Transfer pricing: regulations, determination principles, methods and requirements for documentation (from 1 January 2018)

On 25 October 2018, amendments were adopted to the Taxes and Duties Act as regards the preparation of transfer price documentation. The amendments are applicable to transactions that have been made as of 1 January 2018. The amendments are mainly necessary in order to incorporate into the regulatory enactments the standards for transfer price documentation reviewed as a result of activity 13 of the Action Plan of the Organisation for Economic Cooperation and Development (hereinafter referred to as “Base Erosion and Profit Shifting”). It was also necessary to harmonize the new transfer price documentation requirements with the new Corporate Income Tax Act. It is important to note that the amendments relate to transactions carried out from 1 January 2018, but taxpayers have the right to apply them also to previous periods.

The concept of the market value (arm’s length) of transactions was implemented already in 1995 within the Corporate Income Tax Act, but the interest regarding transfer pricing issues have been rising after Latvia’s accession to the European Union. Most of the EU member states have introduced transfer pricing documentation requirements up to some degree, thus adapting such changes are valued as a positive step towards harmonization of the transfer pricing regulations.

The aim of the article is to deal with the basic issues of transfer pricing: principles for determination, methods, documentation requirements before and after the changes in the law that have come into force.

What is transfer pricing and what is the market value of transactions?

A number of terms are used within the meaning of a transaction between related persons, including “transfer pricing”, “market value of transactions”, “controlled transaction” or “arm’s length principle”. Although legislation acts have brought order to these terms, they still sometimes are used with various meanings.

Transfer pricing, according to changes in the Taxes and Duties Act is the price (value) of goods or services that is applied within the transaction between the persons (companies) involved, one of which is a foreign company. Thus, the concept “transfer pricing” denotes the actual price that is applied in a controlled transaction, this price may or may not be consistent with the market value.

“The market value of a transaction” – this term is used in paragraphs 7.-19. of the Cabinet of Ministers regulation No. 677 ‘’ Rules for the Application of Corporate Income Tax Law’’ , nevertheless the regulations do not provide a comprehensive definition of the term. The principle of the market value of a transaction is established in Article 9 of the model convention of Organisation for Economic Co-operation and Development (OECD). “(..) in either case conditions are made or imposed between the two (related) enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises (mutually unrelated), then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.” In other words, to define market value for a transaction between the related persons, this transaction value (transfer price) must comply to value of such transaction that:

  • has been carried out between unrelated persons (uncontrolled transaction);
  • essentially is analogical or similar (comparable) to such transaction;
  • has been carried out in analogical (comparable) conditions.

The definition of market value transaction results into a number of important conclusions, most important of which is that for the purposes of the transfer pricing analysis the comparability criteria: the subject of the transaction, industry analysis, industry’s, business strategies, business activity’s functions and risks, as well as contractual arrangements, should have to be analyzed.

Another important conclusion arises from the definition, one that is often misunderstood in practice, meaning, as a result of transfer price analysis one indisputable market value is not set. The result of determining transfer pricing will always be series of price or profit indexes – range that includes values that meet market value.

Concept “transfer pricing” in every-day life is also understood as a process – analysis and justification of market value for a controlled transaction’s value.

Why is transfer pricing important?

The main task of transfer pricing is to avoid unjustified flowing of profit outside of Latvia or its redirection to a Latvian commercial as hidden dividends, thus reducing the payable tax.

In dealings between independent companies the profit level depends on the market laws, whereas, in controlled transactions, Latvian taxpayer has to prove that it has observed the principle of market price. If the price or value in case of goods or services acquisition in a transaction with the related person is higher than the market value, but in case of sale or service supply– lower than market price, the taxpayer has to adjust income liable to enterprise income tax for the prices of related transaction and market price difference, increasing it accordingly.

Transfer pricing compliance to the market value is important within the commercial law as an instrument for the defense of a commercial undertaking and their board against possible requirements from minority shareholders or third interested persons.

Furthermore, transfer pricing principles are also used for planning business activity functional models for example, by making service centrs, including accountancy, IT, intellectual property and other companies.

Transfer pricing laws and regulations

Transfer pricing is regulated by both local and international laws and regulations. When applying them the hierarchy of laws and regulations should be remembered, meaning, international laws and regulations have a higher legal force and thus, are being preferred.

