Organisation for Economic Co-operation and Development
Auditing Multinational Enterprises
6. Transfer pricing methods
Centre for Tax Policy and Administration
Methods for applying the arm’s length principle
Traditional transaction methods
 Comparable uncontrolled price
 Resale price method
 Cost-plus
Transactional Profit Methods
 Transactional net margin method (TNMM)
 Transactional profit split method
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Hierarchy of methods: 1995 Guidelines
OECD Transfer Pricing Guidelines:
• Where it is possible to locate reliable enough
comparable uncontrolled transactions, CUP is
the most direct and reliable way to apply the
arm’s length principle.
• Where they can be applied in a reliable enough
manner, traditional transaction methods are
preferred over transactional profit methods.
• Transactional profit methods “exceptionally”
applicable in cases of last resort.
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2010 Update to Guidelines
Selection of a transfer pricing method:
 Exceptionality removed and replaced with a
standard whereby the selected transfer pricing
method should be the “most appropriate method to
the circumstances of the case”.
 Emphasis on :
- the appropriateness to the nature of the transaction /
functional analysis
- availability / reliability of comparables
2010 Update of Guidelines
Other methods:
MNE groups retain the freedom to apply methods
not described in the TP Guidelines
Use of more than one method:
The arm’s length principle does not require the
application of more than one method for a given
transaction (or set of aggregated transactions)
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Comparable Uncontrolled Price
 Identifies the price in place in respect of
identical transactions between independent
parties…. and applies that price to the
controlled transaction.
 Can be used where transactions are not
identical if differences can be adjusted for.
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Comparable Uncontrolled Price
Cutting Edge
Corporation
Products sold to CE
(B) at $ 100 000
each
Cutting Edge (B)
Key question: What would be the sales price of units if they had been sold
by, or to, an independent third party under identical conditions?
Cost-Plus Method
 Uses as a basis of comparability the costs
incurred by the supplier of goods or services.

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Comparison between the tested party and the
comparable party (or comparable parties) is in
relation to the mark-up on “direct and indirect
costs” earned by each.
Cost-plus method
Cutting Edge
Corporation
Mark-up on direct and
indirect costs of 25%
Products sold to CE (B) at
$ 100 000 each
Cutting Edge (B)
Key question: What mark-up would Cutting Edge Corporation
earn if it sold the goods to an independent third party?
Resale Price Method
 Applies to transactions where the tested party
sells to third parties, but buys from a connected
party.
 Most frequently used for a sales/distribution
entity.
 Comparison is made between the gross profit
margin made by the tested party and that made
by the comparable party (or parties).
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Resale price method
Cutting Edge
Corporation
Products sold to CE (B)
at $ 100 000 each
Cutting Edge (B)
Products sold to customers at $
132 000 each
Customers
Key question: What gross profit rate would Cutting Edge (B) earn if it
purchased and sold similar goods from an independent supplier?
Transactional Net Margin Method
Comparison is made at the level of operating
margin (ie before interest deductions) achieved
by the tested party and the comparable parties.
Normally expressed as operating profit as a
percentage of turnover, costs or assets.
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Transactional Net Margin Method
Uncontrolled Transaction
Manufacturer
Net margin, say 5%
Distributor
Net margin = 10%
Customer
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Key questions
 What net margin would the
manufacturer earn on sales to
an independent distributor Or
 What net margin would the
distributor earn from the sale
on goods purchased from an
independent supplier?
NB Net margin may be in relation
to sales, costs or other
measures such as assets
Profit Split Method
Comparison is made at the level of split of overall
profit between the parties. The profit split
between parties to the controlled transaction
should be equivalent to that between
independent parties.
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Profit Split
Uncontrolled transaction
Manufacturer
Profit =15
Distributor
Profit = 10
Customer
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Key question:
What would be the split of
profit between the
manufacturer and
distributor - arising from
the transaction between
them - if they had been
independent?
(A residual profit split
method may also be
available)
Methods - Summary
Method
CUP
RPM
Cost-plus
TNMM
Profit split
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Basis for comparability
Price
Gross margin made by
resellers
Mark-up on direct costs
incurred by supplier
Operating margin
Split of profit
Practical application of methods
1.
2.
3.
4.
5.
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CUP. Most reliable method, but may be unavailable.
Resale price. Often appropriate to benchmarkable
sales/distribution functions. Less appropriate where
distributor owns valuable intangible
Cost-plus. May be appropriate to benchmarkable
manufacturing, R&D or service operations. Less
appropriate where manufacturer owns valuable
intangible
TNMM. May be appropriate to benchmarkable
manufacturing, service or sales/distribution functions.
Profit split. May be appropriate to transactions
between entities that both make significant nonbenchmarkable contributions.
Benchmarkable functions
 CP, RPM and TNMM typically rely on



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benchmarking against comparable transactions
between independent parties.
They are one-sided methods that determine an
arm’s length reward for one of the parties to the
transaction, leaving the residual return to the other
party,
We would normally benchmark the function for
which sufficiently reliable comparable information
can be found
Low-risk functions involving no valuable assets are
most likely to be benchmarkable.
Choice of method
Depends on:
 Suitability, in the light of functional analysis
 The reliability of the method
 Availability of sufficiently reliable comparable
information
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