Introduction to Functional Interviews in Transfer Pricing
Transfer pricing functional interviews are in-depth discussions with key personnel to gather facts about functions performed, assets used, and risks assumed by different entities in a multinational enterprise. Their purpose is to "tell the story" of how and where value is created within the group. In transfer pricing, profits must align with each entity's contributions – an entity performing more important functions or bearing more risk should earn a greater share of profit.
Functional interviews help ensure compliance with the OECD Transfer Pricing Guidelines by capturing the actual conduct of the business (not just what contracts say). They provide the factual backbone for the functional analysis (FAR) section of transfer pricing documentation, which is required in both Master File and Local File reports.
These interviews allow consultants to "disentangle who does what, where, with what resources, and at what risk," thereby supporting arm's length transfer pricing outcomes.
Why Are Functional Interviews Necessary?
According to OECD guidelines, analyzing functions, assets, and risks is fundamental to applying the arm's length principle. Documentation rules now explicitly demand that multinationals demonstrate how profits align with value creation (an emphasis introduced by the BEPS project).
A robust functional analysis – informed by interviews – is often the determinative factor in showing that intercompany prices are arm's length. Tax authorities (and internal auditors) scrutinize whether the transfer pricing reflects the business's substance.
Functional interviews serve to verify that the actual conduct of each entity (who actually performs and controls each activity) matches the transfer pricing characterization. Without this step, there's a risk of basing your analysis on assumptions or contractual fictions that regulators will challenge.
Preparing for Functional Interviews
Identifying Key Stakeholders
The first preparation step is to determine whom to interview. Transfer pricing touches many parts of a business, so you'll need to engage stakeholders across departments and possibly across different entities in the group.
Identify individuals who have deep knowledge of each major function or value-creating activity, such as:
- Finance and Accounting: CFO, finance controller or tax manager – to discuss financial flows, funding, and risk management
- Operations/Production: COO, plant managers, supply chain leads – to cover manufacturing processes, logistics, and inventory management
- Research & Development (R&D)/Engineering: heads of R&D or product development – to understand product development, technology, and who develops or enhances intangibles
- Marketing & Sales: marketing directors, sales managers – to discuss market development, branding, distribution channels, and customer relationship management
- Procurement: purchasing or supply chain managers – to address sourcing of materials, supplier selection, and intercompany purchasing
- Intellectual Property (IP) Management/Legal: legal counsel or IP managers – to cover patents, trademarks, licensing, and how the firm protects and exploits its intangible assets
- General Management: country managers or business unit leaders – for strategic oversight, overall business model, and how decisions are made and coordinated group-wide
- Other Functions: HR (for personnel and organizational structure), IT (if providing services or proprietary software), and any shared service centers or support functions relevant to intercompany arrangements
It's important to include all economically significant activities. For each relevant entity under analysis, list the people who can speak to what that entity does in the value chain. Ensure representation from both sides of any controlled transaction (for example, if analyzing a sale from Company A to affiliate Company B, plan to speak to people at both Company A and Company B).
Background Research
Before conducting interviews, thoroughly research the business. Collect and review background information such as:
- Annual reports
- Organization charts
- Process flow documents
- Industry reports
- The company's website
- Existing transfer pricing documentation (Master File, Local Files, intercompany agreements, prior functional analyses, etc.)
This provides context on the company's value chain and operations. Understanding the broad business model and industry conditions will help you tailor your questions and recognize key economic drivers.
The OECD guidelines and best practices recommend focusing on economically significant activities – knowing the industry and the company's strategy helps pinpoint which functions or assets are likely most critical.
Being well-prepared enables you to ask informed questions and gain credibility with interviewees.
Framing in the OECD Context
It's useful to frame the purpose of the interviews when communicating with stakeholders. Explain that this is part of an OECD-aligned transfer pricing analysis, which requires understanding "who does what" in the business.
Emphasize that actual conduct will be documented to ensure compliance with the arm's length principle. You might mention that OECD Transfer Pricing Guidelines call for a functional analysis in the Master File and a detailed one in each Local File.
The interviews are not an audit or interrogation, but a collaborative fact-gathering exercise to make sure the company's transfer pricing reflects its true value creation.
