Real Price = Toil + Trouble

• "The real price of everything, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it...."  
• "What is bought with money or with goods is purchased by labour as much as what we acquire by the toil of our own body.."
• "Labor was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour, that all the wealth of the world was originally purchased...."

Adam Smith from the Wealth of Nations

I've always believed that the key part of my job as a tax professional is to organize a good story-line for clients, persuasive and illustrative, all based on given facts, in such a manner that no unnecessary challenges from the tax authority can arise. For transfer pricing (TP) matters however, it shouldn't be just a good story-line.  In TP, "capturing" the dynamics between the industry and the company functions (e.g., how profit drivers affects the client's business and functionality) and "translating" that into a common language (so tax authorities and possibly judges can understand) are the most critical process. I would like to call this latter part 'functional analysis.' 

In TP studies, I'd say the key to any functional analyses is to understand the nature of "toil and trouble" the parties have gone through in a related-party transaction. And it is all in the art of how the tax adviser go about interacting with his/her client's key employees along the client company's value chain - for instance, all the way from R&D and product development to logistics and sales - primarily through interviews and/or open discussions. That is perhaps the only way he/she can also breathe life into his story-line, making it less arbitrary and more taxpayer- and reviewer-friendly. 

Unfortunately, for some reasons, that crucial art has been de-emphasized by both TP practitioners and their clients. Somehow, both parties seems to have found comfort in the fact that TP studies are nowadays usually prepared in a very mechanical fashion. The typical ritual is that, with just a basic set of facts provided by the client, the TP practitioner prepares a functional profile write-up, looks for comparables from a commercial/pubic database, selects and applies a transfer pricing method ("TPM") and derive an arm's length result.  

Mannerism is often a vice that obliterates the sense of purpose and value. Sadly, what is often missing from the above ritual is the serious conviction to develop rationales or defense strategies for the client's specific TP position. That part is usually reserved for in times of tax audits or appeals when time is a crucial resource.    

The arm's length principle emphasizes the importance of creating a fiction simulating what would have happened if the transacting parties had been unrelated. The proper starting point, therefore, for creating that fiction is not just to gather as many facts and information as possible from their clients, but also to understand the people behind all those facts and what they actually do and "feel" about the tasks or the risks they are assuming, within the offices, or from the production lines. And such understanding is usually gained from personal interactions with them, that is, through personal interviews and discussions with the company staff.  

As Adam Smith said, labor - toil and trouble - was the first price. If TP is to remain as an art and not a science, I guess one must take certain amount of courage to repent and to do what is right; that is, in terms of TP, to return to the basics of verifying where value truly originates. Value is generated by people's toil and trouble, meaning that true valuation, i.e., TP must always start from understanding the people behind the scene and the nature of their labor.