Plain English
Before you can find a comparable, you have to know what you are actually comparing. Functional analysis is the exercise of mapping out, in concrete terms, what each entity in an intercompany transaction actually does — who negotiates contracts, who holds inventory risk, who owns the brand, who bears currency exposure — rather than what the intercompany agreement says. It typically comes from interviews with operational staff, not just finance, because the people running the business often describe things differently from how the legal paperwork frames them.
Technical definition
The comparability factor analysis under OECD Transfer Pricing Guidelines Chapter I, Section D.1.2, identifying and comparing the economically significant functions performed, assets employed (including intangibles), and risks assumed by each party to a controlled transaction, used to accurately delineate the transaction and select the tested party and most appropriate method.
Why it matters
It determines almost everything downstream: which party is tested, which method applies, and which comparables are relevant. A functional analysis that does not match operational reality invalidates the rest of the study, however well the benchmarking is executed.
How it works in practice
- 01Interview operational personnel — sales, supply chain, R&D, treasury — not only finance.
- 02Document functions performed by each party: manufacturing, marketing, logistics, credit management, IP development.
- 03Identify assets employed, including intangibles, and who controls their use.
- 04Assess risks assumed, applying the six-step risk analysis framework, and confirm which party has financial capacity to bear each risk.
- 05Compare the analysis against the written intercompany agreement and flag any divergence.
- 06Use the resulting risk-and-function profile to select the tested party and screen comparables.
Worked example
Contract manufacturer or full-risk manufacturer?
A Vietnamese entity manufactures electronics under a supply agreement labelled 'contract manufacturing.' Interviews reveal the entity independently negotiates raw material supply contracts, carries six weeks of unsold finished goods inventory at its own risk, and has absorbed material price volatility in two of the last three years without compensation from the principal. The functional analysis reclassifies it as a fuller-risk manufacturer, changing the appropriate profit level indicator and comparables set — a materially different benchmarking exercise than the one implied by the contract's label alone.
Common mistakes
- Relying only on the intercompany agreement rather than interviewing operational staff.
- Treating a risk as contractually allocated without checking financial capacity to actually bear it.
- Producing a generic FAR write-up reused across multiple entities without entity-specific detail.
- Failing to update the functional analysis after a business model change or reorganisation.
Audit red flags
- Functional analysis narrative identical across multiple, functionally distinct entities.
- Contractual risk allocation with no corresponding evidence of financial capacity to bear it.
- No interview trail — the write-up appears to be based on the agreement alone.
Documentation & data
Documents to hold
- Interview notes or questionnaires from operational personnel.
- Functions, assets and risks matrix by entity.
- Six-step risk analysis addressing control and financial capacity.
- Reconciliation between the FAR analysis and the intercompany agreement.
Data you need
- Organisational charts and role descriptions for relevant personnel.
- Intercompany agreements for the transactions in scope.
- Historical financial results showing which party absorbed volatility (an indicator of actual risk-bearing).
Who owns this internally: Group tax or the external advisor leads the interviews; local finance and operations provide the underlying facts.
Jurisdiction notes
- OECD member states
- The six-step risk framework from the 2017 Guidelines update is now the standard reference point in audits.
- United States
- Section 482 regulations independently emphasise substance over contractual form, closely aligned with the OECD approach.
- Emerging markets
- Local tax authorities increasingly request functional interviews or site visits as part of audit, not just the written FAR document.
Notes by role
In-house tax teams
Refresh the functional analysis whenever an entity's headcount, systems, or reporting lines change materially — not just on a fixed documentation cycle.
Students & job seekers
FAR is the concept most likely to appear in a case study interview; practise identifying functions, assets and risks from a short business description.
Frequently asked
- How is functional analysis different from a benchmarking study?
- Functional analysis characterises the transaction and parties; benchmarking uses that characterisation to find and apply comparable data. One feeds the other.
- What is the 'six-step' risk framework?
- It is the OECD's structured approach — identify economically significant risks, determine contractual assumption, analyse conduct and decision-making, confirm financial capacity, and allocate risk to the party in control with capacity to bear it.
Sources & status
- Primary source
OECD Transfer Pricing Guidelines, Chapter I, Section D
OECD, 2022
- Our interpretation
Practical interview-based FAR methodology
This glossary, 2026
Reference material only, not advice on a specific fact pattern. Reviewed 2026-06-30.
Careers
How this shows up in the job
Strong FAR interviewing and write-up skills are what separate a competent TP analyst from a spreadsheet operator.
Careers in transfer pricing