Methods in Transfer Pricing
Methods for determining Arm’s length price
These methods are briefly described as under:
(a) Comparable uncontrolled Price Method (CUP)
a. Under CUP method, price charged for property or services transferred in a controlled transaction is compared to price charged in a comparable uncontrolled transaction.
b. The price identified is to be adjusted to account for material differences between the transactions being compared. The adjustments will be done keeping in view many factors like contractual terms, geographical markets etc.
c. The source of information to identify the comparable price can be challenging task.
(b) Resale price method RPM
Under this method:
- the price at which property or services obtained by the enterprise from an associated enterprise is resold to an unrelated enterprise, is identified;
- such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or services, in a comparable uncontrolled transaction, or a number of such transactions;
- the price is still reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services;
d. the price so arrived at is adjusted to take in to account the functional and other differences if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin;
e. The price so arrived is taken to be an arm’s length price in respect of the purchase of the property or obtaining of the services by the enterprise from the associated enterprise.
The RPM is applicable in resale situation, where the property or services purchased from an associated enterprise are resold to an unrelated enterprise. The RPM is generally regarded as appropriate for the pricing of product purchased by a company that operates as a service provider, which adds a little or no value.
(c) Cost plus Method (CPM)
In this method the cost incurred by the supplier of property or services in a controlled transaction is identified. The cost can be direct & indirect cost of production. An appropriate mark up is then added to this cost, in the light of functions performed and market conditions.
.length price of controlled transactions. In this method overheads are not taken into consideration as cost
(d)Profit split method
Under this method, the arm’s length price is determined through a division of the consolidated profits of the ‘associated enterprises’.
The steps involved in applying this method are:
- The combined profits of the associated enterprises from the related transactions is determined.
- Then contributions of each enterprise towards earning of profits will be evaluated based on functions performed, assets employed and risks assumed.
- The combined net profit will be split in proportion to relative contributions.
The profit thus apportioned is taken in to account to arrive at the arm’s length price.
The method is applicable in cases involving multiple transactions which are so inter related that they cannot be evaluated separately.
(e) Transnational net margin method (TNMM)
The TNMM examines the net profit margin of a taxpayer with an associated enterprise. The net margin is calculated with respect to appropriate base say costs, sales and assets etc. The net margin of the taxpayer from the controlled transaction is determined by reference to the margins earned in comparable uncontrolled transactions for establishing arm’s length price. The comparability is judged with reference to following:-
- Specific characteristics of the property or services
- Functions performed, Risks involved & Assets deployed