What is Benchmarking in Transfer Pricing?
Benchmarking is a comparative study that seeks to demonstrate that the price agreed upon between two related companies is comparable to the price that two independent companies would agree upon under equivalent market conditions.
In simple terms: if the Panamanian subsidiary of a multinational group purchases a service from its parent company in Spain, the tax authority will want to know if that price reflects the economic reality of the transaction or if, on the contrary, it was artificially set to shift profits to another jurisdiction. Benchmarking answers this question by identifying comparable transactions in the market and demonstrating that the intercompany price falls within an acceptable range according to the arm’s length principle.
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The limitations of this tool, however, have become increasingly evident in the post-BEPS environment: benchmarking demonstrates that the price is reasonable, but it does not demonstrate that the service was necessary, nor that it was actually provided. For this reason, it must now be supplemented with additional substantive documentation. In short: benchmarking states how much was charged; post-BEPS documentation must explain the why, the purpose, and the how.
The previous model: benchmarking as a sufficient shield
For years, comparative benchmarking was the cornerstone of multinational groups’ transfer pricing policies. In practice, having a technically sound benchmarking study was enough to structure a company’s tax defense, guide the strategy of its legal advisors, and support its position in the event of a dispute with the tax authorities.
The Turning Point: The Emergence of the BEPS Project
The approval of the OECD’s BEPS (Base Erosion and Profit Shifting) Action Plan marked an irreversible paradigm shift in this area. Benchmarking, considered in isolation, is no longer an effective defense tool: presenting it as the sole evidence no longer neutralizes the scrutiny of tax authorities, who now demand a substantially deeper analysis, focused on the economic reality of the transaction and not solely on its price range.
The New Standard: Substance, Necessity, and Materiality
In the post-BEPS environment, successfully maintaining a transfer pricing position requires demonstrating, at a minimum, three elements:
- The need for the service. It is not enough to state that a service was contracted with a related party; it is necessary to demonstrate why that service was indeed necessary for the business and why it could not be provided with the local entity’s own resources.
- The materiality of the service. It must be proven that the service was effectively and actually provided, through concrete documentation that supports its execution—emails, deliverables, reports, work logs, among other means of proof.
- Contractual consistency. Contracts signed between related parties must have all the supporting documentation that justifies the legal relationship, the agreed price, and the agreed conditions, in a manner consistent with the actual operation of the business.
An illustrative example: the case of technology services
Consider the case of a company domiciled in Colombia that has ten systems engineers on its payroll, but which also contracts technology services with an affiliated company located in a free trade zone in Uruguay. In this scenario, simply presenting benchmarking data no longer solves the problem: the tax authority will ask what the company’s engineers are used for and what the Uruguayan company actually does. If it is not possible to demonstrate the necessity and materiality of the service provided, the transaction is vulnerable to being disregarded or reclassified by the tax administration.
Benchmarking hasn’t disappeared as a tool, but it’s no longer a complete solution, becoming merely one component within a more robust compliance strategy.Presenting it as the sole basis for compliance now constitutes a tax risk, not a defense.The key lies in building documentation that demonstrates real economic substance, justified need, and effective service delivery.
Transfer pricing documentation as a prerequisite to financial closing
The documentation supporting transactions between related parties cannot be treated as a secondary procedure or a reactive formality in anticipation of a potential audit.The supporting documentation for transfer pricing must be prepared, organized, and available before the closing of the financial statements for the corresponding period.
This means that, at the time of closing, the company must have:
- This means that, at the time of closing, the company must have:
- Current contracts with related parties, duly signed and updated.
- The justification for the need for each intercompany service or transaction.
- The transfer pricing study that demonstrates compliance with the arm’s length principle.
- All supporting documentation that links the transaction to its true economic substance.
Documenting after the closing not only weakens the company’s defenses but can also be interpreted by the tax authorities as the artificial fabrication of evidence. The strength of the documentation depends largely on its preparation being contemporaneous with the transaction, not subsequent to it.
One point that deserves special attention at this stage is the treatment of royalties, which are subject to review in virtually all jurisdictions and which, consequently, constitute one of the points of greatest tax exposure that must be resolved before the preparation of the closing financial statement.
The transfer pricing dispute: defense, expert evidence, and procedural strategy
When the Tax Authority Discredits the Taxpayer’s Method
When the tax authorities challenge the transfer pricing method used, the taxpayer cannot simply reiterate their original position. They must be prepared to actively defend each disputed element, offering solid alternative arguments that support both the choice of method and the validity of the benchmarking presented. Exhausting available catalogs and databases is necessary, but insufficient if the company also lacks a clear procedural strategy.
