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Borys Ulanenko
CEO of ArmsLength AI
![Local File Best Practices [2025]: Building Audit-Ready TP Documentation](/_next/image?url=%2Fimages%2Fblog%2Flocal-file-best-practices%2Flocal-file-best-practices.jpg&w=3840&q=75)
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A strong Local File demonstrates arm's length compliance through clear transaction descriptions, thorough functional analysis, defensible comparability analysis, and well-documented benchmarking results. Best practices include: addressing each material transaction type separately, linking the analysis to Master File context, ensuring financial segmentation supports the economic analysis, and preparing documentation contemporaneously for penalty protection.
The Local File is the most detailed element of the OECD's three-tiered documentation framework. While the Master File provides a global overview and the CbCR delivers financial data by jurisdiction, the Local File zooms in on the local entity's specific related-party dealings to prove they are priced at arm's length.
OECD Annex II to Chapter V prescribes the required Local File contents, organized into three main sections:
| Required Content | Description |
|---|---|
| Management Structure | Local organization chart and description of reporting relationships |
| Business Description | Detailed description of the local entity's business and strategy |
| Business Restructurings | Any restructurings or intangible transfers affecting the entity in current or prior year |
| Key Competitors | Identification of main competitors (typically 3-5 in practice) |
For each material category of controlled transactions:
| Required Content | Description |
|---|---|
| Transaction Description | Nature, context, and commercial rationale for each transaction type |
| Amounts | Intra-group payments and receipts broken down by counterparty jurisdiction |
| Related Parties | Identification of affiliated entities involved and their relationship |
| Agreements | Copies of material intercompany contracts |
| Functional Analysis | Functions, assets, risks of each party; changes from prior years |
| Method Selection | Transfer pricing method and why it's most appropriate |
| Tested Party | If applicable, identification and justification |
| Comparables | List of comparable transactions/companies with financial data |
| Adjustments | Any comparability adjustments performed |
| Conclusion | Statement that transactions were arm's length |
| Required Content | Description |
|---|---|
| Financial Statements | Annual accounts (audited if available) |
| Reconciliation Schedules | How financial data used in analysis ties to statements |
| Comparables Data | Summary of comparable company financial information and sources |
OECD Guidance (¶5.22): The Local File should contain "more detailed information relating to specific intercompany transactions" and help ensure that the taxpayer has "complied with the arm's length principle in its material transfer pricing positions affecting a specific jurisdiction."
Not every related-party transaction requires full documentation. The Local File should focus on material categories of transactions—but materiality is both quantitative and qualitative.
| Jurisdiction | Threshold for Documentation Relief | Notes |
|---|---|---|
| Germany | ≤€6M goods, ≤€600K other transactions | Above thresholds: full documentation mandatory |
| UK | £1M aggregate value per category | HMRC de minimis; intangibles, profit splits always material |
| India | Rule 10D exemption up to ₹1 crore (₹10M) | Above threshold: prescribed documentation required |
| Netherlands | Group revenue ≥€50M triggers Master/Local File | TP support expected regardless; formal file above threshold |
| Australia | Simplified record-keeping for less than AUD 2M dealings | PCG 2017/2 options for low-risk scenarios |
| US | No explicit threshold | Focus on transactions with significant tax effect |
| China | Tangible assets >CNY 200M; financial/intangibles >CNY 100M; other >CNY 40M | Local File completed by June 30 following year |
Some transactions are inherently material regardless of amount:
Documentation Strategy: Even when excluding small transactions, list them in a "minor transactions not analyzed" section with amounts and brief justification. This demonstrates nothing was hidden and shows the preparer considered all related-party dealings.
Each material controlled transaction should have its own analysis section. Don't aggregate dissimilar transactions—purchase of goods is different from royalty payments which is different from management fees.
