FAR Analysis – Transfer Pricing

  • Functional, asset and risk analysis is often referred to as FAR analysis.
  • When transactions between the AEs are examined for the purpose of determining the ALP, one has to analyse the three components closely, namely
Far Analysis

Functions performed

  • Functions performed by different parties are examined to ascertain which party performs the most significant activities and which one performs the routine activities.
  • Suppose A Inc (US Company) is a manufacturer of a product and B Ltd (Indian Company) is a distributor while A Inc identifies undertakes the manufacturing process, employs intangibles, conducts quality checks etc. and B Ltd is engaged in identifying the end customer and distributing it, functions of A Inc is significant and not B Ltd. Enterprise which performs key or significant activities has to earn higher return out of the total return.
  • Some of the significant functions are
  • Manufacturing, production or assembly work
  • Purchase and material management
  • Logistic support
  • Business process management
  • Administration functions
  • Finance/ budgeting / Treasury
  • Warehouse / inventory management
  • Quality control
  • Comparing the activities performed in a controlled transaction with that of uncontrolled transaction is a good metric to ascertain the economic value of the activity performed.

Assets Employed

  • In order to perform the requisite functions, each party should deploy assets.
  • The assets employed therefore corroborate with the functions in a transaction.
  • Further, ownership of the intangible assets also plays a key role in the profits attributable to each entity.
  • If one entity has the legal ownership of significant intangible asset and other entity uses the same to perform its functions, then the first entity would be recognised as employing significant assets.

Risks assumed

  • In any business transaction or operation, there are risks involved. Often higher the risk, higher the expected returns.
  • So the party which assumes high risk is expected to remunerate the other party with lower or marginal return.
  • For example, a contract manufacturer who does not assume any product risk will not be remunerated same as the entrepreneur manufacturer.

Common risks that are assumed in a business operations are:

Credit risk

Normally, an enterprise offers some credit period to the customers and if the customer does not pay then such loss has to be borne by the person assuming credit risk

Market risk

Market risk arises due to competition, pricing pressure, etc.

Foreign exchange risk

Enterprises often transact in foreign currency which is different from reporting currency. Any fluctuation in the foreign currency would affect the profit.

Obsolescence risk

The product or services which an enterprise offers may become obsolete over time and the enterprise may have to invent new products / services to stay in business

Technology risk

There is a rapid change in technology and this may result in products become outdated or there may be higher costs for updating the technology.

Capacity utilization risk

Capacity utilization risk relating to loss of profit due to unutilized capacity. Lack of demand for a product or a lock out may result in lower capacity utilization.


Swasta India Ltd manufactures cars by procuring raw materials both from AEs abroad and also locally which are coordinated by the parent company. It has an agreement by which the parent company has to provide necessary intangible and also controls the quality of manufacture, quality of raw material, manufacturing process automation etc. They export all the cars to its unrelated distributors abroad and also sell them in India to unrelated retailers.?

  1. Swasta does not assume credit risk
  2. Swasta does not assume foreign currency risk
  3. Swasta does not assume market risk
  4. Swasta does not assume technology risk

Answer d.

Swasta India has a agreement with its parent company for provision of intangibles, control the manufacturing process etc., We can assume that there are clauses in the agreement which would indemnify Swasta for any deficiency in the raw material, quality or technology. Though it will bear the risk to its ultimate customer the same would be indemnified by the parent company. 

Sourcing information

  • Official publication, reports, studies etc.,
  • Market research studies
  • Price publications including stock exchange and commodity market operations
  • Agreements with AEs and with other unrelated enterprises for similar transactions
  • Letters, communication or other correspondences
  • Accounting policies followed

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing Introduction In the past few decades, the world has seen large movement of capital and investment from developed and developing countries.This has resulted in huge economic development, boosted trade and increases foreign direct investment in various countries.Many developing countries (low – cost …
Read More

Additional reporting by Multinational companies – Transfer pricing

Additional reporting by Multinational companies – Transfer pricing The OECD had devised many action plans to combat BEPS. OECD also recommended a three-tier documentation approach for transfer pricing under Action Plan 13. Three tier documentation Advantages of three tier reporting Elements of CbC and Master File reporting requirement and related matters have been incorporated …
Read More

Anti-Avoidance measures in certain jurisdictions – Transfer pricing

Anti-Avoidance measures in certain jurisdictions – Transfer pricing Specific anti-avoidance measures in respect of transactions with persons located in Notified Jurisdictional area was introduced in the Act under sec 94AWe have seen in earlier sections that transactions with the AEs are subject to transfer pricing provisions.This is generally sufficient to cover …
Read More

Penalties for non-compliance – Transfer Pricing

Penalties for non-compliance – Transfer Pricing The Act has prescribed strict penalties for non-compliance in terms of non-disclosure or incorrect disclosure Question International group shall maintain information and documents in Master file when Consolidated group revenue of the International group is (as reflected in Consolidated Financial Statements of the International Group) is More than …
Read More

Introduction to Transfer Pricing

Introduction to Transfer Pricing Transfer Price “Transfer Price” is the price at which an enterprise charges for its transaction within its group entitiesInternational transaction involves more than one tax jurisdiction, and due to disparity in tax rates and method of computing income, the parties may try to adjust the transfer pricesSince the …
Read More

Limitation of interest deductions – transfer pricing

Limitation of interest deductions – transfer pricing Introduction Popularly known as ‘Thin Capitalization Rules’, this provision intends to cap the interest that can be paid to the AEs in case of borrowings.Generally, debt is a preferred instrument to provide funds to the subsidiary or group company rather than equity due to the …
Read More

Subscribe to our News Letter

Get periodical updates from us

Subscribe to our News Letter

I hope you enjoy reading this blog