Support from Administrative Courts for BEPS Standards
When a tax court bases its decision on BEPS guidelines, the standard of proof is significantly raised.This confirms that the analysis in this area can no longer be merely formal: the economic substance of the transaction must be fully and convincingly demonstrated to the judge.
The expert opinion as preponderant evidence
In transfer pricing matters, the expert report constitutes the most significant evidence in contentious proceedings. Its function is twofold: first, to demonstrate that the transfer pricing method used is technically correct; and second, to prove that the transaction has real economic substance. Beyond its technical rigor, the report also fulfills an essential communicative role, allowing the judge to understand the core of a dispute that, by its nature, is highly specialized and, in principle, outside the scope of ordinary legal knowledge.
The Expert as Strategist: Anticipation and Evidentiary Connection
The expert cannot limit themselves to issuing an isolated technical opinion. Their work also requires an indispensable strategic component:
- They must anticipate the objections that the tax authority will foreseeably raise, preparing their report as a preemptive response to these questions.
- They must anticipate the content and form of the questions during the examination, since the way these are formulated can influence the judge’s perception. Seemingly technical questions—such as whether the service was actually paid to the related company, or whether the expert directly advised the company—can carry a suggestive weight capable of swaying the judge’s assessment.
- When a tax court bases its decision on BEPS guidelines, the standard of proof is significantly raised.This confirms that the analysis in this area can no longer be merely formal: the economic substance of the transaction must be fully and convincingly demonstrated to the judge.
In short, in a transfer pricing dispute, the technical quality of the expert opinion is as crucial as the expert’s ability to anticipate the debate and clearly communicate the substance of the matter to the decision-maker.
The Apple Case in Ireland: A Paradigmatic Transfer Pricing Dispute
Case Context
Apple structured its European, Middle Eastern, African, and Indian operations through two subsidiaries incorporated in Ireland: Apple Sales International (ASI) and Apple Operations Europe (AOE). Both were, in turn, subsidiaries of Apple Operations International, within the corporate structure that ultimately traced back to Apple Inc. in the United States.
ASI and AOE operated under a head office and branch structure: each had a branch registered in Ireland that carried out specific operational functions—primarily the purchase, distribution, and sale of Apple products for the European market—while the “head office” of each entity, formally domiciled in Ireland for company registration purposes, had no employees, occupied no offices, had no operating assets, and carried out no verifiable activity. In practice, it was an accounting construct and not a real business unit.
The 1991 and 2007 Tax Rulings
The element that triggered the European Commission’s investigation was two advance tax rulings issued by the Irish tax authority, in 1991 and subsequently renewed and adjusted in 2007. These rulings approved, in advance and in a way that was binding on the tax authorities, the method that Apple would use to determine the taxable income of the Irish branches of ASI and AOE.
The approved method consisted of assigning each branch a profit calculated using specific formulas—based on operating costs and, in some years, on a percentage of sales—which resulted in a reduced taxable income, and, above all, one disconnected from the actual amount of revenue generated by the branches. The remaining profit—the so-called residual profit, which represented the overwhelming majority of the group’s earnings derived from the exploitation of Apple’s intellectual property—was attributed to the headquarters without substance, and thus, in practice, remained beyond the effective reach of any tax jurisdiction.
The underlying problem: intangible assets without supporting functions
The cost-sharing agreement between Apple Inc. and its Irish subsidiaries allowed the latter to exploit the group’s intellectual property rights—patents, trademarks, product designs, software—for the marketing of Apple products outside the Americas. However, the research and development functions that generated this value were performed, for the most part, in the United States, not in Ireland.
The central mismatch in this case is precisely this: the profit derived from extremely high-value intangible assets was assigned to an entity—the headquarters of ASI and AOE—that did not employ staff, manage risks, make strategic decisions, or carry out any substantive economic activity related to those intangibles. This structure directly contradicted the principle, now enshrined in the post-BEPS standard, that profit should follow function, risk assumed, and assets actually managed, and not mere contractual or accounting ownership.
The European Commission’s position: State aid, not just a transfer pricing issue
In August 2016, the European Commission concluded that the 1991 and 2007 tax rulings did not merely interpret Irish tax law, but granted Apple a selective advantage unavailable to other comparable companies, in contravention of Article 107 of the Treaty on the Functioning of the European Union, which prohibits State aid that distorts competition within the internal market.