Latvian laws and regulations

  • Paragraphs 7.-19. of the Cabinet of Ministers regulations No. 677. ‘’ Rules for the Application of Corporate Income Tax Law’’ (hereinafter – “Regulations of CM”). Regulations of CM is a justified act for the Corporate Income Tax, they define methods for establishing the market values of transactions and their comparability factors that should be taken into account when applying the methods.
  • Article 23.2 of the Taxes and Duties Act anticipates cases in which the State Revenue Service is entitled to verify the value of transaction prices, lists factors that could influence the price changes and approaches that the State Revenue Service could use during a tax audit, and it defines criteria for comparison of goods and services. Note that for defining the transaction prices this law is only applicable as far as it does not contradict the norms of the Corporate Income Tax Act.
  • Article 15.2 of the Taxes and Duties Act (takes effect on 1 January 2013) anticipates obligation to provide information on transactions with related persons.

International sources of law

  • The principle market value (arm’s length) principle of transactions is enforced by the Article 9 of the convention adopted by the Republic of Latvia for the avoidance of the double taxation and tax evasion (hereinafter – “Convention”). If the related company is in a country that has signed the Convention, the Model convention commentaries and other OECD statements on transfer pricing could be applied in order to determine the arm’s length value.
  • The OECD Committee on Fiscal Affairs statement “Transfer pricing guidelines for multinational enterprises and tax administrations” (hereinafter – “OECD Guidelines”) is the most important methodical material. The OECD Guidelines is a relatively big document outlining principles for determination of market value transactions, comparability factors, methods for determination of market value transactions, administrative procedures, requirements for processing transfer pricing documentation and it provides special provisions for intellectual property (intangibles) transactions, as well as, requirements for evaluation of group’s services. OECD Guidelines is an internationally recognised standard for preparing transfer pricing analysis and documentation.
  • On 27 June 2006 the European Council verified the code of conduct on transfer pricing documentation (hereinafter – “Code of Conduct”). The Code of Conduct divides the responsibility of drawing up the documentation among the group’s main company and its subsidiary companies in various countries and it determines that drawing up the transfer pricing is carried out within the group when drawing up the basic document, and within the subsidiary company when drawing up the local documentation.

In which transaction transfer pricing rules apply?

Observation for the market value of transactions is derived from Article 4, 2.p.2 p, (e) of the Corporate income tax Act and refers to transactions with any related person. This means that, for example, when granting a loan to a related domestic company, the market value of interest must be observed, or when the goods are sold to a related domestic company, the market value should also be applied in cases where the transfer pricing documentation is not required.

On the other hand, in amendments to the Law on Taxes and Fees, the obligation to prepare documentation applies to a smaller number of persons. Therefore, if the person is not subject to the obligation to prepare the transfer price documentation, the possible obligation to respect the market value of transactions must always be assessed. The dossiers must therefore be prepared by a taxable person carrying out transactions with:

  • A related person who, within the meaning of the Law On Taxes and Duties, is considered to be a related foreign company;
  • A commercial undertaking or a person, if they are located in, set up or established in low tax or tax-free countries or zones;
  • With an individual related to the company;

Related companies

According to the definition provided in the Corporate Income Tax Act, related companies are two or more commercial undertakings or cooperative societies if:

  • They are the parent and subsidiary companies
  • One commercial undertaking’s or cooperative societies’ stakes in the other commercial undertaking or cooperative society are between 20% to 50% (without majority voting rights) of which one is a foreign company
  • More than 50% of capital asset value in each of these companies is owned by or the contract ensures the substantial influence in these companies:
    • To one person and this person’s relatives up to 3rd degree or to this person’s spouse, or to people in affinity up to 2nd degree;
    • No more than 10 of the same persons;
    • A Company, in which, a physical entity (or their relatives up to 3rd degree, or spouses, or to people in affinity up to 2nd degree) directly or indirectly owns more than 50% of the commercial undertaking’s capital asset or a part of values, or the cooperative society’s debenture value.
  • The same person or the same persons have the majority voting rights in the management institutions of these companies
  • Additionally to the contract on the specific transaction, these companies have an agreement of any kind (including agreement that has not been made known) on any additional compensation to those stated in the contract, or these companies carry out other conforming acts for decreasing tax.

Person related to the company

Person related to the company is a physical entity that themselves, their relatives up to 3rd degree or spouses, or people in affinity up to second degree owns more than 50% of commercial undertaking’s capital assets or part of shares, or which has the deciding influence according to a contract or otherwise within the commercial undertaking. Note that a person related to the company can be both a resident and non-resident of Latvia.

