 -9.758 
S A R L IFOR WILLIAMS 
FRANCE 0.092 3.8321 1.0915 1.1111 -0.0.321 0.023 0.053 -0.0443 0.0122 0.0424 -0.0745 0.0424 -0.0745 3.476 3.584 
SOC COMMERCIALE 
PROMOTION 
DISTRIBUTION 0.2229 0.492 1.8439 0.5641 0.O4S8 0.137 -0.012 0.1503 -0.1015 0.0746 -0.0258 0.0746 -0.0258 5.647 5.443 
STEINDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 0.0743 2.468 0.6868 0.4189 0.0 IKS 0.032 -0.018 -0.1490 0.1678 0.0380 -0.0192 0.0380 -0.0192 4.285 -2.955 
STE TECHNIQUE 
INDUSTRIELLE 
MERIDIONALE 0.037 6.4795 1.3183 1.029 0.0362 0.127 -0.097 0.0143 0.0219 0.0289 0.0073 0.0289 0.0073 5.547 -2.637 
UNICAR F U R G O N A T U R E 
S.P.A. 0.1822 1.4179 1.0948 -0.0153 j 0.0246 -0.044 0.068 -0.0435 0.0681 0.0646 -0.0400 0.0646 -0.0400 2.194 0.126 
UTILITAIRES PRO 
SERVICES UPS 0.2401 0.1363 3.4577 0.9722 0.0376 0.014 -0.007 0.5677 -0.5301 0.0788 -0.0412 0.0788 -0.0412 4.046 -3.316 
VEHICULES INDUSTRIELS 
TRACTES 0.4365 0.5556 0.8492 0.5517 0.051 -0.054 0.022 -0.1070 0.1580 0.1271 -0.0761 0.1271 -0.0761 1.887 -5.207 
VOLQUETES FELICES SL 0.0499 2.8802 2.3579 0.911 0.0645 0.061 -0.017 0.2832 -0.2187 0.0320 0.0325 0.0320 0.0325 4.131 0.019 
ALSACE CONSTRUCTIONS 
CARROSSERIE 0.1906 0.7291 1.1128 0.7054 0.0738 0.073 -0.009 -0.0388 0.1126 0.0666 0.0072 0.0666 0.0072 4.525 1.515 
A M E N A G E M E N T 
CARROSSERIE 
EQUIPEMENT DE 
VEHICULES 0.3258 0.192 1.0088 2.1304 -0,0232 0.125 -0.097 -0.0657 0.0425 0.0999 -0.1231 0.0999 -0.1231 5.186 -2.506 
ANDREOLI RIMORCHI 0.0509 7.4274 1.4925 1.0029 0.1682 0.332 -0.103 0.0594 0.1088 0.0323 0.1359 0.0323 0.1359 9.303 9.287 
A T R A N S A B 0.1603 1.1489 1.3327 0.827 0.0461 -0.053 0.133 0.0181 0.0280 0.0592 -0.0131 0.0592 -0.0131 2.264 5.086 
BALEIKE S.L. 0.0137 16.1457 1.7444 1.0052 0.1001 -0.003 0.081 0.1245 -0.0244 0.0231 0.0770 0.0231 0.0770 2.896 4.314 
B A S C U L A N T E S PEPIN S A 0.1266 0.5409 2.3227 3.8534 0.0033 0.225 -0.092 0.2741 -0.2708 0.0509 -0.0476 0.0509 -0.0476 7.285 4.425 
BOBO C A B S W E D E N AB 0.1237 0.7361 1.3831 0.4708 U.U141 0.092 -0.022 0.0311 -0.0170 0.0502 -0.0361 0.0502 -0.0361 4.704 1.756 
CARROCERIAS D A S A N S A 0.1343 0.87 1.2324 0.416 0.UO95 0.011 0.019 -0.0079 0.0174 0.0528 -0.0433 0.0528 -0.0433 3.173 -0.253 
CARROCERIAS 
FRANCISCO CASTELLO 
B R O S E T A S A 0.0335 2.4383 1.3463 1.1134 0.0243 -0.067 0.028 0.0216 0.0027 0.0280 -0.0037 0.0280 -0.0037 1.687 -5.827 
275 
Company Name 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
LiqRisk 
CATP 
MFin 
Lev 
Net-cosl-
pius 
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
III Fin Lev Residuals 
CARROCERIAS LA 
JUNQUERA S.L. 0.0741 1.272 0.6659 0.6756 0.0367 -0.046 0.075 -0.1544 0.1911 0.0380 -0.0013 0.0380 -0.0013 2.259 0.551 
CARROCERIAS SEIN 
HNOS. S.L. 0.0539 1.5855 2.2162 1.0176 0.106S -0.018 0.049 0.2466 -0.1401 0.0330 0.0735 0.0330 0.0735 2.519 0.461 
CARROSSERE VEHICULES 
INDUSTRIEL MELUNAISE 0.0168 9.4754 1.0394 0.9648 0.123 -0.037 0.038 -0.0578 0.1808 0.0239 0.0991 0.0239 0.0991 2.827 -2.667 
CARROZZERIA OFFICINE 
S.MARCO 0.0773 13786 1.0453 0.8235 0.029 -0.036 0.017 -0.0563 0.0853 0.0388 -0.0098 0.0388 -0.0098 2.251 -4.151 
CCC CONSTRUCTEUR 0.0227 13.1944 1.7444 1.4545 0.0212 -0.086 0.105 0.1245 -0.1033 0.0253 -0.0041 0.0253 -0.0041 2.137 -0.287 
CONSTRUCTE 
VERGAUWE 0.24 1.2062 2.4221 1 0.1394 -0.109 0.146 0.2998 -0.1604 0.0788 0.0606 0.0788 0.0606 1.250 2.290 