Logistics and Planning
Once stakeholders are identified and background research is done, schedule the interviews in a logical sequence. Coordinate with a sponsor from within the company (e.g., the tax director or CFO who is championing the TP project) to introduce the initiative and help secure participation.
Send calendar invites well in advance, and include a pre-read or brief agenda if possible. Aim to schedule about 60-90 minutes per interview, depending on complexity, and let them know you'll follow up with notes or additional questions if needed.
Methodology: Step-by-Step Interview Process
Conducting a functional interview requires a structured yet flexible approach. Below is a step-by-step methodology to ensure consistency and completeness:
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Collect and Review Background Information: Before the interview, gather all relevant documentation and facts. Review the company's business model, organizational chart, financials, and any existing descriptions of functions or intercompany dealings.
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Identify the Interviewees: Confirm the list of stakeholders to be interviewed across finance, operations, R&D, etc. Make sure each person's role correlates with areas of the value chain you need to cover.
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Schedule Interviews and Send Pre-reads: Coordinate timing and invitations. Provide each interviewee with a clear explanation of the interview's purpose.
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Prepare a Detailed Questionnaire: Before each interview, customize a list of questions or a checklist tailored to that person's function. Prioritize questions that address key value drivers in that area. You can use our Functional Interview Questions Generator to create tailored questionnaires.
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Conduct the Interview:
- Start Broad: Ask high-level questions to let the interviewee describe their department's role in the value chain.
- Dive into Functions & Responsibilities: Systematically cover the functions. Who performs each key function? How are tasks executed and decisions made? Where is each function performed?
- Elicit Assets and Intangibles: Ask about the assets used or developed by the department. This includes physical assets and intangible assets.
- Probe Risks and Controls: Discuss the major risks in their area and how they are managed. Always ask who has authority to make decisions related to those risks.
- Intercompany Transactions & Pricing: Explicitly ask about intercompany transactions the interviewee's department is involved in. For each identified transaction, query the pricing mechanism.
- Clarify and Cross-Check: Throughout the interview, practice active listening and clarifying. Paraphrase complex answers to confirm understanding.
- Flexibility: Be prepared to go off-script if the interviewee brings up something unexpected but relevant.
- Maintain a Professional but Comfortable Tone: Use interview techniques that encourage openness.
- Conclude the Interview: Recap the key points. Summarize back to the interviewee what you understood about their functions, assets, and risks.
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Documentation and Follow-Up: Immediately after the interview, write up your notes while details are fresh. Document the findings in a structured format. Highlight any points of uncertainty or potential inconsistency that may require follow-up.
Gathering Information on the Value Chain and Key Drivers
A crucial outcome of functional interviews is a clear understanding of the company's value chain and the key economic drivers of profit. The value chain refers to the full sequence of activities by which a company adds value – from product development, procurement of materials, manufacturing, and logistics, to marketing, sales, and after-sales service.
By piecing together insights from all interviewees, a consultant can map out this chain and identify who in the multinational group contributes what at each link. During interviews, encourage stakeholders to describe the end-to-end process of how the company's products or services reach the market.
Understanding the value chain is important because the OECD now expects a holistic view of value creation in transfer pricing analysis. In fact, BEPS Action 13 (transfer pricing documentation) requires a description of the MNE's global value chain in the Master File.
When mapping the value chain, pay attention to key economic drivers at each stage. These are the factors that materially affect profits. Examples include: proprietary technology driving manufacturing efficiency, brand strength driving sales volume, or supplier terms affecting cost of goods.
Techniques for Eliciting DEMPE Intangibles Information
One of the most challenging – and important – parts of modern transfer pricing interviews is gathering information on intangibles and the DEMPE functions: Development, Enhancement, Maintenance, Protection, and Exploitation of those intangibles.
The OECD Guidelines (post-BEPS) put heavy emphasis on analyzing who performs and controls these DEMPE functions for any valuable intangible assets, because those are the entities entitled to the returns from the intangible.
Understand the Intangible Assets First: Start by identifying what the key intangibles of the business are. These could be patents, trademarks, technical know-how, software, proprietary algorithms, customer lists, brands, etc.
Once you have a catalog of key intangibles, for each one, walk through the DEMPE functions:
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Development: Who was involved in the development of the intangible? This typically means R&D or product development teams.
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Enhancement: Intangibles are rarely static; they evolve. Ask who improves or refines the technology or brand after its initial development.
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Maintenance: This covers routine but essential upkeep – e.g., maintaining a technology (bug fixes, regular updates) or managing a brand's presence (consistent quality control, brand guidelines enforcement).
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Protection: This relates to legal protection (patents, trademarks, copyrights) and safeguarding the intangible from infringement or loss. Typically, this involves the legal or IP department.
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Exploitation: This is about using the intangible to generate income – e.g., manufacturing and selling products using a patented process, licensing out the IP, or otherwise commercializing it.
Interview Techniques for DEMPE
People you interview might not be familiar with the term DEMPE, so frame your questions in plain language around their work. Use scenario questions:
- For Development: "Suppose a new product idea comes up – who decides to pursue it and who actually does the work to develop it?"
- For Enhancement: "If the product needs a significant improvement to stay competitive, how does that happen and who funds it?"
- For Maintenance: "Once the product is launched, who provides ongoing support or updates?"
- For Protection: "If a competitor copied our product or if we needed to enforce our IP rights, what would you/your team do?"
- For Exploitation: "How do we earn money from this technology or brand? Who makes money from it?"
Don't neglect funding and risk control. While DEMPE focuses on activities, the OECD also emphasizes that the entity that funds development and controls the financial risk should earn an appropriate return.
Understanding Intercompany Transactions and Pricing Mechanisms
Functional interviews are also a prime opportunity to inventory and understand the company's intercompany transactions and how prices are set for those transactions. A thorough transfer pricing study must identify all controlled transactions – tangible goods, services, royalties, loans, etc. – and ensure they have arm's length pricing.
Identifying Intercompany Flows
Early in the process, compile a list of intercompany transactions from documentation. Then, during interviews, confirm and expand on this list. Ask each functional head if their department buys from or sells to any affiliate companies.
Some intercompany transactions might not be obvious from financial statements – for example, the exchange of use of an asset or a shared service arrangement that is booked via allocations.
Understanding Pricing Policies
For each significant intercompany transaction, gather information on how the price is determined. Many businesspeople might not know the technical transfer pricing method (that's often set by tax/finance), but they can describe the process.
Sample questions:
- For a manufacturing manager: "How do you decide the transfer price for products sold to our distributor in Country X?"
- For a procurement manager: "If you purchase raw materials from our affiliate in Country Y, how is the price of those materials arrived at?"
- For service transactions: "We pay an annual management fee to the parent – do you know what that covers? How is it calculated or agreed?"
Roles and Responsibilities
Determine who within the organization is responsible for setting or approving intercompany prices. The interviews might reveal a centralized pricing policy or a decentralized one.
Documenting Functions, Assets, and Risks (FAR)
After conducting functional interviews, the consultant's job is to synthesize the findings and document the functional analysis thoroughly. Good documentation will clearly outline each relevant entity's functions performed, assets employed, and risks assumed (FAR), as well as the nature of intercompany transactions and the roles of each party.
Structured Functional Analysis Write-up
It's common to document the functional analysis in a narrative form, often organized by entity or by transaction. For each entity (or each party to a transaction), describe:
Functions: Summarize the key functions that entity performs in the business model. Focus on significant functions that materially contribute to value or require unique capabilities.
Assets: Document the assets each entity uses or provides. Separate tangible assets and intangible assets.
Risks: Outline the risks borne by each entity. This should align with your earlier findings on who makes decisions and who bears outcomes of uncertainty.
Integrating DEMPE in Documentation
Ensure that for intangible-related functions, you explicitly incorporate the findings on DEMPE. If there's a section on intangibles, clearly assign who does each of the DEMPE functions for each major intangible.
Capturing Economic Context
Include any external or internal context that affects the FAR analysis. For example: "Given the highly regulated environment in Country X, the local entity's compliance function is significant."
Capturing Industry-Specific Insights and Practical Examples
While the fundamental approach to functional interviews is consistent across industries, each industry has its unique characteristics that influence which functions and risks are most important.
Tailoring to Industry Context
Start by identifying what typically drives value and profit in the client's industry:
- In pharmaceutical or biotech, intellectual property from R&D is the primary value driver
- In manufacturing/heavy industry, operational efficiency and supply chain management might be key
- In technology/software companies, speed of innovation and scalability are crucial
- In consumer goods/retail, brand and distribution networks are everything
- In commodities or B2B industries, maybe procurement and logistics are the stars
Incorporating Examples
Weave in short examples or case studies that emerged from interviews. These make the document tangible:
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Example (Pharma): "Company X's R&D centre in Country A undertook the development of Compound Y. Despite three years of work and $50m investment, the project failed in Phase III trials and was abandoned. This cost was absorbed by the R&D centre, underscoring that it bears substantial development risk."
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Example (Distribution): "LocalCo launched a marketing campaign featuring a celebrity endorsement without prior HQ direction, investing $2m. The campaign significantly boosted local sales by 20%, reflecting LocalCo's active role in enhancing and exploiting the brand in its market."
Handling Sensitive or Uncertain Responses
During functional interviews, consultants often encounter sensitive topics or hesitant interviewees. Knowing how to navigate these situations is crucial for getting truthful, complete information without damaging trust.
- Build Trust and Set the Tone: Begin by reiterating that the interview is confidential and that candid input is essential.
- Rephrase Potentially Touchy Questions: If a direct question is met with discomfort, try a different angle.
- Fill Gaps with Hypotheticals: For uncertain respondents, sometimes pose a hypothetical scenario.
- Use Silence Strategically: If an interviewee seems unsure, don't jump in to rescue them too quickly.
- Defer When Necessary: If someone truly can't answer, do not push them too hard.
- Address Contradictions Tactfully: If two interviewees give conflicting information, approach the second round delicately.
- Manage Sensitive Content: There may be things the company doesn't want in writing. Note it privately and translate to factual terms in documentation.
Sample Interview Templates by Function
A. Sales and Distribution Interview Template
Goal: Understand how sales are made, local vs central responsibilities in sales and marketing, customer base, and related risks.
Key Questions:
- "Can you describe your market and the role of your team?"
- "How are sales made and who is involved?"
- "Who sets or approves the prices at which you sell products here?"
- "What marketing or promotion do you carry out locally?"
- "Do you handle warehousing and delivery of products to customers?"
- "What risks do you face here in the sales/marketing function?"
B. R&D / Product Development Interview Template
Goal: Document the development of new products/technologies, how R&D is structured, and intangible creation.
Key Questions:
- "What kinds of R&D projects do you work on?"
- "Who decides which R&D projects to pursue?"
- "How is your R&D budget determined and funded?"
- "What happens to the IP that results from your R&D?"
- "What are the biggest risks in R&D? Who bears the cost if a project fails?"
C. Intellectual Property (IP) / Legal Interview Template
Goal: Clarify legal ownership of IP, how IP is protected and licensed, and identify intangible assets and related intercompany flows.
Key Questions:
- "What are the key intellectual properties our company/group has, and which entities own them?"
- "Who handles patent filings and trademark registrations?"
- "Do local entities pay royalties or fees for using intangibles to an IP owner within the group?"
- "Who bears the legal risk and costs related to IP?"
D. Marketing and Advertising Interview Template
Goal: Understand creation and management of marketing intangibles (brand, customer base), advertising activities, and their funding.
Key Questions:
- "Who develops the marketing strategy for our products in this region?"
- "Do you create advertising content here or use materials from HQ?"
- "Who sets the marketing budget for your unit?"
- "Do you use any local sub-brands or trademarks unique to this market?"
- "How do you measure marketing success here? Who bears the cost if a campaign flops?"
E. Procurement / Supply Chain Interview Template
Goal: Understand how inputs are sourced, whether purchasing is local or centralized, and related logistics and inventory management.
Key Questions:
- "What materials, components, or services do you procure for the business?"
- "Do you have autonomy to approve purchase orders up to a limit?"
- "Do you purchase any inputs from other subsidiaries?"
- "Who manages inventory levels for raw materials or goods?"
F. Manufacturing / Operations Interview Template
Goal: Capture production process, assets used, decision-making hierarchy, and operational risks.
Key Questions:
- "What products do you manufacture at this plant?"
- "Who developed the production process and techniques used here?"
- "How do you decide how much to produce and when?"
- "Who owns the manufacturing facility and equipment?"
- "What are the main operational risks here? Who bears the cost if they occur?"
