INTM467130 - Establishing the arm's length price: gathering your own evidence

Searching for comparables: using commercial databases

The easiest way to search for comparable companies is to use a commercial database. These take information from a variety of publicly-available sources, put them into a user friendly format, and provide a way of finding of companies that may look comparable to your company. The basis of any alternative model you construct involving cost plus, resale minus and transactional net margin method ('TNMM') methodologies will need a review of comparables using a commercial database. This page looks at how to construct a search model and what guidelines you should take account of.

What is a commercial database?

In the UK, there are two popular commercial databases that are used by CT & VAT, International CT: OneSource and FAME. Some inspectors will be familiar with FAME as it is used by SCO, LBOs and network offices. Both databases hold information on UK companies only. Both products will provide similar results. While OneSource has approximately 400,000 company records, and FAME only has around 100,000, both databases hold information on the larger companies that are likely to be used as comparables.

The majority of transfer pricing reports produced by the major accountancy firms use FAME. For European companies, Amadeus is a popular database. It is provided by the same company which provides FAME, so the format is consistent.

The following information can be provided by FAME or OneSource:

The drawbacks of using commercial databases

All databases have drawbacks. You need to be aware of the following:

• The basic information is taken from accounts filed with Companies House. Accounts can be presented in a number of ways under UK GAAP, for example there can be different options for deciding how gross profit is calculated.
• Some companies that are independent, according to the databases, are in fact owned by overseas parents.
• Business descriptions are limited to what the accounts say. This can be very little and it is subjective.
• Companies are classified by SIC codes, which group companies into sectors. Some sectors may only have one or two companies; others may contain thousands. Companies can be described by more than one SIC code. On occasion, the company may have been allocated an inappropriate SIC code.
• The databases are best for comparing net operating profits. They can be used to obtain gross operating profits for comparison, but you may have difficulty in establishing exactly how the gross profit has been calculated in each case and whether expenses have been taken to gross costs or operating costs.

Guidelines for picking and discarding comparable companies

When reviewing search models you should work within the following guidelines:

1. Leave a clear audit trail of your search, so it can be repeated by someone else. A search model will generally start out with a wide net and produce a lot of companies, the majority of which will not be comparable. Further searches can be then be refined, producing, hopefully, narrower ranges of companies, which are more likely to be comparable. You should keep a record of the companies you find under each part of the overall search and note down reasons why the search criteria was changed and why particular companies were discarded.
   
2. As part of your search you will need to obtain accounts information for a number of years. The number of years' data you consider will vary depending on facts and circumstances. You will certainly be constrained by the database itself, which only provides 6 years' of results, starting with the latest year for which accounts have been submitted to Companies House. Ideally you should consider at least 3 years' accounts information for each likely comparable company. This allows for variations in the economic cycle. You are unlikely to get more than 5 years' data. You should start with your test year, and then work backwards. So if your year of enquiry is the year ended 31 December 2000, you should look at the results of comparable companies whose accounting years end in 2000, 1999 and 1998 (and possibly earlier). You do not need to limit yourself to companies with the same accounting date as your company.
   
3. You should avoid small, close companies. The results of these companies will invariably be distorted by the fact that the directors are most likely the shareholders. This could lead for example to directors taking most of the profits as bonuses, which will of course affect the net operating profit.
   
4. Avoid companies that are part of a group. However, if the group is wholly UK- based, and the accounts show there are no intra-group transactions (or these can be eliminated), then the particular company in the group you have found can be included if appropriate.
   
5. Search for comparable companies whose turnover is roughly at the same level as your company. You need to be realistic - if your company has a turnover over of £250 million, then limiting your search to comparable companies with turnovers of between £240 million and £260 million will probably leave you with no hits. Looking for other companies with a turnover of between £100 million and £500 million is far more likely to provide you with some comparables. Do not set your limits too high or low. It is doubtful that a company with a turnover of £500 million is going to be comparable to a company with a turnover of £10 million, even if they are in the same business sector.
   
6. Whether to discard any comparable companies that make losses can be a contentious issue although generally searches carried out by the big firms of accountants leave out loss making companies. Certainly consistent loss-making companies should be discarded; something is clearly wrong with such a company, but it will probably be impossible to establish what the problems are. Whatever the problems are, it is unlikely they are being encountered by the tested party, and so the two are not going to be comparable.
   
7. If the tested party is part of a large group, they will generally have the benefits that go with that, such as high calibre staff, successful products, good communications and infrastructure, access to top grade business advice, etc. The OECD Transfer Pricing Guidelines do not say that these benefits should be ignored when searching for comparables. There is no reason they should; the company will either be paying for those benefits or the benefits will arise as a direct or incidental outcome of belonging to the group. Those benefits means it is unlikely the tested party should be making losses, and so it should not be compared to companies that are loss making.
   