Principles for establishing market price

The basis for analysis of transfer pricing is a comparison of related company’s transactions with transactions carried out by unrelated market members. In each transaction, the goods price or service value is established by a number of factors. Thus, analysis of factors affecting pricing should be done at first to identify those unrelated person’s transactions that can be compared, meaning they are similar enough that the influence of difference would be possible to be corrected as a result of a mathematical calculation.

OECD Guidelines define five comparable factor groups.

Characteristics of goods or services

OECD Guidelines recommend viewing of such transaction subject factors:

  • In case of a tangible property – property’s physical qualities, quality and reliability, accessibility and volumes of delivery
  • In case of services – characteristic and range of service
  • In case of an intellectual property – type of transactions (for example, sale or licensing), type of property (patent, trade mark, know-how), duration and degree of defence of the intellectual property as well as the potential benefits from such property.

Functional analysis

The OECD Guidelines state that in transactions between independent companies the price of transaction usually reflects the functions of each company (including the risks undertaken and assets used). Because of this, for determination of comparing the transaction has to be done by function comparison of the controlled company’s functions with other, unrelated companies.

Functions of commercial activities contain design, manufacturing, assembly, research and development, related services, purchases, distribution, marketing, advertisements, funding and management.

Whereas the comparable risks include market risks, as fluctuations of expenses and prices, investment or property, or fixed asset risk of loss; risks related to investments into research and development, currency exchange fluctuations, a risk of loss, credit risk, etc.

Functional analysis is the cornerstone of the transfer pricing analysis, guided by its results, a decision is made for the selection of a method and comparable data to establish the transaction’s market value.

Contractual arrangements

A contract serves as interest security of the employer between independent companies, whereas in a controlled transaction, the contractual provisions of division may be ignored, thus it is important to detect if they are observed and, if the actual actions are not as in the formal contract, it is important to analyze these actual contractual relationships.

Additionally, it has to be set out that the agreement between the related persons may exist not only in written form in the contract but also in correspondence/communication between them. In a case of absence of written contract, contractual provisions have to be concluded based on economic principles that are usually agreed on by independent companies.

Economic conditions

The OECD Guidelines recommend analysis of economic circumstances for a transaction, in which a transaction with a related person is carried out. It is important to analyse factors such as geographical location, market size, competition volume, and merchants and buyers’ position of competitiveness, the existence of substitute goods, level of supply and demand within the market both generally and within separate regions. If necessary, the purchasing power of the customers, a degree of state regulation of market, manufacturing expenses including costs on land, workforce and capital, transportation costs, type of sales (e.g. wholesale or retail), location and time of division, etc.

Business strategy

By defining comparability between controlled or uncontrolled transactions, it is sometimes important to view the business strategy.

Such aspects of the company have to be analysed within business strategy, as goods’ innovations and development, diversification, risk management, reaction to political changes, changes in work legislation and other aspects influencing everyday commercial activity management. Business strategies may also reflect the company’s attitude towards the market, for example, market conquest structures, e.g. short-term price deduction. Taxpayer who plans to enter a new market may have higher costs (for example, because of outstanding marketing expenses).

Methods for establishing market values of transactions

OECD transfer pricing guidelines, as well as Regulations of CM (Items 13.-17.) describe five methods for establishment of transfer pricing: comparable uncontrolled price, resale minus, cost plus, transactional net margin and profit split.

Preference in both OECD transfer pricing guidelines and Regulations of CM is given to the first three (based on transactions) methods of transfer pricing, whereas methods based on profit, has to be applied only if it is impossible to apply the aforementioned methods.

Comparable uncontrolled pricing method

OECD guidelines give preference to comparable uncontrolled price method in contrast with other methods. By applying this method, the price of mutual transactions between associated companies is compared with the price in one of the following transactions:

  • a price applied during a transaction with the associated company is compared with the price in a similar transaction concluded with an unrelated company (internal comparable uncontrolled price)
  • a comparable transaction price of two unrelated companies (external comparable uncontrolled price).

