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Form C YA 2022 - Characterisation of Entities for Transfer Pricing Purposes: Distribution Activities

Updated: Nov 8, 2022

Photo: 廖秋容
Functional Analysis ("FAR")

The necessity to carry out a Functional Analysis, which determines whether controlled and uncontrolled transactions are equivalent, is an essential part of the Arm's Length Principle.

This functional analysis aims to identify and compare the economically relevant activities and responsibilities (i.e. Functions) that were carried out by the parties to the transaction, as well as the assets that were utilised and the risks that were absorbed by them (see para 1.51 of the OECD Transfer Pricing Guidelines).

Recent changes were made to Form C by the Inland Revenue Board in preparation for the YA 2022. One of the most critical changes is for those businesses participating in transfer pricing arrangements. As a result, the disclosure items have been significantly expanded to cover new areas.

These new areas include, among other things, stating the characterisation of your company by reference to its functional profile, the business restructuring undertaken by the group during the year, whether or not your company engages in cash pooling activities, performs any research and development activities or owns any intellectual properties.

Form C Requires Additional Disclosures

The taxpayer is NOW obligated to provide an entity characterisation concerning its business activities, specifically its manufacturing, distribution, and service activities; for instance:

  • Whether manufacturing activities are carried out as a toll manufacturer, contract manufacturer, full-fledged manufacturer, or any other form of manufacturing;

  • Whether distribution activities are carried out as a full-fledged distributor, commissionaire distributor, agent distributor, limited risk distributor, licenced distributor or any other form of distribution;

  • Whether service activities are carried out as a management-service provider, IT service provider, treasury or any other form of service.

The accurate definition of the entity is critical, and it must be decided based on an analysis of the transfer pricing functions, assets, and risks (FAR).

Functional Analysis Interviews

After completing the preliminary Transfer Pricing Interviews (also known as Functional Analysis Interviews), it is time to move on to the next step, characterising the taxpayer's business model in detail.

Why is Characterisation of the Business Model of an Entity Important?

When calculating an Entity's profits for the sake of transfer pricing, how an entity is characterised from the point of view of functional analysis is one of the factors that will be considered.

Using the OECD Transfer Pricing Guidelines, a company's categorisation can be determined by determining its functions, risks, and assets, as well as the structure and organisation of its group and how these factors influence the environment in which the company operates (see para 1.51).

Characterisation of the Business Model (Operational Framework) of the Entities

It is common practice to regard an entity's sales function as its final function in the value chain. The sales force is the one that interacts directly with the end user. This function can range from purely logistical or distributional activities to tasks more closely tied to marketing activities.

According to the information provided in Section A of the Appendix of Form C for YA 2022, the following is a list of some of the most common business models used by current sales and distribution entities.:

  1. Full-Fledged Distributor;

  2. Commissionaire Distributor;

  3. Agent Distributor;

  4. Limited Risk Distributor;

  5. Licenced Distributor;

  6. Others

This entails differentiating the functions carried out, the assets utilised, and the risks taken on by the entities engaged in intercompany transactions to ensure that the transactions are under one of the various business models the tax authorities have outlined.

The IRBM does not define any of the terms listed above. It is strongly advised that a comprehensive explanation be provided for each of the respective terms of the characteristics mentioned in Form C concerning manufacturing, distribution, and service activities.
Performing a FAR Analysis
  • The contractual terms.

  • The conduct that actually carries out.

  • Where are the contracts signed, and by whom

  • What are the responsibilities of the distributors and the principal, for example:

  • Providing demonstration to the client

  • Promotional activities to the general population.

  • To identify customers' needs.

  • Negotiating the contract: