Approaches in transfer pricing

Author: Iloka Benneth Chiemelie
Published: 15-October-2014

1.      Introduction

The increase in globalization coupled with more companies internationalizing has created new practices in the business setting, and one of such practices is transfer pricing. In a general sense, transfer pricing is used to describe the process of creating an arm’s length prices payable or charged physical goods or intangible properties that are transferred or supplied in a given transaction between two companies that are located within the same tax jurisdiction or outside the same tax jurisdiction.

2.      Transfer pricing approaches

OECD (2010) presented a discussion of the different transfer pricing method as discussed below.

2.1. CUP Method

In this approach, the prices charged for a given property or services that is transferred controlled transaction is compared with the prices charged for a comparable properties or services that has also bene transferred in an uncontrolled transaction with similar circumstances (OECD, 2010). If such comparison shows differences, it does show that the associated enterprises are not arm’s length and the price obtained from the uncontrollable transaction is likely to be substituted by the price obtained from the controllable transaction (OECD, 2010).

2.2. Resale price method

This method begins with the selling price of a given product or services, which is the price the product has been purchased from an associated enterprise and then resolved to a difference and independent enterprise. This method involves reducing the resale price by the right gross margin by referencing the gross margin obtained form an uncontrollable transaction as a way of obtaining the price that the reseller will need to sale the product in order to be able to cover both the selling price and other operating expenses incurred in the course of all involved activities and also make appropriate profit from the transaction (OECD, 2010).

2.3. Cost plus method

This approach starts with the cost that the suppliers has incurred in a controlled transaction for the property or service that has been transferred in a controlled transaction. It does involves understanding the right mark-up on the incurred cost by reference the mark-up that has been earned by earned in a comparable uncontrolled transaction and then adding associated cost as a way of ensuring that the suppliers obtain necessary profit after covering up cost for the transaction (OECD, 2010).

2.4. Transaction net margin method

This approach does analyze the net profit margin indicator which a taxpayer drops from a given controlled transaction in reference to the earned net profit from a comparable uncontrolled transaction (OECD, 2010). This is hugely beneficial when it comes to determining the arm’s length net profit indicator for the taxpayer.

2.5. Transactional profit split method

The first step in this approach is to identify the combined profit that will be split between associated enterprises in a controlled transaction (OECD, 2010). Under certain conditions, the obtained combined profit will be a residual profit which has been allocated to represent the profits which cannot be readily assigned to one of the parties involved in application of a different transfer pricing approach.

3.      How to reconcile the use of approaches between seller and buyers

From the above discussion, it is clear that there are different methods in transfer pricing. This makes it necessary to ensure that a uniform or broadly understandable approach is adopted between sellers and buyers in order to eliminate issues that can occur from adopting different approaches between these two parties.

OECD (2010) highlighted that the solution to this will be by both the buyers and suppliers focusing more on the approach that best suits their respective needs, then comparing this approach with a related uncontrollable transaction before finally arriving at a common approach that will be adopted in the final transaction. From a general sense, it does involve adopting a uniform concept or an agreed approach that meets the respective needs of the parties involved in the transaction in order to ensure that both parties benefit from profits that will be made from the transaction.

4.      References

The organization for economic co-operative and development (OECD) (2010), “Transfer pricing methods.” Available at: http://www.oecd.org/ctp/transfer-pricing/45765701.pdf [Accessed on: 20/9/2014].