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Appendix 4 Pricing methods

Last updated 26 November 2009

See Taxation Ruling TR 97/20 and Taxation Ruling TR 1999/1 for a more complete explanation of the operation and suitability of each of the methods mentioned below for particular circumstances.

The explanations below are only brief summaries of each method, and the list is not exhaustive. The methods may not be appropriate for determining an arm's length price under all circumstances. Other methods, which are not listed below, might also be appropriate.

It is not possible to identify all the circumstances under which the various methods will produce valid results, and the applicability of any particular method for any given transaction must be determined from all the facts and circumstances of the dealing.

Comparable uncontrolled price method - code 1

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

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

Resale price method - code 2

This pricing method may be appropriate where an enterprise sells a product to a related party, who then re-sells 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.

Cost-plus method - code 3

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, assets used 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 are sold between related parties
  • related parties have concluded joint facility agreements or long-term buy-and-supply arrangements, or
  • the controlled transaction is the provision of services.

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

Profit split method - code 4

This is a method of determining the appropriate pricing for transactions by:

  • identifying the combined profit or loss from the dealings between the related parties, and
  • splitting that combined profit or loss between the related parties.

The split of profit or loss between the parties must be made on an economically valid basis that approximates the division of profits that would have been arrived at in an agreement made at arm's length.

Transactional net margin method - code 5

This pricing method is based on comparisons made at the net profit level between the taxpayer and independent parties, in relation to a comparable transaction or dealing.

Comparisons at the net profit level can be made on a single transaction or in relation to some aggregation of dealings between associated enterprises.

Marginal costing - code 6

Marginal costing is a method of pricing that applies only the variable production costs to the costs of a product. Marginal costing is often used by companies and multinational enterprise groups for internal cost accounting and management control purposes. However, its use in setting transfer prices on international dealings between associated enterprises for tax purposes is acceptable only if pricing on the basis of marginal costs represents an arm's length outcome for the transfer of goods or services into the particular market.

Cost-contribution arrangement - code 7

A cost-contribution arrangement is one where members of a multinational group act in concert for the benefit of each of the participants to:

  • produce or provide goods, intangible property or services, or
  • acquire these jointly from a third party,

and agree to share the actual costs and risks undertaken.

Each participant bears a fair share of the costs, and is entitled to receive a fair share of rewards. The concept is akin to a joint venture or partnership.

To be consistent with the arm's length principle, the contributors must be satisfied that they can obtain an acceptable rate of return within a timeframe that takes into account their financial and business circumstances.

For more information refer to Taxation Ruling TR 2004/1 - Income tax: international transfer pricing - cost contribution arrangements.

Apportionment of costs - code 8

This pricing method apportions the costs associated with a controlled transaction among the associated enterprises. An answer must be found to all transfer pricing problems. However, cases may arise where neither comparable dealings nor data are available to apply to traditional, or profit-based, methods. In these instances, application of an indirect method such as apportionment of costs on the basis of a formula may be applicable.

Apportionment of income - code 9

This pricing method apportions the income associated with a controlled transaction among the associated enterprises.

As with the method for code 8, this method may be applicable where there are neither comparable dealings nor data to apply the traditional, or profit-based, methods to the pricing problem.

Fixed percentage mark-up applied to costs - code 10

This pricing method determines the transfer price for a controlled transaction by applying a fixed percentage mark-up to a relevant cost base, where the mark-up is not benchmarked against comparable independent dealings. The absence of benchmarking distinguishes this method from the cost-plus method discussed at code 3.

Fixed percentage of resale price - code 11

This pricing method determines the transfer price for a controlled transaction as a fixed percentage of the resale price, where the fixed percentage chosen is not benchmarked against the gross margins earned in comparable independent dealings.

The absence of benchmarking distinguishes this method from the resale price method, code 2.

Other arm's length methods - code 12

Any arm's length method which is not included at codes 1 to 11.