Transfer pricing method

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 10.Give the meaning of transfer pricing methods

Transfer pricing methods are sets of rules and frameworks used to determine the "arm’s length" price for goods, services, and intellectual property exchanged between related entities (e.g., a parent company and its subsidiary). Their primary purpose is to ensure transactions reflect fair market value to prevent artificial profit shifting and ensure proper tax compliance. [1, 2]



These frameworks are categorized into Traditional Transaction Methods and Transactional Profit Methods. Tax authorities worldwide recognize the following five primary methodologies: [3, 4]


1. Traditional Transaction Methods


These methods evaluate transfer pricing by comparing specific, individual controlled transactions directly with uncontrolled (third-party) transactions.
  • Comparable Uncontrolled Price (CUP) Method: Compares the price charged for a property or service in an internal or external related-party transaction to the price charged in a comparable transaction between entirely independent parties. It is the most direct approach for standard goods or financial arrangements.
  • Resale Price Method (RPM): Begins with the resale price of a product bought from an affiliated entity and sold to an independent party. This price is then reduced by an appropriate gross margin representing the reseller's costs and fair profit. This is ideal for straightforward distribution activities.
  • Cost Plus Method (CPM): Calculates the costs incurred by the related supplier (both direct and indirect) and adds an appropriate, market-rate profit markup. It is heavily utilized in manufacturing and routine service provisions. [6, 8, 9]
2. Transactional Profit Methods


These methods assess the profits resulting from particular controlled transactions by examining the net operating profits that independent enterprises would have earned in similar circumstances.
  • Transactional Net Margin Method (TNMM): Measures the net profit margin realized by a related entity from a controlled transaction and compares it to the net profit margins realized by similar, independent companies on comparable bases (e.g., sales, costs, or assets). It is the most widely used method when comparable transaction data is hard to find.
  • Transactional Profit Split Method: Identifies the combined profit from a controlled transaction and splits it between the associated companies based on the economic value, relative contributions, and risks taken by each entity. This is used for complex, highly integrated operations or when valuable intellectual property is shared. [6, 7, 9, 10, 11]
For a deeper dive into choosing the right framework for your business, you can consult the Wise Transfer Pricing Overview.





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