Transfer Pricing for CFOs/ Tax Heads (Learning Byte 07)
Should Loss Making Comparables be considered for Benchmarking?
The general rule is that both profit and loss makers together are representative of an industry and hence the comparables' set must include both.
No Indian Regulation requires exclusion of loss making comparables as such. However, Indian Tax Authorities are known to exclude companies making losses for 3 consecutive years. The rationale being that such companies have abnormal circumstances giving rise to consecutive losses.
What if losses (over 3 years or more) are reducing and the company is on path to recovery? Should such a company still be rejected?
There is no one size fit all answer. For planning purpose one could be conservative and excludeloss making companies. However, a truly representative setshould ideally capture both players. Even consecutive losses are merely a (potential) symptom of abnormal financial circumstances and not conclusive per se (OECD). A company may be on the path to economic recovery - dwindling losses followed by profit in fourth or fifth year ending losing streak. Hence, closer analysis may suggest inclusion.
Bottomline - each case is to be analyzed on its own facts and circumstances and it is difficult to apply any thumb rule.