CORBIN 0.2934 1.2283 0.8797 0.7263 0.0984 -0.007 0.014 -0.0991 0.1975 0.0919 0.0065 0.0919 0.0065 3.321 -2.621 
DALA LAMINAT AB 0.1594 0.5712 1.4857 0.7178 0.0506 0.270 -0.255 0.0576 -0.0070 0.0590 -0.0084 0.0590 -0.0084 7.936 -6.516 
ETABLISSEMENT KOLLE 0.0541 2.4647 2.755 1.0224 0.0763 -0.013 0.040 0.3860 -0.3097 0.0331 0.0432 0.0331 0.0432 2.938 -0.338 
ETS LEROUGE 0.0792 3.6579 1.4107 1.0476 0.0301 0.027 -0.003 0.0382 -0.0081 0.0392 -0.0091 0.0392 -0.0091 3.472 -1.122 
EUROLIFT SARL 0.0575 1.9804 1.0592 1 0.0155 0.029 -0.032 -0.0527 0.0682 0.0339 -0.0184 0.0339 -0.0184 1.900 -2.170 
FOKOR OY 0.2156 0.7157 1.3455 0.1635 0.0109 0.021 -0.005 0.0214 -0.0105 0.0728 -0.0619 0.0728 -0.0619 3.522 -1.982 
HARSH LIMITED 0.2405 0.7971 1.8663 0.9557 0.0949 0.021 -0.014 0.1561 -0.0612 0.0789 0.0160 0.0789 0.0160 3.661 -2.961 
M.D.M. INDUSTRE 0.2618 0.9111 1.3227 2.0588 -0.0122 -0.121 0.134 0.0155 -0.0277 0.0842 -0.0964 0.0842 -0.0964 1.181 0.149 
MOBIL BAGES SAL 0.1233 0.5449 1.5401 0.9793 0.1032 0.159 -0.093 0.0717 0.0315 0.0501 0.0531 0.0501 0.0531 5.744 0.426 
NOGE BUS FRANCE 4.918 0.163 1.0202 1 0.032 0.172 -0.122 -0.0628 0.0948 1.2296 -1.1976 1.2296 -1.1976 6.200 -1.440 
NORRLANDSVAGNAR AB 0.0822 1.3712 1.7963 0.9465 0.0691 -0.129 0.236 0.1380 -0.0689 0.0400 0.0291 0.0400 0.0291 0.461 9.189 
OY INNSOL AB 0.0009 108.119 1.4111 0.8919 0.(1692 0.044 0.050 0.0383 0.0309 0.0200 0.0492 0.0200 0.0492 3.813 4.757 
PETIT LOCATION 0.0007 224 3.0986 1.0131 0.3634 0.055 -0.034 0.4748 -0.1114 0.0199 0.3435 0.0199 0.3435 3.850 -1.760 
RAPID CONTAINER 
SERVICES 0.0394 5.731 2.161 3 0.0016 -0.105 0.075 0.2323 -0.2307 0.0295 -0.0279 0.0295 -0.0279 0.754 -3.864 
REKO TRAILER AB 0.1732 0.9753 2.5031 0.9066 0.1159 0.018 0.008 0.3208 -0.2049 0.0624 0.0535 0.0624 0.0535 3.184 -0.644 
REMOLQUES HERMANOS 
GARCIA S.L. 0.1796 1.1106 1.731 0.9708 0.0471 0.055 0.176 0.1211 -0.0740 0.0639 -0.0168 0.0639 -0.0168 4.302 14.508 
ROUERGUE CARROSSERIE 
INDUSTRIELLE 0.1433 0.3772 1.0601 0.6426 0.0511 0.276 -0.148 -0.0525 0.1036 0.0550 -0.0039 0.0550 -0.0039 8.303 3.047 
SARL D'EXPLOITATION 
DU GARAGE BERTA 0.0642 1.0519 1.4513 1 0,0261 -0.058 0.074 0.0487 -0.0226 0.0356 -0.0095 0.0356 -0.0095 1.786 -0.266 
SARL HUWER 
HYDROVIDE 0.1352 2.2488 1.8476 0.9959 0.0861 -0.146 0.185 0.1512 -0.0651 0.0530 0.0331 0.0530 0.0331 0.424 3.286 
SARL IFOR WILLIAMS 
FRANCE 0.0788 3.5714 1.0103 1.0482 -0.0397 -0.033 0.062 -0.0653 0.0256 0.0391 -0.0788 0.0391 -0.0788 2.283 0.527 
SOC COMMERCIALE 
PROMOTION 
DISTRIBUTION 0.1968 0.7278 1.9964 0.5889 0.0594 0.035 -0.008 0.1897 -0.1303 0.0682 -0.0088 0.0682 -0.0088 3.520 -0.810 
276 
Company Name 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
Liq Risk 
CATP 
M Fin 
Lev 
Nel-cust-
plus 
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
Fin Lev 
Fitted 
Values 
Fui Lev 
Residuals 
STEINDUSTREELLES DE 
VENTES ECHANGES 
LOCATIONS 0.1451 1.4281 0.9582 0.7541 0.(1459 -0.017 0.021 -0.0788 0.1247 0.0555 -0.0096 0.0555 -0.0096 3.319 -2.889 
STEORNAISEDE 
CHAUDRONNERIE 
CAROSSERIE 0.0229 7.6667 1.7753 0.9365 0.S688 0.269 -0.193 0.1325 0.0363 0.0254 0.1434 0.0254 0.1434 7.997 -0.907 
STE TECHNIQUE 
INDUSTRIELLE 
MERIDIONALE 0.021 10.64 1.4337 1.0139 0.0312 0.164 -0.058 0.0442 -0.0130 0.0249 0.0063 0.0249 0.0063 5.954 3.666 
THERMOCON OY 
ELEMENT 0.0872 2.2991 3.0354 0.9689 0.2284 -0.024 -0.045 0.4585 -0.2301 0.0412 0.1872 0.0412 0.1872 2.419 -9.819 
UNICAR FURGONATURE 
