Transfer Pricing methods

The OECD Guidelines provide for five methods, which can be used to determine the price for intra-group transactions (also referred to as “controlled transactions”). The first step in selecting the appropriate transfer pricing method is to understand the controlled transaction based on a functional analysis, assessing the functions performed, assets used and risks assumed by the parties to the controlled transaction.

#1 Comparable Uncontrolled Price (CUP) method

The OECD preferred and most reliable transfer pricing method is the Comparable Uncontrolled Price (CUP) method. The CUP method establishes a price based on the pricing of similar transactions which have taken place between third parties or between a MNE entity and a third party. When applying the CUP Method, an uncontrolled transaction is considered comparable to a controlled transaction if:

there are no differences in the transactions being compared that would materially affect the price; or
reasonably accurate adjustments can be performed to account for material differences between the controlled and the uncontrolled transaction.

#2 Cost-Plus Method

When the CUP cannot be utilized due to lack of sufficiently comparable transactions, the cost-plus method may be applied. This method calculates the price on the basis of the cost of supplying the goods or providing the services, and adding a profit margin. However, this pricing method looks solely at the costs of the enterprise and ignores the prices set by competitors, therefore, it may not always be the most appropriate method.

#3 Resale Price Method

The third OECD approved method is the Resale Price method, which bases the price for an intercompany controlled transaction on the resale price of a product, asset or service sold to a third party. The resale price is then adjusted by subtracting the gross margin, along with additional costs associated with the purchase and for this reason is mostly applicable to the supply of goods.

#4 Transactional Net Margin Method

When transaction data is not available, MNEs can use margin levels to establish the arm’s length price. The transactional net margin method measures the net operating profits realized from controlled transactions and then compares the profit level to the profit level realised by independent enterprises engaging in comparable transactions.

#5 Profit-split Method

The last method is the profit split method, which is appropriate to be used when two parties are contributing to a venture and it’s difficult to examine each party on its own. Instead, the profit split method uses the profitability, or potential profitability, of a product or venture and utilises allocation keys to split profits in a fair manner between the transaction parties.

Transfer pricing is a complex topic that requires a great deal of attention from both governments and businesses. Governments often establish regulations and policies to ensure that transfer pricing policies are transparent and established in a way that is fair to all parties. Similarly, businesses typically involve tax experts, legal advisers, and management staff to ensure that their transfer pricing policies are robust enough to withstand scrutiny.

While transfer pricing is essential for businesses that trade internationally, it often leads to disputes among tax authorities and multinational corporations. Resolving these conflicts requires transparency and cooperation among the parties involved. Governments and multinational corporations can achieve this by establishing clear and transparent transfer pricing policies that are consistent with international guidelines.