G. Finance, Admin, and Support Functions Interview Template
Goal: Cover support activities like finance, HR, IT, and any central services, plus intercompany loans and overall governance.
Key Questions:
- "What finance functions are handled by your team here?"
- "Does your entity receive any support from a shared service center for accounting, IT, HR, etc.?"
- "What intercompany charges do you receive or pay regularly?"
- "Are you part of any intercompany financing arrangements?"
- "If you deal in multiple currencies, who manages foreign exchange risk?"
Conclusion
Transfer pricing functional interviews are a critical exercise for consultants to gather the substance behind intercompany dealings. By carefully preparing, engaging the right stakeholders, and asking detailed questions across all relevant functions, you can map out the entire value chain and each entity's role within it.
A well-conducted series of functional interviews results in a robust functional analysis that stands up to scrutiny. It will clearly show who in the multinational group performs and controls each significant function, who provides and owns the critical assets (tangible and intangible), and who assumes each key risk, as well as how these align with the company's transfer pricing policies.
For consultants, mastering functional interviews means you can uncover practical insights and "red flags" early and address them in your analysis and recommendations. For the company, this process often has the side benefit of educating their teams on transfer pricing and highlighting internal inconsistencies or areas for better alignment.
By following the structured yet flexible approach detailed in this guide, both new and experienced consultants can conduct functional interviews effectively across industries. The end result will be a comprehensive, well-supported transfer pricing report that not only meets compliance requirements but truly reflects the business's operating reality – the best defense for any transfer pricing position.
Frequently Asked Questions
How long should functional interviews typically take?
Functional interviews usually take 60-90 minutes per session, depending on the complexity of the function being discussed and the interviewee's role. For key functions like R&D in a technology company or manufacturing in a production-heavy business, you might need longer sessions or multiple interviews.
How many people should I interview for a typical transfer pricing study?
For a mid-sized multinational with 5-10 entities, you would typically interview 8-15 people across different functions. The exact number depends on the complexity of the business model, the number of significant intercompany transactions, and how centralized or decentralized the organization is.
What if interviewees give conflicting information?
This happens frequently! When two interviewees provide contradictory information, follow up tactfully with clarifying questions to both parties. Often, the contradiction stems from different perspectives or incomplete information rather than deliberate misrepresentation. Document both viewpoints and try to reconcile them through additional inquiry or by checking supporting documentation.
Should functional interviews be recorded?
Generally, recording interviews is not recommended as it can make interviewees uncomfortable and less forthcoming. Instead, take detailed notes during the interview and write them up immediately afterward. If you do need to record, always get explicit permission and explain the purpose and confidentiality measures.
How often should functional interviews be conducted?
For transfer pricing documentation purposes, functional interviews should be refreshed whenever there are significant changes to the business model, reorganizations, new intercompany transactions, or shifts in how functions are allocated between entities. Even without major changes, it's good practice to conduct refresh interviews every 2-3 years to capture gradual operational evolution.
Can functional interviews be conducted remotely?
Yes, functional interviews can be conducted via video conferencing when in-person meetings aren't possible. Remote interviews can be effective, but may require more preparation and careful management to build rapport and capture nuances. Consider sending questions in advance and using screen sharing for any visual aids or documents that need to be discussed.
How do you handle interviewees who claim they don't know about transfer pricing?
Many business people aren't familiar with transfer pricing terminology. Frame your questions in business terms rather than tax jargon. Instead of asking about "transfer pricing policy," ask "How do you determine the price when selling to your affiliated company in Country X?" Focus on their day-to-day activities and decisions rather than the tax implications.
Related Resources
- Understanding Transfer Pricing: The Backbone of International Tax - A comprehensive introduction to transfer pricing concepts and their significance in international taxation.
- Ultimate Guide to Arm's Length Principle - Detailed exploration of the arm's length principle, which is the cornerstone of transfer pricing compliance.
- Benchmarking Study Guide - Learn how to conduct effective transfer pricing benchmarking studies that can withstand tax authority scrutiny.
- Functional Interview Questions Generator - Our free tool to help you generate customized functional interview questionnaires based on your specific company profile and industry.
- Future-Proofing Transfer Pricing - Insights on emerging trends and best practices in transfer pricing compliance.