S.P.A. 0.1781 0.636 1.0639 1.5307 ■0.044 0.068 -0.042 -0.0515 0.0075 0.0636 -0.1076 0.0636 -0.1076 4.033 -1.513 
UTILITAIRES PRO 
SERVICES UPS 0.291 0.1169 3.4975 0.978 0.0534 0.012 -0.019 0.5780 -0.5246 0.0913 -0.0379 0.0913 -0.0379 1.996 -2616 
VEHICULES INDUSTRIELS 
TRACTES 0.5158 0.4583 0.8291 0.3529 O.030S 0.029 0.139 -0.1122 0.1430 0.1466 -0.1158 0.1466 -0.1158 2.595 0.765 
VOLQUETES FELICES SL 0.0595 3.4817 2.7602 0.9566 0.128 -0.031 0.066 0.3873 -0.2593 0.0344 0.0936 0.0344 0.0936 3.783 10.617 
ALSACE CONSTRUCTIONS 
CARROSSERIE 0.1493 1.1007 0.9581 -0.8095 O.OI14 -0.044 0.094 -0.0788 0.0902 0.0565 -0.0451 0.0565 -0.0451 2.423 2.357 
ANDREOLI RIMORCHI 0.0621 7.2525 1.6197 0.9963 02317 0.200 -0.135 0.0923 0.1394 0.0350 0.1967 0.0350 0.1967 6.860 -0.800 
ATRANS AB 0.1456 0.671 1.5531 0.8662 00359 -0.016 0.047 0.0751 -0.0392 0.0556 -0.0197 0.0556 -0.0197 3.378 -0.418 
BALEIKE S.L. 0.0229 12.8696 1.7308 1.0113 0.0954 -0.066 0.090 0.1210 -0.0256 0.0254 0.0700 0.0254 0.0700 1.721 0.649 
BASCULANTES PEPIN SA 0.1241 0.6927 2.2431 1.5587 0.009S 0.083 -0.035 0.2535 -0.2437 0.0503 -0.0405 0.0503 -0.0405 4.515 0.105 
BOBO CAB SWEDEN AB 0.0938 1.6693 1.2964 0.4603 0.0135 -0.013 0.040 0.0087 0.0048 0.0428 -0.0293 0.0428 -0.0293 2.854 -0.194 
CARROCERIAS DASAN SA 0.1414 0.6191 1.2737 0.3365 0.0114 -0.013 0.044 0.0028 0.0086 0.0545 -0.0431 0.0545 -0.0431 2.974 -0.014 
CARROCERIAS 
FRANCISCO CASTELLO 
BROSETA SA 0.1062 2.5999 1.6933 1.0205 0.0264 0.062 -0.053 0.1113 -0.0849 0.0459 -0.0195 0.0459 -0.0195 3.848 -2.908 
CARROCERIAS SEIN 
HNOS. S.L. 0.0699 1.044 2.2041 1.0854 0.0658 0.078 -0.073 0.2435 -0.1777 0.0370 0.0288 0.0370 0.0288 4.239 -3.689 
CARROSSERIE VEHICULES 
INDUSTRIEL MELUNAISE 0.0106 14.1842 1.3651 0.9751 0.1122 -0.159 0.034 0.0264 0.0858 0.0224 0.0898 0.0224 0.0898 -0.017 -14.213 
CARROZZERIA OFFICINE 
S.MARCO 0.1004 1.455 3.7424 1 0.0209 0.010 -0.009 0.6414 -0.6205 0.0445 -0.0236 0.0445 -0.0236 0.512 -0.352 
CCC CONSTRUCTEUR 0.1051 3.5252 1.7267 2.6923 0.0099 0.002 0.018 0.1200 -0.1101 0.0456 -0.0357 0.0456 -0.0357 3.308 -1.348 
CORBIN 0.0406 6.5345 0.583 1.1232 -0.1245 -0.040 0.059 -0.1759 0.0514 0.0297 -0.1542 0.0297 -0.1542 2.737 -0.837 
DALA LAMINAT AB 0.1613 0.8938 1.655 0.7557 0.075 -0.010 0.046 0.1014 -0.0264 0.0594 0.0156 0.0594 0.0156 2.935 0.555 
ETABLISSEMENT KOLLE 0.0731 2.7895 2.7748 1.1081 0.0144 -0.014 0.038 0.3911 -0.3767 0.0377 -0.0233 0.0377 -0.0233 2.466 -0.096 
ETS LEROUGE 0.0746 2.8585 1.1751 1.037 -0.0187 0.050 0.063 -0.0227 0.0040 0.0381 -0.0568 0.0381 -0.0568 3.959 6.231 
277 
Company Name 
CATP 
MInv 
Risk 
CATP 
M Rec 
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CATPM 
Liq Risk 
CATP 
MFin 
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(NCP) 
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Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
HI Fin Lev Residuals 
EUROUFT SARL 0.0929 3.8264 1.1112 1.0278 O.Q238 -0.051 0.128 -0.0392 0.0630 0.0426 -0.0188 0.0426 -0.0188 2.500 4.670 
GROTHKAROSS AB 0.0533 1.9692 1.2481 1.016 -00689 0.009 0.040 -0.0038 -0.0651 0.0329 -0.1018 0.0329 -0.1018 3.230 1.400 
HARSH LIMITED 0.283 0.7215 1.3569 1.4838 -0.0)29 -0.034 0.054 0.0243 -0.0372 0.0894 -0.1023 0.0894 -0.1023 2.664 -0.664 
HERMANNS IBERICA SA 0.1207 1.2598 1.1573 0.9843 0.0097 0.075 0.021 -0.0273 0.0370 0.0495 -0.0398 0.0495 -0.0398 4.957 3.753 
