Practical Valuation of Risk Transfer in Advance Pricing Agreements

Authors

  • Zvika Afik Senior Lecturer of Finance, Department of Business Administration, Guilford Glazer Faculty of Business and Management, Ben-Gurion University of the Negev, Beer-Sheva, Israel
  • Yaron Lahav Senior Lecturer of Finance, Department of Business Administration, Guilford Glazer Faculty of Business and Management, Ben-Gurion University of the Negev, Beer-Sheva, Israel

Keywords:

Transfer Pricing, Advanced Pricing Agreement, Risk Valuation, Multinational Enterprise, Intercompany Transaction

Abstract

A recently published paper argues that Advance Pricing Agreements adopting the Comparable Profits Method or the Transactional Net Margin Method, overlook the risk transferred from the tested party (subsidiary) to the party related to the transaction (parent) - a shift caused by fixing the profitability of the tested party. In this paper, we propose a practical implementation methodology to estimate the model parameters and discuss the theoretical and practical reasons for our proposed method. Finally, we also provide numerical examples demonstrating the miss-allocation of profits and taxes. According to our examples, fixing the profitability level of a manufacturer equals a shift of 0.5% of its profitability, while fixing the profitability of a management entity means a shift of 0.85% of its profitability. These amounts can be significant on aggregate levels.

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Volume 4.1 of JOTA - Afik and Lahav Cover

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Published

08-05-2018

How to Cite

Afik, Z., & Lahav, Y. (2018). Practical Valuation of Risk Transfer in Advance Pricing Agreements. Journal of Tax Administration, 4(1), 38–54. Retrieved from https://journals.docuracy.co.uk/jota/article/view/95