The Commission’s reasoning was expressly based on the arm’s length principle as a benchmark: any tax ruling that validates an intragroup profit allocation that deviates from what independent parties would have agreed upon under comparable conditions in accordance with OECD transfer pricing guidelines constitutes, for these purposes, a selective advantage. The Commission did not question the legality of the Irish income tax rate as such, but rather the way in which, through the approved allocation method, a substantial portion of the tax base went untaxed in any jurisdiction. Consequently, it ordered Ireland to recover €13 billion, plus interest, from Apple for the period between 2003 and 2014.
The Legal Back-and-Forth: Apple and Ireland’s Initial Victory in 2020
Both Apple and Ireland—the latter with a direct interest in preserving its advance tax settlement regime as an investment incentive—appealed the decision to the General Court of the European Union. In July 2020, the General Court ruled in favor of Apple and Ireland, overturning the Commission’s decision. The Court held that the Commission had failed to demonstrate, to the required standard of proof, that a selective advantage actually existed, nor had it sufficiently proven that the profit allocation method deviated from the arm’s length principle according to the applicable methodological criteria.
The expert opinion should be understood as an active, not static, piece of evidence: it should be connected with the rest of the evidentiary material in the file, reinforcing it and giving it coherence, rather than constituting an isolated document.
7.6.The final ruling of the Court of Justice of the European Union (2024)
The European Commission appealed the General Court’s ruling to the Court of Justice of the European Union (CJEU), the bloc’s highest court.In September 2024, the CJEU overturned the 2020 ruling and definitively upheld, without further appeal, the Commission’s original 2016 decision.
The European Commission appealed the General Court’s ruling to the Court of Justice of the European Union (CJEU), the bloc’s highest court. In September 2024, the CJEU overturned the 2020 ruling and definitively upheld, without further appeal, the Commission’s original 2016 decision.
7.7.Lessons for the practice of transfer pricing
The Apple case offers lessons that are directly applicable to current practice, beyond the specific context of European competition law:
- Contractual form does not replace substance. Having cost-sharing agreements, advance tax rulings, and a formally impeccable corporate structure does not protect a tax position if the allocation of profits does not reflect the actual functions, assets, and risks of each entity.
- Profit must follow function. The attribution of income derived from high-value intangibles requires identifying where the functions of development, improvement, maintenance, protection, and exploitation of these assets are actually carried out (the standard known in the BEPS literature as DEMPE analysis), and not limiting oneself to formal legal ownership.
- An entity without employees cannot be the final destination of residual profit. A headquarters without staff or a physical presence is, by definition, incapable of assuming risks or making strategic decisions, and therefore cannot, from an economic substance perspective, justify the attribution of substantial profits.
- The risk is no longer exclusively tax-related. This case demonstrates that transfer pricing structures lacking substance can be challenged not only through traditional tax law, but also through other branches of law—in this case, the State aid regime of European competition law—when they create an advantage that distorts competition within a market.
Relevance to the Post-BEPS Debate
This case confirms, in the highest court within the European Union, precisely what has been argued throughout this article: the transfer pricing method can be distorted and profit recharacterized when it is not supported by real economic substance. Apple had an extensively documented structure from a formal standpoint, including advance tax rulings issued by the Irish tax authority itself; however, the group’s residual profit was being channeled to locations with no employees, no functions, and no physical presence, which ultimately proved indefensible before the European courts, both from a transfer pricing and a competition law perspective. The Apple case is, in that sense, the most visible example globally of this article’s central thesis: benchmarking and formal documentation are insufficient when economic substance does not accompany the structure.
Conclusion
Benchmarking is not dead as a transfer pricing tool, but it is no longer, on its own, a sufficient defense. In the post-BEPS environment, the strength of a tax position depends on the price agreed upon between related parties being supported by real economic substance, demonstrable need, and the effective provision of the service or goods involved in the transaction. Comparative experience, from disputes before tax administrative tribunals to the Apple case in the European Union, confirms that tax authorities and courts now assess the economic reality of the transaction over its mere formal consistency. For companies and their advisors, this requires a change of approach: documenting the transaction contemporaneously, building comprehensive supporting documentation, and preparing for any potential dispute with the same strategic foresight used to structure the transaction itself.
Official Sources Consulted
- OECD, Applicable Transfer Pricing Guidelines (2022). ↗
- OECD, Transfer Pricing Documentation and Country-by-Country Reporting. ↗
- Court of Justice of the European Union, Case C-465/20 P, Judgment of 10 September 2024. ↗
This article is for informational and general legal analysis purposes; it does not constitute legal advice for a specific case.
