What are the most effective transfer pricing methods in intercompany transactions?

1 Comparable Uncontrolled Price Method

The comparable uncontrolled price (CUP) method is the simplest and most direct transfer pricing method. It compares the price of the intercompany transaction with the price of a comparable transaction between unrelated parties under similar circumstances. The CUP method requires a high degree of similarity between the products, services, functions, risks, and markets involved in the transactions. The CUP method is effective when there is a reliable source of comparable data, such as public databases, market reports, or contracts. The CUP method is preferred by tax authorities because it reflects the market conditions and minimizes the scope for manipulation.

3 Cost Plus Method

The cost plus method is based on the mark-up that a producer earns from selling a product or service to a related entity. The cost plus method adds the mark-up to the production cost to arrive at the arm's length price of the intercompany transaction. The production cost includes all the direct and indirect costs incurred by the producer, such as materials, labor, overhead, and depreciation. The mark-up is determined by comparing the producer's functions, risks, and assets with those of independent producers in similar transactions. The cost plus method is effective when the producer does not incur significant post-production costs, such as marketing, distribution, or warranty. The cost plus method is suitable for transactions involving intermediate goods or services.

4 Transactional Net Margin Method

The transactional net margin method (TNMM) is based on the net profit margin that a related entity earns from an intercompany transaction relative to an appropriate base, such as sales, costs, or assets. The TNMM compares the net profit margin of the related entity with the net profit margin of independent entities in comparable transactions. The TNMM requires a functional analysis to identify the most appropriate entity to be tested, the most relevant profit level indicator, and the most comparable transactions. The TNMM is effective when there is a lack of comparable data for the prices or margins of the products or services involved in the intercompany transaction. The TNMM is suitable for transactions involving complex or unique products or services.

5 Profit Split Method

The profit split method is based on the division of the combined profits or losses that result from an intercompany transaction among the related entities according to their relative contributions. The profit split method requires a functional analysis to determine the value of the functions, risks, and assets of each related entity and to allocate the profits or losses accordingly. The profit split method is effective when there is a high degree of integration, interdependence, or synergy between the related entities, such as in the case of joint ventures, strategic alliances, or global value chains. The profit split method is suitable for transactions involving intangible assets, such as patents, trademarks, or know-how.

6 Here’s what else to consider

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