Functional analysis crucial
Within the broad heading of contract research services, there is a considerable spectrum of activity. For example, services may range from data collection and testing under parameters provided by the principal to the development of a concept from scratch into a marketable product, platform or concept.
It is crucial to undertake a detailed functional analysis prior to considering the appropriate transfer pricing method. An analysis of options realistically available may also be informative. For further details, refer to paragraph 7.41 of the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations - July 2017.
Cost plus approach
A cost plus approach is commonly applied where contract research services display both of the following characteristics.
- The research company does not own any intellectual property created during the course of its activities.
- The research company does not assume any commercial or financial risks in relation to any intellectual property created or other outputs of its research, regardless of whether its research leads to economic success as these risks are assumed by the principal. The risks assumed by the research company are limited to its performance of the intra-group research services. (Further guidance on the assumption of risk for transfer pricing purposes is contained in Chapter 1 of the OECD's Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations - July 2017.
A considerable spectrum of activity can also be observed for contract research services exhibiting these characteristics and this will determine how much a principal would be willing to pay at arm's length - in other words, how much the 'plus' should be. This could range from as little as 5% for basic product testing to over 15% for the most complex activities.
If a New Zealand research company was operating right at the top end of the spectrum of research services (for example, the development of a concept from scratch into a marketable product, platform or concept), it would be difficult to benchmark conventionally in order to determine the mark-up on costs as it would be a reasonable hypothesis that at arm's length, a company making this kind of unique and valuable contribution would want to have the right to share in the rewards from the work. However, that is likely to be an exceptional case, which would require detailed consideration.