Chapter 5 Transfer Pricing Methods
[This paper is based on a paper prepared by Members of the UN Tax Committee’s Subcommittee on Practical Transfer Pricing Issues, but includes some Secretariat drafting and suggestions not yet considered by them – the Secretariat takes responsibility for any relevant errors and omissions. Formerly, Methods were dealt with in Chapters 4 and 5, which are now combined – hence the reference, on a temporary basis, to Parts 5A and 5B of this paper].
[Table of Contents to be added]
Chapter 5A‐ Traditional Methods
This part of the Chapter describes several transfer pricing methods that can be used to determine an arm’s length price and it describes how to apply these methods in practice. In general, the OECD Transfer Pricing Guidelines are followed, with emphasis on practicality solutions when using and applying transfer pricing methods. In response to practical difficulties that may exist in applying the OECD TP Guidelines, for example when no access to databases with relevant information on comparables are readily available, some requirements for applying the arm’s length standard are softened or more flexibly applied, [and some deviations/departures are suggested from the OECD TP Guidelines in this Chapter. These deviations/ departures from the OECD TP Guidelines may assist with allowing governments
and taxpayers in UN Member Countries to gain experience with the application of transfer pricing methods while seeking ways to get more conformity with the OECD TP Guidelines. ] 1.1 Use of methods
In order to calculate or test the arm’s length nature of prices or profits, use is made of transfer pricing methods or methodologies. Transfer pricing methods are ways of calculating the profit margin of transactions or an entire enterprise or of calculating a transfer price that qualifies as being at arm’s length. The application of transfer pricing methods is required to assure that transactions between associated enterprises conform to the arm’s length standard. Please note that although the term “profit margin” is used, companies may also have legitimate reasons to report losses at arm’s length. Furthermore, transfer pricing methods are not determinative in and of themselves. If an associated enterprise reports an arm’s length amount of income, without the explicit use of one of the transfer pricing methods recognized in the OECD Transfer Pricing Guidelines, this does not mean that its pricing is automatically not at arm’s length and there may be no reason to impose adjustments. 1.2 Selection of methods (how, why and use of methods)
Some methods are more appropriate and indicative to provide for an arm’s length result for certain transactions than others. For example, a cost‐based method is usually deemed more useful for determining an arm’s length price for services and manufacturing, and a resale price‐based method is usually deemed more useful for determining an arm’s length price for distribution/selling functions. [The following overlaps with the Comparability Chapter – to be synthesised] The starting point to select a method is the functional analysis which is necessary regardless of what transfer pricing method is selected. Each method may require a deeper analysis focusing on aspects in relation with the method. The functional analysis helps:
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• • • • • to identify and understand the intra‐group transactions, to have a basis for comparability to determine any necessary adjustments to the comparables, to check the accuracy of the method selected and over time, to consider adaptation of the policy if the functions, risks or assets have been modified. ...