Traditional transfer pricing methodologies

Code 1 - comparable uncontrolled price method

This method compares the price for property or services transferred in a controlled transaction - that is, with a related international party - to the price charged for comparable property or services under the same or similar circumstances in an uncontrolled transaction.

Where it is possible to locate comparable uncontrolled transactions, the comparable uncontrolled price method is the most direct and reliable way to apply the arm's length principle. If there is any difference between the prices or the terms of the controlled transaction and the uncontrolled transaction, this may indicate that the dealings of the associated enterprises are not arm's length.

Note that intangible and intellectual property transactions present particular problems with regard to comparability, especially where such property is unique or specialised.

If you use this method but the comparable uncontrolled price is adjusted to allow for particular circumstances of the controlled dealing, you should still record the adjusted price under this code.

Code 2 - resale price method

This method may be appropriate where an enterprise sells a product to a related party who then resells that product to an independent third party.

The resale price is reduced by the arm's length resale price margin and may then be regarded - after adjustments for other costs associated with the original purchase of the product - as an arm's length price of the original transfer of property between the related parties.

Further analysis can be undertaken by reviewing the resale price margin of the reseller in the controlled transaction. This is done by referencing the resale price margin that the same reseller earns on items purchased and sold in comparable uncontrolled transactions. The resale price margin earned by an independent enterprise in comparable uncontrolled transactions may also provide guidance.

Margins are usually measured at gross profit level. However, a comparison undertaken at an intermediate level may be more accurate. A comparison at the net profit level falls under a different methodology - the transactional net margin method.

The resale price margin will vary depending on the value added by the reseller. Variables such as functions performed, economic circumstances, assets employed, and risks undertaken should reflect higher margins.

Code 3 - cost-plus method

The cost-plus method begins with the costs incurred by the supplier of property or services in a controlled transaction for property transferred or services provided to a related purchaser. An appropriate arm's length cost plus mark-up is then added to this cost to make an appropriate profit in light of the functions performed and the market conditions. What is arrived at after adding the arm's length cost plus mark-up to the above costs may be regarded as an arm's length price of the original controlled transaction.

This method is probably most useful if:

  • semi-finished goods subject to additional manufacturing or assembly are sold between related parties
  • related parties have concluded joint facility agreements or long-term buy-and-supply arrangements
  • the controlled transaction is the provision of services.

This method is not suited for high value intangibles.

Further analysis can be undertaken by reviewing the cost plus mark-up of the supplier in the controlled transaction. This is done by referencing the cost plus mark-up that the same supplier earns in comparable uncontrolled transactions. The cost plus mark-up that would have been earned in comparable transactions by an independent enterprise may serve as guidance.

If a fixed percentage mark-up is applied to the relevant cost base without any benchmarking of that percentage against comparable independent dealings, it is not regarded as cost-plus method.

    Last modified: 21 Feb 2012QC 25356