The unrelated transaction must be comparable with the related transaction, i.e., goods or services must be same or similar, their quality and quantity must be on the same level, as well as the transactions must occur at the same period of time and they must be based on identical terms and conditions. In accordance with the explanation provided in Cabinet Regulation No. 677, this method is applicable for the determining of market prices in delivery of goods or provision of services transactions, if the price can be compared with the transaction prices performed by unrelated merchants (i.e. the transactions are mutually comparable) or sufficiently precise corrections are possible to exclude significant influence of differences between the transactions on the value of transactions. Although, theoretically, this method is comparatively simple to use, practical finding of comparable uncontrolled transactions, the differences of which with the associated transaction do not involve difference in prices, is usually problematic, or information on individual uncontrolled transactions is insufficient to check the comparability of transactions. Most frequently, comparable uncontrolled price method can be used in the cases, where the company sells identical goods or provides similar services to associated, as well as unrelated companies, i.e., by using internal comparable uncontrolled price.

Resale price method

This method evaluates the market value of a controlled transaction, considering normal gross profit, which is earned in a comparable uncontrolled transaction.

In accordance with Section 14.1. of Cabinet Regulation No. 677 resale price method „is based on the price at which the goods (products) purchased from an associated person (company) is resold to an unrelated person. The aforementioned price is reduced by gross profit from which the reseller would have to cover sales and administrative costs by receiving appropriate profit or normal profit, considering the functions performed for the performance of the transaction, associated risks, used assets and other factors that affect the transaction”.

In accordance with Section 14.2. of the Cabinet Regulation No. 677, this method is applied to goods purchasing transactions of the reseller, if the reseller resells the goods to unrelated person, without considerably increasing the value of the goods and retaining their identity.

Resale’s method could be characterised with such example.

Lithuanian manufacturer LTCo sells goods to the Latvian distributor LVCo for 400 EUR , LVCo resells these goods to an unrelated person for 450 EUR. By carrying out a comparable resellers’ data analysis, it is found that the gross profit index has to be at least 30%, meaning the gross profit of LVCo should be at least 450 EUR x 30% = 135 EUR. Because of this, the purchase price from a related company should be no more than 450 – 135 = 315 EUR. Thus, LVCo has to increase the taxable income.

Cost plus method

In accordance with Section 15.1. of Cabinet Regulation No. 677, cost plus method is “a method whereby the market price of transactions is determined by adding appropriate cost mark-up that a seller would apply in a comparable transaction with an unrelated person to the direct and indirect costs of the products sold by the seller or services provided by the service provider that are associated with sales or product or service provision to an associated person, considering the functions implemented for the provision of the transaction, associated risks, assets used and other factors affecting the price of transaction.”

Example. LVCo sells manufactured production for Lithuanian related company LTCo for 600 EUR, but the goods manufacturing costs are 500 EUR. By carrying out analysis of comparable independent companies, it is determined that gross profit markup rate is at least 30%. Meaning the market value of the transaction has to be – 500 x 130% = 650 EUR, meaning the transaction occurred below market value.

In accordance with Section 15.2, this method is applied to the transactions of the supplier (producer) of goods (products) or provider of services, if no significant and unique intangible property has been invested in the respective transaction objects.

In accordance with OECD guidelines cost plus method is most appropriate in transactions of associated companies where semi-finished goods are sold between related companies, or where related companies have concluded joint facility agreements or long-term buy-and-supply arrangements, or where the controlled transaction is the provision of services.

Transactional net margin method

In accordance with Section 16.1 of Cabinet Regulation No. 677, according to net margin method “transaction value (price of goods, a product or a service) is determined by evaluating the net profit against an appropriate base (for instance, costs, income, assets or other appropriate base), considering the functions performed for the ensuring of the transaction, associated risks, used assets and other factors that affect transaction value or price of the goods”.

Section 16.2 of the regulation provides that the method is applied in the manner that is similar to the application of resale price method or cost plus method, if the comparison of direct and indirect cost mark-ups or normal gross profit in controlled transaction with the respective financial indicators of unrelated persons fails to provide sufficiently credible result that is substantiated by transaction price (value) affecting factors.

Latvian trader LVCo manufactures and sells goods to foreign related company LTCo. The Transfer pricing of the transaction is 1050 EUR.

LVCo profit and loss calculation

Net turnover    1050

Expenses of manufacturing of the sold production    1000

Gross profit     50

Sales costs       12

Administrative expenses         8

Profit or loss before tax          30

Markup of total expenses (profit before taxes / total expenses * 100%) 2.9%

Direct and indirect LVCo goods expenses are 1020 EUR, total expense markup 2.9%. When carrying out comparable company research, it has been found out that the total expense markup has to be at least 5%. Meaning the market value of the goods has to be 1020 x 105% = 1.071.

