Method of transfer pricing

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 18. What are the methods of transfer pricing? Explain.

Transfer pricing methods are standard guidelines used by organizations to determine the fair market value (the arm's length price) for transactions between related entities or divisions. They are primarily divided into traditional transaction methods and transactional profit methods. [1, 2, 3]



1. Traditional Transaction Methods


These methods evaluate transfer pricing by comparing the price and conditions of a specific controlled transaction directly with an uncontrolled (third-party) transaction.
  • Comparable Uncontrolled Price (CUP) Method: Considered the most direct and preferred method when data is available. It compares the price charged for goods/services in an intercompany transaction to the price charged in a comparable transaction between independent parties in open market conditions.
  • Resale Price Method (RPM): This method begins with the price at which a product is resold to an independent third party. This resale price is then reduced by an appropriate gross profit margin (representing the reseller's value addition) to calculate the transfer price for the affiliated supplier.
  • Cost Plus Method (CPM): Used frequently for manufacturing or long-term supply arrangements. This method determines the transfer price by taking the direct and indirect costs of the supplier and adding an appropriate gross profit markup to reflect a fair profit margin. [2, 4, 10]
2. Transactional Profit Methods


These methods examine the net operating profits resulting from specific intercompany transactions rather than analyzing the individual prices of the goods or services.
  • Transactional Net Margin Method (TNMM): This is one of the most widely used methods. It compares the net profit margin (relative to a specific base like costs, sales, or assets) that a taxpayer earns in a controlled transaction to the net profit margin earned by independent enterprises in similar, comparable transactions.
  • Transactional Profit Split Method (PSM): This method is typically applied to highly integrated global operations or transactions involving unique, non-routine intellectual property. It identifies the combined profit earned by the related parties from a controlled transaction and splits it among the entities based on the relative value of their contributions, risks assumed, and functions performed. [1, 4, 13]
For detailed regulatory guidelines and application frameworks, you can refer to the OECD Transfer Pricing Guidelines or the United Nations Transfer Pricing Manual for international tax compliance. [1, 14]



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