Big Mac index, Burgernomics and Transfer Pricing!

August 09,2017
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Manish Sabharwal (Partner, Price Waterhouse & Co., LLP)

Rinit Gupta (Associate Director, Price Waterhouse & Co. LLP)

Nishi Chaudhary (Manager, Price Waterhouse & Co. LLP)

Transfer Pricing (‘TP’) was conceptualized to compare the prices of controlled transactions with those in uncontrolled transactions (arm’s length price/ ALP). However, the focus of TP practitioners has remained largely on comparing profitability of controlled and uncontrolled transactions as compared to prices. This is largely attributable to two factors. Firstly, the ALP data for prices is not available for many products/ services while profitability data is easily available. Secondly, the comparability threshold for profitability is lower than that for prices. So you can compare the profitability of manufacturer of engine parts with the manufacturer of suspension parts but it is not appropriate to compare the price of an engine part with a suspension part.

This preference for comparing profitability (under Transactional Net Margin Method (‘TNMM”)) as against price comparison (under Comparable Uncontrolled Price (CUP)) is reflected in Indian Advance Pricing Agreements (APA) outcomes. As of March 31, 2017[1], less than 10% of transactions covered in the signed APAs followed CUP with the majority relying upon TNMM. Also, this issue is not peculiar to India. Even in developed countries like US which has had TP Regulations for many years, TNMM remains preferred method. Just 11% of APAs agreed in US in 2016[2]followed methods other than TNMM.

Inspite of this huge reliance on TNMM, OECD itself has been critical of this method accepting that the profitability can be influenced by many factors and thus TNMM is not the best method for comparison[3]. In fact, before 2010, OECD TP Guidelines mentioned a clear preference of CUP over TNMM. But unavailability of CUP data implies that TNMM continues to be relied upon largely for TP analysis.

In many instances though, CUP data is available in different jurisdiction but not in the jurisdiction of the controlled transaction and hence is not relied upon. If a reliable adjustment can be made for geographical differences, it would increase the potential to rely upon CUP. The toolkit designed to help developing countries address the lack of “comparables” for TP analysis issued by OECD, United Nations (UN), International Monetary Fund (IMF) and World Bank Group (WBG) (hereinafter referred as ‘Toolkit’) suggests various methodology to address the geographical differences by performing country risk adjustment. However, it addresses the methodology based on profit margin and does not specify anything for price level analysis.

Is it possible to adjust geographical differences in prices? So, for instance, if the data for an unbranded 40 inch TV is available in Thailand, can the same be adjusted for identifying ALP in India? The answer seems to be yes. We now explore how the same can be done by application of the Big Mac index.

What is the Big Mac Index?

The Big Mac index was introduced in “The Economist” magazine in September 1986 by Pam Woodall as a semi-humorous illustration of Purchasing Power Parity (‘PPP’) and has been published by it annually since then. The index also gave rise to the word burgernomics.


Post a Comment

  • Observer on Aug 10,2017

    This article displays very surfacial understanding, that has not evolved over the years at all. Maybe it was copy pasted from some old article.

  • CA Raman Singh on Aug 10,2017

    Such lunatics. Big Mac Index was dead in the nineties itself and it is royally dissed among the 'learned' economics community. But then what would you expect out of an article written by CAs and half economists.

  • Neeraj Jain on Aug 09,2017

    In the TP study prepared for Moser Baer for FY 2001-02, Big Mac Index was used for making adjustment for Geographical diff , for benchmarking exports applying CUP method . Delhi Tribunal in ITA 882/Del/2008 (reported in Taxsutra) also approved use of Big Mac Index. Stone age article