For each transaction category, include:
Description and Commercial Context
Amounts and Counterparties
Functional Analysis
Method Selection and Rationale
Comparability Analysis
Economic Analysis
Conclusion
The functional analysis is the backbone of the Local File—it drives method selection, tested party identification, and comparable selection. A superficial FAR analysis is among the most common documentation weaknesses.
| Element | Weak (Generic) | Strong (Entity-Specific) |
|---|---|---|
| Functions | "Performs marketing and sales" | "Executes marketing campaigns designed by HQ, manages 15-person sales team covering DACH region, handles post-sale support" |
| Assets | "Uses typical business assets" | "Operates 10,000 sqm warehouse; utilizes parent's trademark under license; employs €2M inventory on average" |
| Risks | "Bears normal business risks" | "Assumes credit risk on 45-day receivables (bad debt ~1.5%); inventory obsolescence risk capped at 3% via buy-back clause; no product liability (retained by manufacturer)" |
The Local File should analyze both parties to the transaction, not just the local entity. Tax authorities (especially HMRC) criticize one-sided analyses that don't explain what the counterparty contributes.
Example structure:
The Specificity Test: Read your functional analysis aloud. If it could describe any company in your industry, it's too generic. Add facts specific to this entity: headcount numbers, specific assets, contractual risk allocations, decision-making authority examples.
The Local File must demonstrate how arm's length prices were determined. This means integrating the benchmarking study into the document—not just referencing an external report.
Method Selection Rationale
Tested Party Selection
PLI Selection
Comparables Search Documentation
Accept/Reject Matrix
Comparables Data
Arm's Length Range
Results Comparison
| Approach | When Appropriate | Documentation Required |
|---|---|---|
| Full refresh | Every 3 years minimum; or when facts change materially | New search, new comparables set |
| Roll-forward | Intervening years when business unchanged | Same comparables, updated financials; confirm validity |
| Annual review | Every year | Check for M&A, business changes; update data |
Best Practice: Update comparable financials annually; conduct full re-search every 3 years or when the tested party's business model changes. Document in the Local File: "The 2024 comparables set was reviewed in 2025 and deemed still appropriate. Financials were updated. No companies were removed or added."
Section C of the Local File requires financial data that ties the economic analysis to the audited accounts. This reconciliation is critical—tax authorities frequently challenge documentation where numbers don't trace back to financials.
Annual Financial Statements
Segmentation Schedules
PLI Calculation Details
| Line Item | Per Financials | Related-Party | Third-Party | Notes |
|---|---|---|---|---|
| Revenue | €100M | €80M | €20M | IP sales segmented |
| Cost of Sales | €70M | €55M | €15M | By product line |
| Gross Profit | €30M | €25M | €5M | |
| Operating Expenses | €22M | €20M | €2M | Allocated by revenue |
| Operating Profit | €8M | €5M | €3M | |
| OP Margin | 8.0% | 6.25% | 15.0% | Tested: 6.25% |
Common Pitfall: Presenting analysis on a segmented basis without showing how segments add up to the whole. If an auditor can't follow the trail from financial statements to your analysis, they may distrust the entire study. Always include a reconciliation bridge.
"Contemporaneous" documentation means prepared before or at the time of filing the tax return—not reconstructed after an audit notice arrives.
| Jurisdiction | When Documentation Must Exist | Submission Timeline | Penalty Risk for Late |
|---|---|---|---|
| US | By tax return filing date (including extensions) | Within 30 days of IRS request | Loses penalty protection (20-40% of adjustment) |
| Germany | Submission upon request; extraordinary transactions within 6 months of year-end | 60 days (30 days for extraordinary) | €5K+ fixed; 5-10% of adjustment may apply; daily fines |
| India | By statutory due date for Form 3CEB (confirm annually) | Within 30 days of request | 2% of transaction value may apply |
| UK | Prepared before corporate tax return submission | Within 30 days of HMRC request | "Careless behavior" penalty; fixed penalty for record failures |
| Australia | By tax return filing | Upon ATO request | 25-50% of tax shortfall if no RAP |
| Netherlands | By tax return filing deadline | Within ~4 weeks of request | May lead to adverse procedural consequences |
Workflow Recommendation: Treat the Local File as part of an ongoing transfer pricing process: set prices at year start (planning), monitor results mid-year, make adjustments if needed, and finalize documentation by year-end or shortly after. Don't wait until the last moment before the tax return.
