Transfer pricing is what businesses rely on to ensure that transaction pricing between is comparable to fair market value of related parties. We can see that for the process of transfer pricing is conducted according to the the Organization for Economic Cooperation and Development (OECD) guidelines which also requires the governing entity in this transaction to choose a pricing method that offers the best estimation of this fair market value.
We can see that the a transfer pricing method selection is a top-down strategic decision that benefits from using tools and resources designed to help businesses identify the most advantageous and appropriate methods for their transfer pricing strategy. They are also used in advance of negotiating new advance pricing agreements (APAs). Listed below is the different transfer pricing methods that organizations can consider by seeing which method best suits their organization.
Transfer Pricing Methods
Transfer pricing method is used by businesses to alleviate their manual burdens in the accounting process. The Software-based transfer pricing also allows one to monitor the success of each pricing method one uses hence helps us gather insights to help us guide one’s strategy going forward.
When choosing a transfer pricing method we also need look at that option that offers the greatest fiscal benefit to our organization while also considering a reasonable pricing structure. Listed below are five widely used transfer pricing methods a business can consider.
1. Comparable Uncontrolled Price
The comparable uncontrolled price (CUP) is a method that establishes a price based on the pricing of similar transactions that have taken place between third parties. This is a reliable transfer pricing method however it is a challenge.
The major challenge of this pricing method is that comparable transactions can be difficult to find. Since even the addition of a few small variables can lead to different cases enough to render the CUP method insufficient for establishing an accurate price based on the available information. Hence here arriving at a single price would be the challenge.
2. Cost-Plus Method
When market prices are not available there is no range to serve as a basis for pricing then organizations can use the cost-plus transfer pricing method. Here in order to set a price one can start by calculating the standard cost of delivering the relevant goods and on top of that they add a standard profit margin. Thus the sum of these two can then be used as a fair transfer price for the transaction.
This method bases it’s pricing on the price of resale of a product or asset that is sold to the third party. That resale price is first adjusted by subtracting the gross margin along with the cost that is additional to the purchase.
Post deducting all these costs from the resale price we can arrive at an arm’s length price to help guide the transfer pricing between two entities.
4. Transactional Net Margin (TNMM)
Again here when transaction data is not available enterprises can use the margin levels to establish transfer pricing. This method uses the net profits obtained from another controlled transaction to arrive at a net profit that can end up being applied when establishing transfer pricing for comparable and uncontrolled transactions.
This transfer pricing method offers extra flexibility in identifying transactions to compare to one another because actual transactions are not being used.
5. Profit Split
Profit split method is considered when two parties are involved in the development of a product or some other venture in a way that makes it difficult to each party on to be examined on its own.
The pricing method comes with its own set of challenges that is because it is based on margin levels the accuracy of the profit splitting is subject to debate. However in the absence of concrete data or a clear division of roles between entities this transfer pricing method can come of help to the two parties to arrive at a fair compromise.
Improving Calculations That Drive Transfer Pricing
No matter what transfer pricing method is used we can see that the process is data-intensive. Enterprises use transfer pricing tools and solutions to increase the strength of their calculations. Given the guidance from OECD BEPS (base erosion and profit shifting) , scrutiny from revenue Authorities along with the increased public scrutiny and reputation risks that come from transfer pricing is cause they are tax avoidant.
Other Transfer pricing solutions like the long view allows one to effectively manage large volumes of data. Then one can apply their methodology and measure their effectiveness or their alignment depending on what the business is actually dealing with.
We can see that to validate the quality of the data driving transfer pricing intelligent data management solutions must be implemented along with data-cleansing. At the same time this software helps one define realistic measurements that end up supporting transfer pricing and assist in strategy adherence and strategic decisions making.
Choosing an effective transfer pricing software can so improve data collection and management across multiple departments and entities especially those organisations that deal with complex data stream and equally complex transfer pricing challenges.
The software manages to simplify transfer pricing process for organizations by increasing automation and eliminating manual steps allowing the organisations to respond to new business challenges faster and with better accuracy and success despite the complexity of business challenges.
How to Harness the Value of Intelligent Transfer Pricing
Thus transfer pricing method enable a business to identify which framework suits their business create the framework for transactions taking place within the large structure of the multi entity corporation. Lastly it must implement the framework by ensuring the fairness for both parties which is again in compliance with regulatory laws.
These transfer pricing methods need to be managed in such a way that solutions can be created and processes can be enforced. Such that the organized data can support high level strategic decisions based on what transfer pricing method the company’s respective tax advisors recommend.
- Identify the framework
- Create the framework
- Implement the framework