These days, Tax authorities across the world are paying close attention to the area of Transfer Pricing (TP). Businesses that trade cross-border face the pressure of demonstrating that the prices between their related parties are always fair. The problem comes when there is a doubt: are the profits allocated in the right way, or are the risks and rewards shared fairly?
A solution to the above problem is “functional analysis”, also known as FAR (Functions, Assets, Risks) analysis. FAR is a tool that breaks down the real business story: who does what, who takes which risks, and who uses which assets. By clarifying these points, functional analysis supports a fair TP outcome.
Tax Gian has professional TP agents in the UAE who help businesses with comprehensive FAR analysis for TP, ensuring accurate and valuable results.
What Does Functional Analysis Mean in TP?
Functional analysis in TP is about examining three things: functions, assets, and risks. Together, these form the foundation of how profits should be shared between related entities.
- Functions:These are the activities carried out, like research and development, manufacturing, sales, or financing.
- Assets:These cover both tangible assets (buildings, machinery, equipment) and intangible ones (brands, patents, intellectual property).
- Risks:These inter alia, include market risk, credit risk, contractual risk, and regulatory risk.
The idea is simple: the greater the role in carrying out functions, using assets, or assuming risks, greater would be the expected reward.
Why is Functional Analysis Important?
Functional analysis brings clarity to whether a business’s transfer prices reflect the arm’s length principle. By mapping activities, assets, and risks, tax authorities and businesses alike can see if the profits line up with economic contributions.
This process does not just list business activities. It explains who performs the work, where it happens, and who ultimately bears responsibility. This level of detail reduces disputes and gives a structured base for comparison with independent transactions.
Steps in Conducting Functional Analysis
There are different ways to carry out functional analysis, but the process often follows a clear order. TP agents in the UAE will choose the method that suits your business.
- Gathering Information
Questionnaires, documents, and interviews with managers and staff help capture how the business operates in practice. - Reviewing Functions
Each entity’s role is studied. Typically, one entity could handle product design, another can manage production, and another could focus on marketing or after-sales services. - Examining Assets
The next step is the examination of assets. Both tangible and intangible assets are identified. The role of intellectual property is particularly important, as it often has a major impact on profitability. - Identifying Risks
Risks are mapped carefully. It is not just about naming risks but checking who controls them and who has the capacity to bear them. - Studying the Contracts
Written agreements between related parties are reviewed. These show how the parties intended to share functions and risks. - Analyzing Risk Allocation
Control over risks is matched with actual conduct. The OECD recommends a six-step method for testing whether risks are allocated realistically.
Presenting the Findings
The outcome of functional analysis is usually presented in a clear and structured format. Many companies use a summary table along with narrative explanations. The table highlights key functions, assets, and risks, side by side, for each entity. The presentation in this way makes it easier to see if the profit allocation really matches the business reality.
You can talk to your TP agent in the UAE about the presentation of findings to have them structured in a customized format.
What are the Benefits of Functional Analysis
- Transparency: The topmost is transparency. It shows how the business really operates, reducing uncertainty.
- Fairness: It helps align profit with economic activity.
- Compliance: It strengthens the company’s TP documentation against audits.
- Risk Management: It reduces the chance of penalties or disputes.
Common Challenges
Carrying out functional analysis is not always straightforward. Some challenges include:
- Incomplete information: Employees may not have full knowledge of how decisions are made at the group level.
- Intangibles: Identifying and valuing intellectual property is complex.
- Risk allocation: Legal contracts may not always reflect real control of risk.
Despite these challenges, functional analysis is an important tool for defending TP positions.
You should collaborate with your TP agent in Dubai to overcome any challenges that might arise during the analysis.
How can Tax Gian help?
Functional analysis is not just a practice. It also ensures that TP reflects real contributions. By focusing on functions, assets, and risks, businesses can defend their positions with confidence and demonstrate to the tax authorities that their profits are fairly earned. Tax Gian helps companies with a comprehensive functional analysis. Our experts can also help you with comparability analysis and benchmarking studies for TP. Avail our exhaustive TP services today!