M.D.M. INDUSTRIE 0.2096 0.9307 1.3586 0.8252 0,0525 0.085 0.084 0.0248 0.0277 0.0713 -0.0188 0.0713 -0.0188 4.913 9.527 
MEKAUTOAB 0.0708 1.6375 1.9178 2.1071 -0,0027 0.045 -0.024 0.1694 -0.1721 0.0372 -0.0399 0.0372 -0.0399 3.800 -1.720 
MOBIL BAGES SAL 0.0663 1.0503 0.6724 0.9502 0.1068 -0.069 0.048 -0.1527 0.2595 0.0361 0.0707 0.0361 0.0707 2.263 ^t.463 
NOGE BUS FRANCE 0.6819 0.2027 1.739 0.7791 0.0445 0.015 0.016 0.1232 -0.0787 0.1875 -0.1430 0.1875 -0.1430 3.669 -0.649 
NORRLANDSVAGNAR AB 0.085 1.4273 1.3133 0.9623 0.0777 -0.051 0.074 0.0130 0.0647 0.0407 0.0370 0.0407 0.0370 2.850 -0.590 
OYINNSOL AB 0.0294 3.0078 1.6137 0.9413 0.1135 -0.044 0.075 0.0907 0.0228 0.0270 0.0865 0.0270 0.0865 3.444 -0.434 
PETIT LOCATION 0.0006 331 2.8121 1.0398 0.3774 -0.060 0.183 0.4007 -0.0233 0.0199 0.3575 0.0199 0.3575 2.242 8.708 
REKO TRAILER AB 0.1641 1.0856 2.4141 0.8719 01084 -0.070 0.118 0.2978 -0.1894 0.0601 0.0483 0.0601 0.0483 2.327 2.263 
REMOLQUES HERMANOS 
GARCIA S.L. 0.2247 0.6396 1.0774 0.8543 0.0458 -0.070 0.147 -0.0480 0.0938 0.0750 -0.0292 0.0750 -0.0292 2.278 4.812 
ROUERGUE CARROSSERIE 
INDUSTRIELLE 0.1479 0.2735 1.0867 0.4702 0.02K8 0.079 0.021 -0.0456 0.0744 0.0561 -0.0273 0.0561 -0.0273 5.248 3.852 
SARL DEXPLOITATION 
DU GARAGE BERTA 0.0509 6.5606 1.1868 1 0.0347 -0.001 0.025 -0.0197 0.0544 0.0323 0.0024 0.0323 0.0024 3.659 -1.279 
SARL HUWER 
HYDROVIDE 0.0957 2.932 2.0253 0.9756 0.1248 -0.050 0.138 0.1972 -0.0724 0.0433 0.0815 0.0433 0.0815 2.815 5.195 
SARL IFOR WILLIAMS 
FRANCE 0.0763 4.0455 1.0245 0.6667 0.0016 0.006 0.107 -0.0617 0.0633 0.0385 -0.0369 0.0385 -0.0369 3.764 6.326 
SOC COMMERCIALE 
PROMOTION 
DISTRIBUTION 0.2233 0.731 1.8139 0.7517 0(1994 -0.007 0.098 0.1425 -0.0431 0.0747 0.0247 0.0747 0.0247 4.906 3.494 
STEINDUSTRIELLES DE 
VENTES ECHANGES 
LOCATIONS 0.1758 1.4673 1.0021 1.3333 -0.0268 0.148 0.185 -0.0675 0.0407 0.0630 -0.0898 0.0630 -0.0898 6.753 18.277 
STEORNAISEDE 
CHAUDRONNERIE 
CAROSSERIE 0.0504 6.2658 1.0967 0.9333 0.0502 0.037 0.012 -0.0430 0.0932 0.0322 0.0180 0.0322 0.0180 4.317 0.403 
STE TECHNIQUE 
INDUSTRIELLE 
MERIDIONALE 0.0273 6.6154 1.4322 1.0636 0.0485 0.069 -0.041 0.0438 0.0047 0.0265 0.0220 0.0265 0.0220 5.801 -3.051 
THERMOCON OY 
ELEMENT 0.1035 2.1613 2.7792 0.9551 0.2551 0.115 0.170 0.3922 -0.1371 0.0452 0.2099 0.0452 0.2099 14.791 7.399 
THIERRY 0.0647 2.9808 0.87 1.16 -0.0302 0.091 -0.022 -0.1016 0.0714 0.0357 -0.0659 0.0357 -0.0659 11.631 -5.161 
UNICAR FURGONATURE 
S.P.A. 0.1663 0.994 1.0246 0.8383 0.O218 0.499 -0.135 -0.0616 0.0834 0.0607 -0.0389 0.0607 -0.0389 26.772 -0.122 
UTILITAIRES PRO 
SERVICES UPS 0.2627 0.1552 3.4541 0.9821 0.0534 0.223 0.129 0.5668 -0.5134 0.0844 -0.0310 0.0844 -0.0310 22.514 3.506 
278 
Company Name 
CATP 
M Inv 
Risk 
CATP 
M Rec 
Risk 
CATPM 
Liq Risk 
CATP 
MFin 
Lev 
Net-cost-
plus 
(NCP) 
NCP 
Fitted 
Values 
NCP 
Residuals 
Inv Fitted 
Values 
Inv 
Residuals 
Rec Fitted 
Values 
Rec 
Residuals 
Liq 
Fitted 
Values 
Liq 
Residuals 
Fin Lev 
Fitted 
Values 
Fin Lev 
Residuals 
VEHICULES 1NDUSTRIELS 
TRACTES 0.6134 0.355 0.8801 0.2941 0.0485 0.523 -0.146 -0.0990 0.1475 0.1707 -0.1222 0.1707 -0.1222 34.192 -6.792 
279 
Appendix 4.5. Net-Cost-Plus (NCP) Scatter plot 
Figure 34: Net-Cost-Plus CATPM Inventoiy Scatter plot 
280 
Figure 35: Net-Cost-Plus CATPM Receivable Scatter plot 
, „ Correlation = 0.095 
0.4-
♦ 
0.0 
-0.4-
* * * * $ * . . . ♦ * < * " . ♦ ' . 
