Transfer pricing methods – explained
The Organisation for Economic Co-operation and Development (OECD) guidelines outline five methods for establishing the arm’s length price for transactions between related parties; which is most appropriate will depend on the particular scenario at hand.
In this video, our experts explain each of the five OECD recognised transfer pricing methods, using practical, real-world examples to demonstrate how they can be applied effectively in different business contexts.
The five transfer pricing methods
Comparable uncontrolled price method (CUP)
The CUP method compares the price charged in a controlled transaction to the price charged in comparable uncontrolled transaction in comparable circumstances. For a transaction to be a CUP, there must be a high degree of product/service comparability. CUPs may also be useful for pricing related party commodity transactions or financial transactions.
Cost plus method
The cost plus method calculates the arm’s length price of a transaction by identifying the costs of the supplier and adding an appropriate mark-up to remunerate the functions performed, assets used and risks assumed. The mark-up should be calculated with reference to what a party in an uncontrolled transaction would earn if it performed comparable functions or services. Cost plus is often appropriate for pricing services, particularly where they are of a routine nature, and the service provider bears limited risk.
Resale price method (RPM)
The resale price method is based on gross profit margin, i.e. it establishes the price at which a product should be purchased from a related party with reference to the price at which it is sold to an unconnected third party. The RPM is frequently employed in cases in which tangible property has been purchased and resold without substantial value being added to the product by the reseller. However, it is not appropriate where the reseller’s activities amount to creating local marketing intangibles.
Transactional net margin method (TNMM)
The transactional net margin method compares the net profit margin earned in a controlled transaction with the net profit margin earned between unrelated parties. This method is less affected by product/service differences than is the case with the CUP method. Comparable data is also more likely to be available as TNMM looks at net vs gross profit.
Profit split method
This method looks at the combined profit derived from the controlled transactions and then splits that profit on the basis of the relative contribution of each party. This method is generally used where highly integrated transactions are undertaken by related parties and/or where both parties to a transaction make a unique and valuable contribution to the transaction, such that neither entity can be considered the simpler, and therefore tested, party.
How can Price Bailey help?
Our team are specialists in transfer pricing. To explore how these methods could apply to your organisation, speak to one of our experts today.
We always recommend that you seek advice from a suitably qualified adviser before taking any action. The information in this article only serves as a guide and no responsibility for loss occasioned by any person acting or refraining from action as a result of this material can be accepted by the authors or the firm.
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