This method allows disabling the influence of additionally carried out functions on finance results as the expenses usually related to taking on additional functions are reflected in expenses of business activities, meaning both direct and indirect expenses, except interests and taxes.

Nevertheless, this method has a number of disadvantages. Firstly, base activity’s profit level is influenced by administrative costs that could be subjective, thus SRS shall definitely verify justification for expense base. Secondly, this method cannot be applied if the company of a group has various transactions within the group (e.g. goods purchase, recycling and successive sales to the related company).

Profit split method

In accordance with Section 17.1 of the Cabinet Regulation No. 677 “the nature of the method – a method that is used, if the associated persons perform mutually related transactions or participate in consecutive transactions within the framework of the delivery of goods or service provision cycle and these transactions cannot be evaluated separately. When this method is applied, the total profit generated as a result of mutual transactions performed by associated persons is calculated first. Based on the functional analysis of the transaction, where the functions performed by each person involved in the transaction, associated risks, assets used ad other factors affecting the transaction price are evaluated, the profit is divided between the participants in accordance with such economically substantiated distribution of profit that unrelated parties would have agreed upon”.

Profit split method for establishing transfer pricing is used in cases when related companies carry out mutually related transactions or take part in consecutive transactions within goods delivery or service provision cycles that cannot be divided and evaluated separately and when a unique intellectual property is involved in the transaction.

By applying this method, the total profit acquired as a result of mutual transactions of related companies is determined. This profit is divided among companies, according to such economically justified profit division that unrelated traders would have agreed on.

For illustrating the profit division method, an example of Regulation of the CM is set out here. In the example, three traders from various companies – SIA A, B and C are related companies that are developing (inventing), manufacturing and trading household electrical devices. Manufacturing of electrical devices includes the use of modern electronic process technology use and manufacturing of product’s main component. This component is invented and manufactured by Latvian SIA A, and then it is delivered to a related company B in another country that designs and develops the rest of the product. Afterwards, the product is distributed by another related company C. In the transaction between B and C, the market value is established by using resale’s method. It is impossible to find an appropriate comparable transaction for the transaction between SIA a and related company B because both SIA A and related company B invests significant non-material property value in manufacturing of the goods by doing research and development functions

SIA A and related company B’s profit and loss calculation before profit correction (EUR):

SIA „A” Related company „B”
Realization 50 100
Expenses for acquisitions 10 50
Manufacturing expenses 15 20
Gross profit 25 30
Research and development expenses 15 10
Operative expenses 10 10
Net profit

Comparable company research establishes that the unrelated comparable manufacturer earns 10% for the carried out manufacturing function (operative profit index in relation to manufacturing costs), thus the manufacturing profit is:

  • SIA A: 1.5 EUR = 15 x 10%
  • Company B: 2.0 EUR = 20 x 10%

SIA A and related company B’s total base activity profit is 10 (0+10), subtracting total profit of SIA A and its related company B for manufacturing company – 3.5 (1.5+2.0), thus receiving total remaining profit – 6.5 EUR (10-3.5), that is divided among SIA A and related company B, based on each trader’s investment for achievement of this profit. These 6.5 EUR in its essence is profit that is generated for the companies by additional research and development costs.

SIA A expenses on research and development are 15 EUR, whereas related company B’s research and development expenses are 10 EUR, meaning both traders use a total of 25 EUR (15 + 10) in costs for research and development. The total remaining profit between SIA A and related company B is defined in relation – 15/25 SIA A and 10/25 for related company B. Thus, the remainder profit of SIA A is 3.9 EUR (6.5*15/25), but related company B’s remainder profit is 2.6 EUR (6.5*10/25). As a result of profit division, profit for SIA A is 5.4 EUR (1.5+3.9) and related company B has a profit of 4.6 EUR (2.0+2.6).

The rest of the profit in the mentioned example is divided based on the investment of each company for research and development of the goods. But, depending on transaction’s type and division of functions, the remainder of the profit may be divided based on other indexes, for example, non-material investment, a division of capital assets or assets among the companies of the group.

Note that in the hierarchy of transfer pricing determination, this method is the lowest and it should be applied only if no other method is applicable.

Structure of transfer pricing documentation

The transfer pricing documentation sections are usually structured in a logical sequence from general to separate and it contains such sections: industry analysis, company’s (transactions) analysis, functional analysis and economic analysis (choice of method and analysis of comparable data selection).