♦ . ♦ ♦ * ♦ ♦ 
?*""<r 4 V" ♦ ♦ 
♦ ♦ 
♦ 
H 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1-
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 
CATPM RecRisk 
281 
Figure 36 Net-Cost-Plus CATPM Liquidity Scatter plot 
282 
Figure 37: Net-Cost-Plus CATPM Activity Scatter plot 
2.4 i 
♦ 
Correlation = -0.262 
2.0 -
1.6-
1.2-
N
et
 C
os
t 
P
lu
s 
p CO
 
♦ 
0.4-
0.0 J 
♦ ♦♦ ♦ 
► ♦ ♦ ♦♦ ♦«*♦ ♦ * 
-0.4-
♦ 
3 1 2 3 
CATPM Activity Risk 
4 5 6 
283 
Figure 38: Net-Cost-Plus CATPM Solvency Scatter plot 
284 
Figure 39: Net-Cost-Plus CATPM Financial leverage Scatter plot 
0.8 -I Correlation = 0.012 
0.6 -
♦ 
N
et
 C
os
t 
P
lu
s 
o 
p 
p 
♦ * ♦ - ♦ ♦ " < * * $ 
♦ 
♦ +\ ♦ ♦ 
♦ 
♦ 
-0.2 -
♦ 
-0.4-
-0.6 -
-0.8 - 1 1 1 1 1 1 1 
-1.6 -0.8 0.0 0.8 1.6 2.4 3.2 4.0 
CATPM Fin Lev 
285 
Figure 40: Net-Cost-Plus CATPM Taxation leverage Scatter plot 
286 
Appendix 4.6. CATPM arm's length NCP consideration 
Regression NCP for the period 1998 to 2002 
Estimation of the Arm's 
length consideration 
Tested Party Hypothetical first quartile Company Hypothetical Median Company Hypothetical third quartile Company 
Tested 
Party 
Ratio's 
(Median) 
Regression 
Output 
Coefficients 
or weights 
Weights 
x Tested 
Ratio's 
first 
quartile 
Ratio's 
Regression 
Output 
Coefficients 
or weights 
Weights 
X 
Median 
Ratio's 
Median 
Ratio's 
Regression 
Output 
Coefficients 
or weights 
Weights 
X 
Median 
Ratio's 
third 
quartile 
Ratio's 
Regression 
Output 
Coefficients 
or weights 
Weights 
X 
Median 
Ratio's 
Intercept 1.000 -0.1968 -0.1968 1.0000 -0.1968 -0.1968 1.0000 -0.1968 -0.1968 1.0000 -0.1968 -0.1968 
Inventory Risk 0.384 0.1386 0.0532 0.0549 0.1386 0.0076 0.1062 0.1386 0.0147 0.1754 0.1386 0.0243 
Receivable Risk 0.596 0.0008 0.0005 0.7971 0.0008 0.0006 1.5253 0.0008 0.0012 3.5572 0.0008 0.0027 
Liquidity Risk 1.115 0.1941 0.2165 1.0867 0.1941 0.2110 1.3651 0.1941 0.2650 1.7753 0.1941 0.3447 
Financial Leverage -0.114 -0.0731 0.0083 0.7470 -0.0731 -0.0546 0.9560 -0.0731 -0.0699 1.0169 -0.0731 -0.0743 
Sum 8.17% -3.22% 1.43% 10.06% 
Difference amongst Tested 
Party and Comparable Data 1139% 6.74% -1.89% 
Interquartile PLI Operating Margin 
r D 
1.99% 3.56% 7.02% 
Tested Party Profit Level Indicate 2.40% 2.40% 2.40% 
Variance Premium (Discount) 5.62? 0.97% ■7.66% 
287 
Appendix 5. ZA CASE 01 
Appendix 5.1. Transfer pricing evaluation process planning 
Appendix 5.1.1. Cross-border dealings amongst the connected parties 
The following structure was used in the evaluation of the cross border transactions of ZA Case 
01, it is numbered for ease of reference, and the numbering is indicative of the chorological order 
of the process. 
Planning 
Process planning, setting up meetings 
Business Operations 
Site visits and presentation 
De-brief session 
Follow-up and process mapping 
Administration 
Set up interviews with concerned parties 
Compile and finalise questions 
Forward questions for forthcoming meetings and interviews 
Interviews and documentation of interview information 
Overview of organisation 
Commercial and industry conditions 
Consideration of transactions under review 
Nature and terms 
Form of consideration charged or paid 
Sales or purchase volume 
Scope and terms of warranties 
Rights to updates, revisions or modifications 
Duration of licences, contracts or agreements 
Termination or renegotiation rights 
Collateral transactions or ongoing business relations 
Arrangement for ancillary or subsidiary services 
Credit and payment terms 
288 
Economic Conditions 
Geographic location 
Size of market 
Extent of competition 
Availability of substitute goods & services 
Transportation cost 
Level of market (Wholesale - Retail) 
Property involved 
Business Strategies 
Treatment of risk 
Risk of change in cost, price or stock (supply, demand, market) 
Risk relating to the success or failure of research and development (R&D) 
Financial risk, foreign exchange and interest rates 
Risk of lending and payment terms 
Risk of manufacturing liability 
Business risk related to ownership of facilities or assets 
Consistency of risk allocation with economic substance 
Purported allocation of risk is consistent with economic substance of transaction 
Analyse risk (business cycle), market risk over which neither party has control 
Verify risk in terms of strategy, i.e. hedge/put and call options, forward contracts 
Internal review 
Verify and change/incorporate reviews 
External review 
Verify and change/incorporate external review(s) 
Appendix 5.1.2. Selecting the appropriate transfer pricing method 
Selection and application of method documenting 
Degree of comparability amongst uncontrolled and controlled transactions 
Completeness and accuracy of data relied on 
Reliability of assumptions 
Sensitivity of results and possible deficiencies in data and assumptions 
Assessment of quality of data and information including which pricing method(s) is the most 
appropriate under the circumstances. 
Consider the quality of data 
Consider level of consistency 
Consider which pricing methods will be the most appropriate 
Verify 
Integrate information obtained in Section 1 to determine 
Determination of comparability (transactional) under the traditional transaction 
methods 
Determination of comparability (enterprise) under the profit level indicators 
methods 
Allocation of consideration amongst enterprises when the profit split method is 
applicable 
Appendix 5.1.3. Application of the pricing method or methods 
Once selection has been made, functional analysis as pertained in section 1 can be extended to 
reflect method selection 
Pricing based on external benchmarks to establish the degree of comparability. 