8. No two companies are exactly alike. You will not find exact comparables. Some comparables can be discarded because there are too many differences in function, etc. Other potential comparables can be improved by making adjustments to their results.

Constructing a search model

The instructions given here are for using the FAME database. At present, there is no national licence for OneSource; any search models using that database have to be done by CT & VAT, International CT, although the principles used in conducting a search are the same. The key criteria to use when carrying out a FAME search are:

• The SIC (Standard Industry Classification) code.
• The turnover.
• The business description.

1. The first step in a search is to open the Industry selection tool, and from that select the UK SIC option. This will allow the user to enter the SIC code, ideally the primary SIC code of the company under enquiry. A Standard Industrial Classification (SIC) is used to classify business establishments and other statistical units by the type of economic activity in which they are engaged. Introduced in 1948, the SIC coding framework has been revised several times to take account of new industries and areas of commerce which emerge over time. The primary code indicates a company's main business activity, and one SIC may be sufficient for smaller and/or specialised companies. Larger companies - e.g. multinationals - and/or companies which operate in a number of business areas may have two or more SIC codes accordingly.
   
2. The database will then find all the companies to which that SIC code applies. The user may also specify whether the companies selected have the SIC code as their main or secondary SIC code, or whether companies showing this code at any level are to be included. If the user specifies a search for companies which share the same primary code only, then fewer companies will be selected for comparison. If this produces too few comparators, the search can be widened by modifying this stage of the selection process to include companies which have the same SIC code as the company under enquiry at secondary or any other level. If the company under enquiry has itself a primary and a secondary SIC code, the user may choose to select all companies with the same primary code, and then use the secondary code to refine the search as the next stage in the selection procedure.
   
3. Depending on how specialised the trade of the company under enquiry is, the first stage of the selection process may have produced a set of companies numbering from a handful to thousands. The next step is to ensure all the companies to be included in the study are independent. The selection is done by accessing the Ownership Data option in the Search section. This allows the user to choose Ownership Status from the list that appears, and subsequently All 'Independent' Cos. Clicking on Qualified Only will generate a smaller set of companies, but one in which the size of the companies may vary greatly.
   
4. To filter out all companies not comparable by Turnover, select the Financials button, where the Profit & Loss option allows turnover (global or UK only) parameters to be set.
   
5. The companies selected by following these stages can be viewed in the section entitled List. The bottom tool-bar includes a Format button, which allows the user to choose which data should appear at a glance e.g. Turnover and Business Description. The latter is very useful as, although the descriptions are subjective (supplied by the companies themselves) it allows the user to remove from the selection those companies which can now be seen to be unsuitable for the transfer pricing report. If necessary, this is done by marking the relevant companies and pressing the Delete button in the bottom tool-bar.
   
6. However, it may be at this stage that none or too few of the companies selected appear suitable for inclusion in the set of comparable companies being selected. The options to widen choice are either to look at related SIC codes, and/or to select companies (again, using the industry selection tool) by the terms used in the 'Business Description' of the company under enquiry. Key words can be tried in several permutations, and the results reviewed for suitability in the List section. If several searches have been necessary to produce sufficient companies for the purposes of comparison, and each sub-set has been saved, the sets may now be merged, using a facility offered through 'File' on the main tool-bar.
   
7. A search model can be saved at any time by opening 'File' then 'Save the company set'. The File tool enables any report created to be saved as an Excel file.

The easiest way to compare the data from the companies found in the search is to select 'Peer Analysis' from the main toolbar, and from that, opting for 'A company compared to 1 to 20 companies'. The company set selected by the user may now be laid out in rows or columns and, from the 'Variables' and 'Years' menus, selections can be made of the accounts data and financial ratios required.

Generally the following data will be useful:

1. FAME will also provide figures for EBIT (earnings before interest and tax), EBITDA (earnings before interest, tax, amortisation and depreciation) and gearing (ratio of debt to equity); all of these are useful reviewing comparable companies during an enquiry involving thin capitalisation.
   
2. You can produce a report from FAME for each of the comparable companies - the 'Report' tool (top tool-bar) allows full or customised reports to be printed out or transmitted electronically.

None of this should encourage a mathematical or formulaic approach to transfer pricing. Transfer pricing is an art not a science. You are reviewing the price of transactions between connected parties and considering whether the price would have been different between independents. This requires care, thought, analysis and judgement. All of these attributes need to be exercised when searching for comparisons.

Always review individually any company selected by a database search. A database search is only a starting point.