A structured preparation process ensures documentation quality and contemporaneous completion. Rushing at year-end produces weak documentation that invites audit challenges.
During the Year (Ongoing):
Q1 (Months 1-3 after fiscal year-end):
Q2 (Months 4-6):
Q3 (Months 7-9):
Q4 (Months 10-12):
The Local File should reference and align with the Master File. Key coordination points:
For complex entities: Entities with intangibles, restructurings, or multiple transaction types should begin preparation earlier (Q1) to allow adequate time for thorough analysis. Don't underestimate the time required for proper functional interviews and comparables research.
There's no magic page count—focus on completeness and clarity, not length.
| Entity Complexity | Estimated Length | Key Driver |
|---|---|---|
| Simple (1-2 routine transactions) | 30-50 pages | Straightforward functional profile |
| Moderate (3-5 transaction types) | 50-80 pages | Multiple transaction categories |
| Complex (many transactions, intangibles, financing) | 100+ pages | Extensive analysis required |
Tax authorities consistently criticize:
They want:
While OECD Annex II provides the template, local rules add nuances.
Based on audit experience worldwide, these are the most frequent problems:
Problem: Generic text that could apply to any company Fix: Customize every section with entity-specific facts
Problem: No contracts to support documented arrangements Fix: Ensure all material transactions have written agreements; if none, document terms explicitly
Problem: Using comparables data from years ago without updates Fix: Update financials annually; full refresh every 3 years
Problem: Local File contradicts Master File descriptions Fix: Cross-reference both documents during preparation; align terminology
Problem: Generic FAR that doesn't distinguish the entity Fix: Conduct real interviews; include specific facts, numbers, examples
Problem: Financial data in analysis can't be traced to statements Fix: Include reconciliation schedules showing the tie-out
Problem: Documentation prepared only after audit notice Fix: Establish firm deadlines; prepare by tax return filing
Problem: Material transactions missing from the Local File Fix: Cross-check against related-party disclosures in statutory accounts
Problem: No accept/reject matrix; unclear search methodology Fix: Document every step; maintain comprehensive matrix with reasons
Problem: Tested party outside range with no explanation Fix: Address anomalies; explain year-specific factors; note any adjustments made
Profile: GermanCo is a full-risk distributor purchasing products from USCo (parent) for resale in Germany.
| Transaction | Description | Annual Amount | Method |
|---|---|---|---|
| Purchase of Goods | Finished products from USCo | €50M | TNMM |
| Royalty | Trademark license from USCo | €2M (2% of sales) | CUP |
| Management Fee | Group services allocation | €0.5M | Cost Plus |
B1: Purchase of Goods (€50M)
Functional Analysis:
Method: TNMM with GermanCo as tested party (simpler profile; USCo owns valuable IP)
PLI: Operating Margin (revenue-driven business)
Benchmarking: 12 comparable European distributors identified; IQR operating margin 2.8%-5.2%
Result: GermanCo OM = 4.1% → within arm's length range
B2: Royalty Payment (€2M)
Analysis: 2% of net sales for trademark use Method: External CUP using trademark royalty database Comparables: Industry royalty rates range 1.5%-3.5% for similar consumer products trademarks Result: 2% within range → arm's length
B3: Management Fee (€0.5M)
Analysis: Allocation of group shared services (HR, IT, legal support) Method: Cost Plus (5% markup on direct costs) Basis: OECD elective simplified approach for low-value-adding services (where jurisdiction accepts) Result: Cost + 5% consistent with OECD simplified approach → arm's length
[Reconciliation table showing how €50M purchases, €2M royalty, and €0.5M fee tie to German statutory accounts]
Documentation Guides:
Benchmarking Resources:
Glossary:
Nearly all countries following OECD BEPS recommendations require Local Files (or equivalent documentation) for large MNEs, but specifics vary. Thresholds differ: Netherlands requires formal Master/Local Files if group revenue ≥€50M; Germany has transaction-level thresholds (€6M goods, €600K other business transactions); India has a Rule 10D exemption up to ₹1 crore but expects TP support regardless. Some countries (like the US) have documentation requirements under different names (§1.6662-6) but serve the same purpose. Even where not strictly mandated, documentation is necessary to demonstrate arm's length pricing if challenged. The safest approach: prepare a Local File for every jurisdiction with material related-party transactions.