Clarify comparability in terms of 
Characteristics of goods and services 
Relative importance of functions performed 
Terms and conditions of relevant agreements 
Relative risk assumed by MNE, connected enterprises and any independent party 
where such party is considered as a possible comparable 
Economic and market conditions 
Business Strategies 
Make and document adjustments to enhance comparability taking cognisance of the 
following whilst using foreign comparables 
Country specific risk 
Risk free rate of return 
Inflation 
Characteristics of goods and services 
Relative importance of functions performed 
Terms and conditions of relevant agreements 
Economic and market conditions 
Business Strategies 
Appendix 5.1.4. Determination of the arm's length consideration 
Documentation and demonstration of determination of arm's length outcome 
Verify and careful consideration of all facts pertaining to the specific case and the arm's length 
consideration as calculated 
Appendix 5.2. Functional Analysis Questionnaire 
Appendix 5.2.1. Intangible property 
Manufacturing 
Research and development 
Has the company developed their own products? Are they unique? 
Has the company developed manufacturing processes? 
Determine how important these processes are to the business and are they unique? 
Manufacturing processing/technological know-how 
Does the company possess technological know how? 
If so, describe the nature of this know-how 
How important is this know -how to the business of the company? 
Is this know how unique? 
Trade marks/patents etc 
Does the company own any trade marks/patents? 
What is the significance of these trade marks/patents to the existence of the 
companies business? 
Product quality 
Does the company have a reputation for high quality? 
Is there any other manufacturing intangibles? 
Marketing 
Trade marks/trade names 
Does the company own any trade names/trade marks? 
291 
Does the company pay royalties for the use of any trade names/trade marks? 
Does the company charge royalties for others to use trade marks/names, which 
they own? 
How are these calculated? 
How significant are these to the business of the company? 
Corporate reputation 
Does the company have a corporate reputation? 
What is the nature of this reputation? 
Is this corporate reputation significant to the business of the company? 
Appendix 5.2.2. Operations 
Manufacturing 
Raw materials purchasing 
What materials or partly finished goods are purchased? 
From whom are these purchases made? 
Where are raw materials purchased? 
How are raw materials purchased? 
Who performs the purchasing function? 
Who negotiates the purchasing arrangements? 
Do purchasing decisions require head office approval? 
What are the approvals required? 
Are any purchases made on consignment? 
What are the major risks? 
Inventory 
Where is the stock held? 
Who is in control of the level of inventory? 
How is the inventory levels controlled? 
Are any purchases made on consignment? 
How many days of inventory are on hand? 
Who bears the cost of obsolete inventory? 
What are the major risks associated with holding inventory? 
Production equipment 
Who determines the purchasing budget? 
Who negotiates purchasing? 
Who maintains the plant? 
Who has the authority to incur expenditure for capital equipment? 
Who writes specifications for the plant? 
From who is production equipment purchased? 
Does the company have discretion over the equipment used? 
What decisions require head office approval? 
What are the approvals required? 
Production scheduling 
Who is responsible for production scheduling decisions? 
Is a computer system used? 
What decisions require head office approval? 
What are the approvals required? 
What are the major risks? 
Production Quality Control 
What form does quality control take? 
Who sets finished product quality standards and procedures? 
Who performs the quality control and who bears the costs? 
Who provides the equipment and techniques for quality control? 
How many products are lost because it fails quality control checks? 
What are your major risks? 
What decisions require head office approval? 
What are the approvals required? 
Shipping of products 
Who pays freight charges for product in and out? 
Who arranges shipping of products? 
Who ships the products? 
Who selects the shippers? 
Who is responsible for shipping deadlines? 
What are the major risks? 
293 
Sales and Distribution 
Sales 
How are sales made and who is involved? 
Who issues the invoice to the customer? 
Who formulates projections and sales targets? 
Where are sales orders received? 
Who negotiates sales contracts? 
How much is sold to related companies? 
Are only finished goods shipped from South Africa? 
Who are the competitors? 
What are the risks related to the demand for the companies products? 
Who assumes these risks? 
Are products exported and who is responsible for this function? 
What are the major risks in selling products in foreign countries and who 
assumes these? 
Final Product Quality Control 
What form does quality control take? 
Who sets finished product quality standards and processes? 
Who performs quality control and who bears all costs? 
Who provides equipment and techniques for quality control? 
Who bears the loss of defective products? 
What are the major risks? 
Freight 
Who bears freight charges for product in and out? 
Who arranges the shipment of goods? 
Who ships the products? To where? How? 
What are the major risks? 
Inventory 
Who holds the stock and where is it held? 
Who controls the level of inventory? 
How are inventory levels controlled? 
Are purchases of stock made on consignment? 
How many days of inventory are on hand? 
Who bears the cost of obsolete inventory? 
What are the major inventory risks? 
Marketing 
Strategic 
Does the company carry out its own marketing? 
Who are the competitors? 
Do related companies carry out marketing on behalf of the company? 
Are independent enterprise distributors used? 
Who authorize, choose and control independent enterprise distributors? 
Advertising 
What forms of marketing are utilized? 
What form of advertising is used? 
Are trade shows used and if so who pays for them? 
Who produces product brochures, specification sheets etc? 
What decisions require head office approval? 
Research and development 
What research and development is carried out? 
Is any research and development carried out on behalf of the company by 
related companies? 
Are third parties commissioned to carry out research and development on 
behalf of the company? 
Where are products designed? 
What input do distributors have on manufacturing, product design or 
product modifications? 
How important is the development of patents in the industry? 
What patents is owned that create unique products which competitors 
cannot duplicate? 
What un-patented technical know-how has been developed that may 
differentiate products from competitors, create important cost efficiencies 
or provide an advantage in increasing market share? 
Who formulates the budget? 
Are license agreements in existence amongst the company and related 
companies or third parties? 
Is there a cost sharing agreement in force and if so what are the details? 
Administration and other services 
General administration 
Is there a complete administration function? 
Is any administration performed by the MNE for any related party? 
What decisions require head office approval and what are the 
approvals required? 
Pricing policy 
Is there a transfer pricing policy document in place? 
Who determines the pricing policy? 
What is the pricing policy for various goods and services? 
What are the major risks? 
