4 Common Transfer Pricing Methodologies

With operations spread in many different parts of the world, MNCs often struggle with regards to profit and resource distribution of the subsidiaries. It is with the help of transfer pricing that the revenue and expense of each subsidiary can be allocated in the best possible manner. Check out four of the most common transfer pricing methodologies used by multinational businesses.

While globalization continues to open up new avenues for businesses to expand their operations, it also poses several significant challenges.

For instance, multinational businesses have access to vast natural resources, low-cost labour, manufactured products, and skilled talent across geographies. But they also need to comply with the laws and regulations of each country they have their operations in. This can be very challenging, especially with regards to taxation.

For instance, most MNCs with significant inter-company transactions struggle when it comes to distributing the revenue and expenses to their subsidiaries. It is with the help of transfer pricing that such MNCs try to allocate resources, revenue, and expenses in the most effective and tax-friendly manner.

There are multiple transfer pricing methodologies that can be implemented by businesses as per their requirements and tax strategies. Take a look at four of the most popular methods-

1. Comparable Uncontrolled Price (CUP)

With the CUP method, businesses determine the price of goods and services based on fair market value. In other words, the method compares the prices of controlled transactions with that of 3^rd party transactions.

The 3^rd party transactions could be of two different types-

• Internal CUP- Transactions between an independent enterprise and a taxpayer.
• External CUP- Transactions between two enterprises that are independent.

In the CUP method, it is assumed that two subsidiaries of the same business are hypothetically not related to each other.

2. Resale Price Method (RPM)

Also referred to as the RMM or “Resale Minus Method”, it involves three steps for calculating the ALP (Arm’s Length Price) for controlled transactions. Firstly, the “resale price” or the price at which an enterprise sells a product or service to the 3^rd party is taken into consideration.

Secondly, the resale price margin or gross margin, calculated by comparing margins of uncontrolled transactions, is reduced from the resale price. Thirdly, all the different costs related to product purchases, such as customs duty, are deducted to finally determine the ALP.

3. Cost Plus Method (CPM)

In this method, gross profits are compared with the sales cost. Once the sales cost is known, a markup, which reflects a certain profit for the business based on the functions performed and risks involved, is added to the cost.

The markup is mostly calculated after considering the direct as well as indirect costs involved in supply or production. However, operating expenses such as overheads are generally not added to the markup. The final result after this addition of markup is considered to be the ALP.

4. Profit Split Method (PSM)

Associated enterprises or subsidiaries of a business often engage in transactions that are highly inter-related. In such cases, it can be very complicated to examine such transactions separately. So, the profit is split among the enterprises for such transactions.

SPM is a type of transfer pricing methodology where inter-related controlled transactions are examined by considering the profits that independent enterprises might have realized from those transactions.

 Selecting the Right Transfer Pricing Methodology

The governments all over the world are applying greater scrutiny on inter-company transactions. This has made multinational businesses highly vulnerable to pricing adjustment complexities that could significantly increase the tax outflow. Selecting the right pricing methodology has thus become more important than ever.

Working with a consultancy firm that excels in transfer pricing practices can be an excellent solution for businesses to take advantage of these complexities and optimize their revenue. It is with the help of dedicated practitioners that such multinational companies could build policies that are highly flexible, advantageous, and in line with their tax strategies.