The arm’s length principle requires related parties to apply transfer prices comparable to those agreed upon in transactions between unrelated companies operating under similar economic conditions—particularly with respect to their activities, assets, functions, and risks, as well as economic, social, and political circumstances.

To assess the prices that unrelated parties would agree to, a benchmarking analysis aims to identify independent comparable companies or transactions within the relevant database. Searching different databases (international or domestic), identifying comparable companies, and determining their profit margins are the key objectives of benchmarking analysis.

Key Criteria for Selecting Potentially Comparable Companies in a Benchmarking Analysis

When forming a list of potentially comparable companies from a database, the following criteria are applied:

• Independence – Potential comparable companies must have no related parties in accordance with the Rulebook on Transfer Pricing.

• Availability of financial statements – for the last three years.

• Activity status – Only active companies that continue to carry out regular business operations are considered.

• Geographic region – The Rulebook on Transfer Pricing requires that the search for comparable companies first be conducted in the domestic market. Only if there are not enough comparable companies to ensure the necessary level of comparability for arm’s length pricing can the search be extended to a wider geographic region.

• Exclusion of companies with negative financial results – in the last three consecutive years.

• Year of incorporation – This criterion prevents the arm’s length principle from being influenced by companies in their early stages, which may have incomparable economic conditions during the observed period, such as “start-up” costs.

• Industry classification – Using NACE Rev. 2 codes.

• Revenue and number of employees – Applied to ensure better comparability and to eliminate the impact of specific factors that may influence operations; companies are selected based on revenue size and number of employees.

Qualitative Analysis

Once the list of potentially comparable companies is created, the next step in the benchmarking analysis is a qualitative review. The sample of potential comparables from the database is analyzed based on:

• The business description provided in the database

• Content from the companies’ websites and other publicly available online sources

• Additional verification that the identified companies have no related parties and are comparable in terms of net working capital and fixed assets (through ratio analysis of financial statements)

• Comparison of balance sheet positions and financial ratios

Final Step

The final step in benchmarking analysis, after the set of comparable companies has been identified, is determining the interquartile range of prices (margins) for the comparable transactions (companies).

See the dedicated article on preparing a benchmarking analysis.