Did a reputable professional advisor prepare the transfer pricing 
policy document? 
Does the transfer pricing policy document contain a thorough 
macro and micro economic analysis of the company? 
Does the transfer pricing policy document contain a search for 
independent comparable companies? 
Does the search criteria applied seem reasonable in the 
circumstances? 
Does the method applied seem reasonable in the circumstances? 
Accounting 
What accounting functions are carried out and by whom? 
Where are the financial reports prepared? 
Is a bank account maintained and where? 
Who has cheque signatory authority? 
Who bears the credit risk on sales to customers? 
Who pays product liability insurance premiums? 
Who arranges and pays for other insurance? 
Legal 
Who is responsible for legal matters? 
What decisions require head office approval? 
What are these approvals? 
Risk 
Market risk 
What are the market risks? 
Who bears these risks? 
Inventory risk 
Does inventory become obsolete? 
Who bears the cost of obsolete inventory? 
Who bears the cost of returns? 
Credit and bad debt risk 
What credit terms are given and received? 
Who bears the cost of bad debts? 
Foreign exchange risk 
Is the company exposed to foreign currency risk? 
Does the company take out forward contracts, hedges, put and call 
options? 
If so, who incur the expense of these financial arrangements? 
Who bears this risk? 
To what extent did this risk materialized? 
Failure and cost of overrun of R&D projects 
Who bears this risk? 
To what extent did this risk materialized? 
Intellectual property risk 
Who bears this risk? 
297 
To what extent did this risk materialized? 
Insurance and product liability risk 
Who bears this risk? 
To what extent did this risk materialized? 
Bad debt risk 
Who bears this risk? 
To what extent did this risk materialized? 
Other risks 
Identify all other risks that may impact on the return of the MNE 
298 
Appendix 6. Comparable Data according to current approach 
Appendix 6.1. ZA CASE 01 Comparables 
2001, Values 
in EUR (th) 
BENNES 
GUILLAU 
MESA 
JAPA 
MAINTE 
NANCE 
SARL 
ALQUIER 
JEUNES 
UTILITAIRES 
PRO 
SERVICES 
UPS DEI LA 
SUD EST 
REPARATION 
CARROSSERIE 
VEHICULES 
INDUSTRIEL 
MELUNAISE 
ALLOY 
BODIES 
LIMITED 
J. C. 
PAYNE 
LIMITED 
Operating 
revenue / 
turnover 3441 1297 1383 1794 3000 3609 3634 16996 18405 
Operating P/L 6 14 35 91 105 261 398 457 1079 
Profit (loss) 
before tax 4 11 34 89 108 254 384 407 1108 
P/L after tax 1 8 24 60 52 243 248 304 771 
Current 
assets: stocks 659 76 139 522 630 363 61 982 1120 
Current 
assets: 
debtors 725 281 74 61 590 590 578 2745 3682 
Current assets 1698 378 363 696 1372 1073 1162 4450 5955 
Current 
liabilities 1360 262 217 199 621 920 1118 2909 5055 
Total assets 1831 435 373 775 1997 1191 1340 5044 6251 
Non current 
liabilities: long 
term debt 37 0 0 0 0 0 0 21 5 
Current 
Liabilities: 
loans 34 58 0 27 0 286 151 74 68 
Current 
Liabilities: 
creditors 942 66 169 109 500 488 559 2392 3886 
Shareholders 
funds 153 136 156 557 1193 271 214 2104 1169 
Shareholder 
funds: capital 91 45 44 51 601 40 114 180 10 
299 
Appendix 7. Comparable Data according to CATPM 
Appendix 7.1. ZA CASE 01 CATPM response variables 
Tested Party - ZA Case 01 
Year NCP OM ROA 
Profit 
Margin 
Inventory 
Risk 
Receivable 
Risk 
Liquidity 
Risk 
Activity 
Risk 
Solvency 
Risk 
Financial 
Leverage 
Tax 
Leverage 
2002 ZA Case 01 0.48% 0.48% 0.82% -0.26% 0.2651 0.6086 1.0405 1.7114 2.4480 -0.5377 -0.7109 
2001 ZA Case 01 2.40% 2.34% 3.11% 0.07% 0.2768 0.5957 1.0172 1.3289 3.4574 0.0295 0.0206 
2000 ZA Case 01 3.84% 3.70% 3.86% -0.42% 0.4682 0.5308 4.9516 1.0437 2.0271 -0.1139 -0.0797 
1999 ZA Case 01 9.45% 8.64% 11.63% 2.57% 0.4299 0.4766 1.1151 1.3464 0.9526 0.2979 0.2086 
1998 ZA Case 01 2.19% 2.15% 2.76% -3.52% 0.3840 0.7600 1.2558 1.2873 -2.5722 -1.6381 -1.1467 
1997 ZA Case 01 -1.08% -1.09% -1.65% -10.06% 0.4069 0.3930 1.3885 1.5140 -3.0925 9.2154 6.4508 
1996 ZA Case 01 8.44% 7.79% 9.55% 1.56% 0.4422 0.5363 1.2407 1.2263 -39.9184 0.1999 0.1399 
Inter quartile range of tested party - ZA Case 01 
NCP OM ROA 
Profit 
Margin 
Inventory 
Risk 
Receivable 
Risk 
Liquidity 
Risk 
Activity 
Risk 
Solvency 
Risk 
Financial 
Leverage 
Tax 
Leverage 
first quartile 1.34% 1.31% 1.79% -0.0197 0.3304 0.5037 1.0778 1.2568 -2.8324 -0.3258 -0.3953 
Median 2.40% 2.34% 3.11% -0.0026 0.4069 0.5363 1.2407 1.3289 0.9526 0.0295 0.0206 
third quartile 6.14% 5.74% 6.70% 0.0081 0.4360 0.6021 1.3222 1.4302 2.2375 0.2489 0.1742 
300 
Appendix 7.2. ZA CASE 01 CATPM positioning analysis 
Regression NCP for the period 1996to 2002 
Estimation of the 
Arm's length 
consideration 
Tested Party Hypothetical first quartile ( Company Hypothetical Median Company Hypothetical third quartile Company 
Tested 
Party 
Ratio's 
(Median) 
Regression 
Output 
Coefficients 
or weights 
Weights 
x Tested 
Ratio's 
first 
quartile 
Ratio's 
Regression 
Output 
Coefficient 
s or weights 
Weights 
x Median 
Ratio's 
Median 
Ratio's 
Regression 
Output 
Coefficient 
s or weights 
Weights 