All material controlled transactions—both quantitative (exceeding monetary thresholds) and qualitative (involving intangibles, restructurings, or significant risk). Materiality thresholds vary: HMRC allows exclusion where aggregate value in a category doesn't exceed £1M (except always-material categories like intangibles); Germany requires documentation above €6M goods or €600K other transactions; India's Rule 10D threshold is ₹1 crore aggregate. However, certain transactions are always material regardless of amount: intangible transfers, business restructurings, cost contribution arrangements, and profit split arrangements. Document your materiality approach in the Local File and at least list any excluded transactions with brief justification.
Length depends on complexity: A simple entity with one routine transaction might need 30-50 pages; complex entities with multiple transaction types, intangibles, or financing may require 100+ pages. There's no regulatory minimum or maximum—focus on completeness and quality. Tax authorities criticize both inadequate documentation (too brief to be useful) and bloated documentation (padding with generic text). Every page should add value: specific facts, real analysis, clear conclusions. If you can defend your transfer pricing in 40 well-organized pages, that's preferable to 150 pages of boilerplate.
Contemporaneously—meaning before or at the time of filing the tax return, not after an audit begins. Most jurisdictions tie penalty protection to contemporaneous preparation: US requires documentation by return filing (including extensions) for penalty relief; Germany requires submission upon request with extraordinary transactions documented within 6 months of year-end; India requires documentation by the statutory due date for Form 3CEB (dates vary annually). Preparing documentation only after receiving an audit notice is "better late than never" but forfeits penalty protection in most jurisdictions and appears self-serving to tax authorities. Best practice: complete the Local File within 3-6 months after year-end.
Yes, with conditions. It's common to use the same comparable set for 2-3 years if the business is unchanged, but you must: (1) update financial data for comparables each year, (2) verify comparables are still valid (not acquired, defunct, or diversified), and (3) document that you reviewed and confirmed appropriateness. OECD acknowledges multi-year approaches may be acceptable. However, never use stale data—a study with 2019 financials applied to 2025 results will be challenged. Document the roll-forward approach: "The 2024 comparables set was reviewed and deemed appropriate for 2025. Financials were updated. [Company X] was removed due to acquisition."
Differences are acceptable if explained and justified. The Master File might present a global or regional policy, while the Local File uses jurisdiction-specific comparables—this is appropriate and often required. For example, the Master File might show European distributors at 3-5% margin, while your German Local File uses German/DACH comparables at 2.5-5%. Document the rationale: "Local analysis used German comparables to meet local expectations for domestic data. The range is consistent with the group's global benchmarking but reflects local market conditions." Avoid contradictions in business descriptions or functional analyses—those should align between documents.
No—one Local File per entity covers all material transactions in separate sections. The OECD uses "category of controlled transactions," meaning you group similar transactions (all goods purchases, all service fees) but analyze each category distinctly. Structure the Local File with: Section A (entity overview), Section B1 (Transaction Type 1), Section B2 (Transaction Type 2), etc., Section C (financials). Each transaction section should have its own functional analysis, method selection, and benchmarking. Don't prepare separate documents unless the transactions are completely unrelated or local rules require it.
Lack of agreements is a common pitfall that reduces credibility. Tax authorities expect written contracts for material arrangements—that's how independent parties would operate. If agreements don't exist: (1) document the terms explicitly in the Local File as if there were an agreement, (2) note that no formal contract exists but describe the understood arrangement, and (3) put proper agreements in place going forward. Some jurisdictions (Germany especially) view informal arrangements unfavorably and may question whether arrangements are truly arm's length. At minimum, include the key terms, pricing methodology, and risk allocation in your documentation.
Penalties vary but can be substantial:
Beyond penalties, inadequate documentation may shift the burden of proof to the taxpayer and allows tax authorities to estimate adjustments unfavorably. The cost of proper documentation is almost always less than the cost of penalties and audit defense.