An Argument for Working Capital Adjustments
Tax Management Transfer Pricing Report, Vol. 14, No. 24, April 2006
4 Pages Posted: 17 May 2006
Transfer pricing concerns the price that one member of a multinational organization charges another member operating in a different tax jurisdiction for goods, services or intangible property. Performing Working Capital Adjustments ("WCA") is necessary to ensure that returns derived from a set of comparables can be reliably applied to a tested party operating in a non-arm's length setting. There is no theoretical argument that suggests that WCA should be rejected. The analysis shows that operating in a perfectly competitive environment implies that WCA are required. These findings are supported on theoretical grounds, which are violated when different working capital intensities between firms exist. Given that firms are assumed to be price-takers, the only way that prices charged by all firms can be taken as given is if all of the factors that affect prices, including working capital intensities, are the same. Though theory supports the use of WCA, the need to perform such adjustments is not universally accepted. However, failure to perform WCA may result in a significant difference in the profits assigned to a tested party.
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