x Median 
Ratio's 
third 
quartile 
Ratio's 
Regression 
Output 
Coefficients 
or weights 
Weights 
x Median 
Ratio's 
Intercept 1.000 -0.1738 -0.1738 1.0000 -0.1738 -0.1738 1.0000 -0.1738 -0.1738 1.0000 -0.1738 -0.1738 
Inventory Risk 0.407 0.1539 0.0626 0.0557 0.1539 0.0086 0.1199 0.1539 0.0184 0.1785 0.1539 0.0275 
Receivable Risk 0.557 0.0009 0.0005 0.7977 0.0009 0.0007 1.5052 0.0009 0.0014 3.5325 0.0009 0.0033 
Liquidity Risk 1.716 0.1302 0.2234 1.0643 0.1302 0.1386 1.3459 0.1302 0.1753 1.7370 0.1302 0.2262 
Sum 1128% -259% 2.13% 8.32% 
Difference amongst 
Tested Party and 
Comparable Data 
Sample 13.86% 9.14% 2.96% 
Tested Party Profit Le ve\ Indicator 3.68% 3.68% 3.68% 3.68% 
301 
Appendix 7.3. Step wise regression of net-cost-plus 
Step I - Entering variable: CATPM Liq Risk 
Summary measures 
Multiple R 0.7529 
R-Square 0.5668 
Adj R-Square 0.5652 
StBrrofEst 0.2045 
ANOVA Table 
Source df SS MS F p-value 
Explained 1 14.2334 14.2334 340.2144 3.826E-49 
Unexplained 260 10.8775 0.0418 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit Upper limit 
Constant -0.2362 0.0212 -11.1312 8.589E-24 -0.2780 -0.1944 
CATPM Liq Risk 0.1995 0.0108 18.4449 0.000E+00 0.1782 0.2208 
Step 2 - Entering variable: CATPMInvRisk 
Summary measures Change % Change 
Multiple R 0.8497 0.0969 12.9% 
R-Square 0.7221 0.1552 27.4% 
Adj R-Square 0.7199 0.1548 27.4% 
StErrofEst 0.1642 -0.0404 -19.7% 
ANOVA Table 
Source df SS MS F p-value 
Explained 2 18.1318 9.0659 336.4362 9.787E-73 
Unexplained 259 6.9792 0.0269 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit Upper limit 
Constant -0.1699 0.0179 -9.4900 1.589E-18 -0.2051 -0.1346 
CATPM Liq Risk 0.1331 0.0103 12.9329 7.499E-30 0.1128 0.1534 
CATPM Inv Risk 0.1501 0.0125 12.0278 9.058E-27 0.1256 0.1747 
Step 3 - Entering variable: CATPM RecRisk 
Summary measures Change % Change 
Multiple R 0.8551 0.0054 0.6% 
R-Square 0.7313 0.0092 1.3% 
Adj R-Square 0.7282 0.0082 1.1% 
StErrofEst 0.1617 -0.0024 -1.5% 
ANOVA Table 
Source df SS MS F p-value 
Explained 3 18.3631 6.1210 234.0341 2.640E-73 
Unexplained 258 6.7479 0.0262 
Regression coefficients 
Coefficient StdErr t-value p-value Lower limit Upper limit 
Constant -0.1738 0.0177 -9.8264 1.455E-19 -0.2086 -0.1389 
CATPM Liq Risk 0.1302 0.0102 12.7867 2.506E-29 0.1102 0.1503 
CATPM Inv Risk 0.1539 0.0124 12.4469 3.608E-28 0.1295 0.1782 
CATPM RecRisk 0.0009 0.0003 2.9742 3.215E-03 0.0003 0.0015 
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Appendix 8. Profit split methodology research 
Appendix 8.1. Equal allocation of non-separable returns 
Equal allocation of non-separable returns ("EANSR") is based on the premise that each party to 
the transaction(s) aims to realise the return they would if they were independent. Independence is 
based on the preposition of the arm's length principle. Separable returns are split amongst the 
parties to the transactions' in accordance with the arm's length principle. 
Returns obtained from co-operative activities and functions are equally allocated. The model 
which give effect to the allocation can be written as air. — sr; +\ —Xnsrt where air. is the arm's 
\n ) 
length return, sr. is the separable return, n is the number of parties to the transactions and nsr.{ 
the non-separable returns. 
This approach's focus is on returns based on inclusive coalition of the parties to the transactions 
under review. Non separable return allocation ignores the value of individual parties to the 
transaction alluding to what they would realise if they were independent, i.e. individual returns 
are not based on marginal contribution. 
The value of such an approach lies in its recognition of economies of scale and scope which give 
rise to benefits for the participants to transactions. Recognition and adjustment of benefits 
derived from economies of scale is problematic and is recognised by the OECD, especially in 
adherence to the arm's length principle (OECD 1995:1-4). 
Appendix 8.2. Proportional return 
Proportional return solution is founded on return allocation on the basis of either contribution or 
cost. The profit derived from the profit split based on the transaction under review is the product 
of the total return and the coefficient of cost or contribution to the sum of the cost or contribution. 
C-
This profit split approach can be illustrated as air, = rt -^— where alr; is the arm's length 
t 
return, rt is the total return from the transaction under review, cl the cost or contribution of the 
specific party to the transaction and ct the cost or contribution of all the parties to the 
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transactions. Cost recognition and determination might be a subjective proxy for the basis on 
which a profit split can be based. Defining and determination of cost according to accounting 
and tax reporting standards may differ which make the application more subjective. The premise 
that expenses or costs are incurred in the production of income is not flawed, measurement of 
these cost might be problematic. 
304