Appendix 5: Main pricing methodologies

1

Apportionment of costs

This pricing method apportions the costs associated with a controlled transaction among the associated enterprises. However, cases may arise where neither comparable dealings nor data are available to apply to traditional, or profit-based, methods. In these instances, application of an indirect method such as apportionment of costs on the basis of a formula may be applicable.

2

Apportionment of income

This pricing method apportions the income associated with a controlled transaction among the associated enterprises.

As with code 1, this method may be appropriate where there are neither comparable dealings nor data to apply the traditional, or profit-based, methods to the pricing problem.

3

Comparable uncontrolled price method

This traditional transfer pricing method compares the price for property or services transferred in a controlled transaction, that is, with a related international party, to the price that is charged for comparable property or services under the same or similar circumstances in an uncontrolled transaction.

Where it is possible to locate comparable uncontrolled transactions, the comparable uncontrolled price method is the most direct and reliable way to apply the arm's length principle. If there is any difference between the prices or the terms or nature of the controlled transaction and the uncontrolled transaction, this may indicate that the dealings of the associated enterprises are not arm's length.

Note that intangible and intellectual property transactions present particular problems with regard to comparability, especially where such property is unique or specialised.

If you use this method but the comparable uncontrolled price is adjusted to allow for particular circumstances of the controlled dealing, you should still record the adjusted price under this code.

4

Cost-contribution arrangement

A cost-contribution arrangement is one where members of a multinational group act in concert for the benefit of each of the participants to:

• produce or provide goods, intangible property or services
• acquire these jointly from a third party
• agree to share the actual costs and risks undertaken.

Each participant bears a fair share of the costs and is entitled to receive a fair share of rewards. The concept is akin to a joint venture or partnership.

To be consistent with the arm's length principle, the contributors must be satisfied that they can obtain an acceptable rate of return within a timeframe that takes into account their financial and business circumstances.

For more information, see TR 2004/1 Income tax: international transfer pricing – cost contribution arrangements.

5

Cost-plus method

This is a traditional transfer pricing methodology. The cost-plus method begins with the costs incurred by the supplier of property or services in a controlled transaction for property transferred or services provided to a related purchaser. An appropriate arm's length cost-plus mark-up is then added to this cost to make an appropriate profit in light of the functions performed and the market conditions. What is arrived at after adding the arm's length cost-plus mark-up to the above costs may be regarded as an arm's length price of the original controlled transaction.

This method is probably most useful if:

• semi-finished goods that are subject to additional manufacturing or assembly are sold between related parties
• related parties have concluded joint facility agreements or long-term buy-and-supply arrangements
• the controlled transaction is the provision of services.

This method is not suited for high value intangibles.

Further analysis can be undertaken by reviewing the cost plus mark-up of the supplier in the controlled transaction. This is done by referencing the cost plus mark-up that the same supplier earns in comparable uncontrolled transactions. The cost plus mark-up that would have been earned in comparable transactions by an independent enterprise may serve as guidance.

If a fixed percentage mark-up is applied to the relevant cost base without any benchmarking of that percentage against comparable independent dealings, it is not regarded as cost-plus method.

6

Fixed mark-up applied to cost

This method determines the transfer price for a controlled transaction by applying a fixed percentage mark-up to a relevant cost base where the mark-up is not benchmarked against comparable independent dealings. The absence of benchmarking distinguishes this method from the cost-plus method discussed at code 5.

The fixed mark-up applied to cost code should be used as described by TR 1999/1 Income tax: international transfer pricing for intra-group services where it has been utilised to set the pricing of intra group services.

7

Fixed percentage of resale price

This pricing method determines the transfer price for a controlled transaction as a fixed percentage of the resale price, where the fixed percentage chosen is not benchmarked against the gross margins earned in comparable independent dealings.

The absence of benchmarking distinguishes this method from the resale price method, code 10.

The fixed percentage of resale price methodology code should be used as described by TR 1999/1 Income tax: international transfer pricing for intra-group services where it has been utilised to set the pricing of intra group services.

8

Marginal costing

Marginal costing applies only the variable production costs to the costs of a product. This method is often used by companies and multinational enterprise groups for internal cost accounting and management control purposes. Its use in setting transfer prices on international dealings between associated enterprises for tax purposes is acceptable only if pricing on the basis of marginal costs represents an arm's length outcome for the transfer of goods or services into the particular market.

9

Profit split method

This is a transactional profit methodology. The profit split method determines the appropriate pricing for transactions by:

• identifying the combined profit or loss from the dealings between the related parties
• splitting that combined profit or loss between the related parties.

The split of profit or loss between the parties must be made on an economically valid basis that approximates the division of profits in an agreement made at arm's length.

10

Resale price method

This traditional transfer pricing method may be appropriate where an enterprise sells a product to a related party who then resells that product to an independent third party.

The resale price is reduced by the arm's length resale price margin and may then be regarded after adjustments for other costs associated with the original purchase of the product as an arm's length price of the original transfer of property between the related parties.

Further analysis can be undertaken by reviewing the resale price margin of the reseller in the controlled transaction. This is done by referencing the resale price margin that the same reseller earns on items purchased and sold in comparable uncontrolled transactions. The resale price margin earned by an independent enterprise in comparable uncontrolled transactions may also provide guidance.

Margins are usually measured at gross profit level, however a comparison undertaken at an intermediate level may be more accurate. A comparison at the net profit level falls under a different methodology - the transactional net margin method.

The resale price margin will vary depending on the value added by the reseller. Variables such as functions performed, economic circumstances, assets employed, and risks undertaken should reflect higher margins.

11

Transactional net margin method

This is a transactional profit methodology. The transactional net margin pricing method is based on comparisons made at the net profit level between the taxpayer and independent parties in relation to a comparable transaction or dealing. It examines the net profit margin relative to an appropriate base (for example, costs, sales or assets) that a taxpayer realises from a controlled transaction.

Comparisons at the net profit level can be made on a single transaction or in relation to some aggregation of dealings between associated enterprises.

12

Transactional net margin method (whole-of-entity)

The transactional net margin method is discussed at code 11. If after exercising commercial judgement you have decided to aggregate and test the arm’s length nature of multiple international related party dealings through the application of the transactional net margin method on a whole-of-entity basis, then use code 12 as the main pricing methodology.

See Appendix 9 for when to use Transactional net margin method (whole-of-entity) methodology.

13

Other arm's length methods

Use code 13 if your arm's length method is not represented by codes 1 to 12.

14

No transfer pricing method used

Use code 14 if no principal transfer pricing method has been used.