The Ultimate Guide to Transfer Pricing Methods for Business Success

Unlock the secrets of transfer pricing and navigate global taxation with confidence.

1. Imagine for a moment that you're the captain of a vast multinational enterprise, charting
courses across the sea of the global economy. Your ship is laden with treasures - products,
services, intellectual property - all destined for foreign affiliates.
You've set your sights on maximising profit, but how do you ensure you're not leaving money
on the table or sailing into stormy tax waters?
The answer lies in mastering the art of transfer pricing. It's not just a practice; it's the compass
that guides your financial navigation, ensuring you set the right prices for intra-company
transfers - at arm's length, mirroring the fair market value.
You might ask, "Why is this so crucial for my business?" Well, proper transfer pricing isn't just
about compliance with tax regulations. When wielded correctly, it's a strategic helm that can
help you minimise tax risks, sharpen your competitive edge, and maintain smooth sailing
relationships with global tax authorities.
Fail to give it due attention, and you might find yourself amidst turbulent seas of tax disputes
or, worse, caught in the whirlpool of double taxation.
This guide is your map to mastering transfer pricing, a strategic tool ensuring your business
journey is both compliant and prosperous.
Ready to set sail? Let's unlock the secrets of transfer pricing together.

2. Transfer Pricing in a Global Perspective: The Two-Pillar Framework
The Organisation for Economic Co-operation and Development (OECD) and individual
governments worldwide have led efforts to harmonise transfer pricing principles. Amid
increasing complexities due to digitalisation and the COVID-19 pandemic, a two-pillar
framework has been adopted to address these tax issues.
Pillar One redefines tax jurisdiction rules, requiring MNEs with income above a certain
threshold to pay a 'tax on residual profits' in countries where they generate significant revenue,
regardless of physical presence. It's designed to cover both highly digitalised businesses and
consumer-facing companies with cross-border activities.
Pillar Two, on the other hand, aims to establish a minimum global tax rate of 15% for all MNEs
above a certain income threshold. This pillar has progressed more than Pillar One and will likely
start applying in multiple jurisdictions in 2024.
Transfer Pricing Methods: A Refreshed Look
Businesses typically use the following five transfer pricing methods to determine the
appropriate prices for transactions between related entities.
However, note that the Indian Transfer Pricing regulations adopt the "most appropriate
method" concept and allow for a sixth method prescribed by the Central Board of Direct Taxes.
These methods are:
1. Comparable Uncontrolled Price Method (CUP)
The CUP method compares the price charged for a controlled transaction with those charged
for a comparable uncontrolled transaction under similar circumstances. This method, like
comparing the price of a product sold in an open market, helps establish an arm's length price,
that is, the price at which independent entities would have conducted the transaction.
Let's say Company A in India sells a specific type of bicycle to its subsidiary, Company B in the
USA, for INR 10,000. At the same time, Company A sells the same type of bicycle under similar
circumstances to an unrelated company, Company C, in Germany for INR 9,500.
The price charged to Company C can be used as a benchmark to set the price for transactions
with Company B, suggesting that the transfer price might need to be adjusted to INR 9,500 to
meet the arm's length standard.

3. 2. Resale Price Method (RPM)
The RPM calculates the transfer price by adding a profit margin to the product or service's
selling price. This method is used when a related party buys from another linked party and
resells to a third party. It ensures the profit earned by the reseller aligns with its functions and
risks, thereby maintaining an arm's length pricing arrangement.
Suppose Company A in India sells smartphones to its subsidiary, Company B in the USA, which
then resells these phones to local customers.
If Company B purchases a phone from Company A for INR 20,000 and resells it for INR 30,000,
and the typical gross margin for resellers in the industry is 30%, then the arm's length price
under the RPM would be INR 30,000 / 1.30 = INR 23,077.
3. Cost Plus Method (CPM)
The CPM calculates the transfer price by adding an appropriate profit markup to the cost of
producing a product or service. It's typically used when one linked party provides goods or
services to another related party.
Let’s say Company A in India manufactures goods for Company B in the USA. The production
cost of these goods for Company A is INR 15,000.
If companies in the same industry typically add a markup of 20% on their production costs, then
the arm's length price under the CPM would be INR 15,000 * 1.20 = INR 18,000.
4. Transactional Net Margin Method (TNMM)
The TNMM compares the net profit margin of a controlled transaction to comparable
uncontrolled transactions. It analyses the associated entity's net profit relative to costs, assets,
and sales, ensuring that the controlled transaction's profit aligns with that of similar
transactions between unrelated parties.
Suppose Company A in India provides IT services to its subsidiary, Company B, in the UK.
Company A has operating costs of INR 8,000 and makes a net profit of INR 2,000, resulting in a
net profit margin of 25% (2,000 / 8,000).
If this margin is consistent with the net profit margins of independent companies providing
similar services under comparable circumstances, then the transfer price would be considered
at arm's length.

4. 5. Profit Split Method (PSM)
The PSM allocates profits between related parties based on each party's relative contribution to
the overall value creation of a transaction or business activity. It's often used when the unique
contributions of each party can't be separately identified using other methods.
For instance, Companies A and B are part of the same MNE and jointly develop a new product.
They incur combined costs of INR 1,00,000 and make a combined profit of INR 50,000 from
selling this product.
If it's determined that Company A contributed 60% to the value of the product and Company B
contributed 40%, then the profit would be split accordingly. Company A would receive INR
30,000 (60% of INR 50,000), and Company B would receive INR 20,000 (40% of INR 50,000).
Advantages & Disadvantages of Different Transfer Pricing Methods
Each transfer pricing technique has advantages and disadvantages. Understanding this can help
organisations pick the right technique.
Here are the advantages and disadvantages of different transfer pricing methods:
Method Advantages Disadvantages
CUP
Uses real market prices. Accurate
with comparable data.
Hard to find comparable data. Requires
extensive data analysis.
RPM Good for resellers. Simple to apply.
Not for value-added activities. Needs data
on comparable resellers. Doesn't consider
supplier profitability.

5. CPM
Good when a party provides
services to another. Covers
production costs.
May overlook market conditions. Profit
markup can be subjective. Needs careful
cost documentation.
TNMM
Considers overall profitability.
Flexible with profit indicators.
Difficult to get comparability data. Needs
extensive financial data. It can be subject
to disputes.
PSM
Good when value contributions are
hard to separate. Recognises
unique contributions.
Complex to determine the allocation key.
Needs high collaboration. This may lead to
disagreements.

Note: Remember, in Indian regulations, the choice of method depends on the specific situation
of each transaction. Taxpayers must justify their choice, demonstrating why they believe it's the
"most appropriate" method.
Conclusion:
Mastering transfer pricing is an art, but you can become proficient with practice. It's a powerful
tool to mitigate tax risks, leverage competitive advantage, and maintain harmonious
relationships with global tax authorities.
The road may be complex, but remember, it's okay to ask for guidance. Reach out to industry
professionals for insight, advice, or a second opinion.
Navigating these waters with a network of experts at your disposal can make the journey
smoother. Let's collaborate, share knowledge, and succeed together in the global market.

6. Source: https://www.manishanilgupta.com/blog-details/the-ultimate-guide-to-transfer-pricing-
methods-for-business-success