Entity characterisations


For transfer pricing purposes it is very important to be able to define an entity based on its characterisation. Based on an entity characterisation one can determine if an entity incurs more or less risk. The amount of risk an entity incurs could be an indication if an entities’ remuneration should be higher or lower. This page provides for an overview of the different manufacturing entities that exist as well as the different distribution / sales entities that exist. The entities characterisations are ordered from maximum risk, (i.e. fully-fledged manufacturer and buy-sell distributor) to minimum risk (i.e. toll manufacturer and commission agent).


Fully-fledged manufacturer:

  • Owns intangibles such as patents, industrial know-how and designs
  • Buys raw materials and semi assembled goods on own account and holds stock for both raw and finished goods
  • Subject to risks of selling goods
  • Invests in labour, plant and machinery
  • Is entitled to the residual profit i.e. total profit minus the compensation for the routine functions

Contract manufacturer:

  • Owns plant, machinery and employs labour force
  • Manufactures goods for the principal
  • No risks related with holding finished goods or selling them
  • Contract manufacturer holds title and bears stock risk until goods are bought by the principal
  • Most of the times principal will guarantee to buy all the goods manufactured
  • Is entitled to a routine compensation

Toll manufacturer:

  • Principal holds title to the goods throughout the manufacturing process
  • Principal buys raw materials / assembled goods, yet physical flow is directly to manufacturer
  • Principal bears all the inventory and selling risks
  • Is entitled to a routine compensation

Distribution / SalesDistributor

Buy / sell distributor

  • Businesses that sell finished goods, be it wholesale or retail, may do so by buying products, holding them as stock, and promoting and selling them to customers. A distributor buys the products from the manufacturer and then sells them to third-party customers. It bears the risks associated with buying, holding and selling stock, such as:

o   The risk of not selling

o   Stock obsolescence

o   Product returns and warranty (but there may well 
be some recourse to the manufacturer)

o   Bad-debt risk of customers

o   Exchange risk of buying the goods

  • Incurs costs for

o   Carrying stock

o   Promoting

o   Marketing

o   Selling the products

o   Transportation to customer

  • After-sales servicing
  • May own marketing intangibles such as brand names. Derive profits from these intangibles as well


  • Representative of principal
  • Enters into sales contracts in his own name and issues invoices to customers
  • Legal title from goods passes from principal to customer (physical flow can deviate)
  • Receives percentage of sales value or a cost plus mark-up from the principal
  • Acts in his own name on behalf of and at the risk of the principal
  • Products remain property of principal until they arrive at the customer
  • Functions and risks involved with buying and holding stock and credit risk of selling goods are with the principal
  • Possible changes in a reorganization

o   Physical location of stock

o   Marketing intangibles such as brand names, client lists, trade marks etc., may be  transferred to principal

o   Marketing budget etc. taken over by principal

o   Invoice processing will be moved.

Limited-risk distributor

  • Buying goods and market them to customers
  • Contract between distributor and principal who will indemnify certain costs
  • Main functions and risks are with the principal
  • Risks relating to inventory and debtors are reimbursed by principal, e.g. obsolescent stock will be redeemed by principal and bad debts will be compensated

Commission agent

  • Canvasses for sales and interacts with customers
  • Terms and contract are agreed outside his territory without its interference
  • Does not take title of goods
  • Receives a routine compensation
  • Agent’s staff limited role, do not enter in any contract, only introducing customers

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