Industry analysis

A controlled transaction has to be analysed within the industry, the company acts in. The purpose of industry analysis is to identify industry peculiarities and it may include analysis of such issues:

  • Description of industry (goods or services, their classification and general description)
  • Peculiarities of industry (e.g. necessity of capital, workforce, investments, diversity of products, market maturity, etc.)
  • Factors promoting competitiveness (necessity of innovations, ensuring quality, formation of customer relationships, sales strategy, etc.)
  • Industry’s level of legislation
  • Industry’s statistical indices
  • Indexes of most important risks (stock risk, credit risk, innovations risk)

Results of industry analysis allow to establish industry’s sector in which the related company operates, it allows to select analogic companies that operate within the same sector, thus can be used for selection of useful comparative indices as well as factors and risks that influence price formation within the industry.

Company analysis

The purpose of the company analysis is to identify peculiarities of the company which influence price formation, for example, management model, business strategy and compliance structure. Typically, a company analysis contains:

  • Profile of the group of company (history, facts, finance indexes)
  • Company’s strategy
  • Organisational structure and division of liability of the company
  • Description and analysis of division of related companies
  • Finance indexes, etc.

As a result of company analysis, factors characteristic to this company that influence price formation, are isolated – company’s strategy, risks characteristic to the company, etc.

Functional analysis

The benefit of every participant of the transaction must comply with its relative investment and risks undertaken in the particular division. Thus, a functional analysis of the transaction must be carried out with the aim to identify the role of each participant of the transaction carried out between related persons.

Example. LVCo manufactures goods and sells them to related Lithuanian company LTCo. As a result of functional analysis, it is found that LVCo manufactures goods, purchases raw materials and undertakes technological risks of manufacturing. Whereas LTCo undertakes goods planning, marketing, distribution and logistical functions, undertakes risks of market, currency fluctuations and bad debts. It also carries out group’s management function. From such a division of functions, it can be deduced that LVCo acts as a manufacturer by contract that has restricted functions and risks. Such conclusion is basis for selection of comparable companies that act as manufacturers by contract.

Economic analysis

On the basis of industry’s, company’s and functional analysis, criteria are selected that are used for choosing transaction market price method and selecting comparable indices. The goal of these criteria is to identify comparable divisions that would allow deducing market value of the transaction.

Economic analysis must contain:

  • Choice and argumentation of transactions’ market value establishing method about why the corresponding price method has been chosen
  • Selection and analysis of comparable data

To detect comparable data for profit norms, Bureau van Dijk database AMADEUS is usually used as it contains information on 19 million European companies. By using this database, comparable companies are selected, and their annual reports are analyzed.

As a result of selection of comparable companies, a sequence of numbers for comparable data (e.g. profit ratios) is found. To filter the indices that do not reflect the market value, while analysing comparable data, the statistical quartiles (In statistics: any of the three points that divide a sequence of numbers into four equal intervals, each of which contains 1/4 if the result value) number sequences. It is considered that transaction’s market value is reflected by all indices of the number sequence, that are located between the first and third quartile. This approach allows to ignore 25% of price’s (profit indices) range lower- and 25% of upper values, which thus allows balancing the possible offsets arising due to as an example, comparable company’s function differences, annual report differences or due to other reasons.

Example. Latvian company manufactures and sells goods to a related company by applying 5% markup to full prime cost. To establish if 6% markup rate conforms to the market value, based on industry, company and functional analysis, 10 comparable companies are selected, which operate in similar industry and carry out goods delivery to unrelated companies (that are done between unrelated persons and in analogical circumstances). Profit indexes of these companies are:

Company 1 2 3 4 5 6 7 8 9 10
Profit norm 3% 4% 4.5% 5% 6% 6.4% 7% 8.2% 8.6% 9%

Within the selection, it is found out that these companies have applied a markup of 3% to 9%. 1st quartile of the number sequence is 4.63%, the median is 6.2%, but 3rd quartile is 7.9% (Quartiles are calculated by use of Excel functions).

Figure. Analysis of comparable companies’ profit ratios


As seen in the figure, market value is between 4.63% that is between the indices of 3rd and 4th company and 7.9% that is closer to the 8th company. The preferred profit ratio in this case is median (6.2%), however, it does not mean that this profit norm would be the only right one. As a result, it can be concluded that the profit norm 5% is within the quartiles’ range and, thus, conforms with the market value.