Functional Analysis (FAR): Functions, Assets and Risks Explained
Functional analysis defined: the description of each party's functions performed, assets employed and risks assumed — the input every transfer pricing decision is built on.
Definition
The functional analysis (FAR) is the description of what each party to a controlled transaction actually does: the functions it performs, the assets it employs (tangible and intangible), and the risks it assumes and controls. It is the analytical foundation of the whole exercise — the tested party is selected from it, the method follows from it, the comparables are screened against it, and the TPO examines it first.
The three elements:
- Functions — the actual work: producing, distributing, servicing, developing, financing — at the level of decision-making authority, not job titles. “Manages the business” is not a function; “negotiates and sets prices for a defined customer set” is.
- Assets — what the party contributes: property, plant, equipment, licences, know-how, data, the right to use another party’s intangibles. Using an intangible and owning it are different asset positions.
- Risks — what the party bears: price risk, demand risk, inventory risk, credit risk, regulatory risk — and, decisively, whether it controls the risk (the decision and the ability to mitigate) or merely bears its consequences.
Why it drives everything
| Decision | What the FAR supplies |
|---|---|
| Tested party selection | Which party is the least complex, routine one |
| Method choice | Whether a one-sided test can capture the result, or a two-sided approach is needed |
| PLI choice | Which return indicator isolates the routine contribution |
| Comparable screening | The profile the pool must match (product, function, risk) |
| Audit defence | The factual base every challenge is tested against |
A FAR drawn from the contracts and the actual organisation — not from what the study needs — is the one that survives examination. The full framework is in the functional analysis guide.
Example
Two parties in a distribution transaction: the Indian entity owns the brand, the customer relationships and the pricing decisions, and bears demand risk; the foreign entity operates the logistics and order-processing under a service-level agreement. The FAR says one party is the entrepreneurial principal and the other is a routine operator — which is why the operator is the tested party, benchmarked at a routine return, and the principal carries the residual.
See also
FAQ
Who prepares the functional analysis, and from what? The taxpayer (or its advisors), from the intercompany agreements, the organisation’s actual decision-making (who approves what), the asset registers and the risk allocation in the contracts. It is a factual document — the examination tests it against the same sources.
Is the FAR static? It is a year-by-year description of the year’s actuals. A reorganisation, a new product line or a changed risk allocation changes the FAR — and with it the tested party, the method and the pool, which is why a structural change voids a study rather than updating it.
Run the screens as a study, not a spreadsheet
Quartyl applies the method, PLI and screening steps above as a pipeline — and keeps a documented reason for every exclusion.
Related docs
Tested Party: Definition, Selection Logic and Documentation
The tested party defined: the entity whose result is benchmarked against the comparable pool — selected as the least complex party, and documented as a decision.
Read docRoutine Return: What It Is and Why It Drives Benchmarking
A routine return defined: the arm's length profit level of a routine function — the return a benchmarked party should earn, and the anchor of every one-sided method.
Read doc