Approaches in transfer pricing
The organization for economic co-operative and development (OECD) (2010) made identification of the five transfer pricing methods as:
The CUP approach – this approach involves comparing the price charged for a given property of services that has been transferred in a controlled transaction to the price charged for a property of services that has also been transferred in a comparable but uncontrolled transaction on the bases of comparable circumstances. If differences are established with such comparison, it is an indication that the associated enterprises are not arm’s length and the price of the uncontrollable transaction might need to be substituted for the price of the controllable transactions.
The resale price method – this method starts from the price at which a product that has been bought from an associated enterprise is resold to a different and independent enterprise. The process actually involves reducing the resale price by an appropriate gross margin with reference to the gross margin of a comparable uncontrolled transaction, in order to obtain the amount at which the reseller will be bale to cover its selling and other operating expenses following activities involved and still make appropriate profit.
The cost plus method – this approach begins with the cost that has been incurred by the supplier or a property of service in a controlled transaction for any transferred property of services provides for an associated enterprise. This approach involves determining an appropriate mark-up by referencing the mark-up earned by suppliers in a comparable uncontrolled transaction and adding associated cost in order to obtain an appropriate profit in the light of activities undertake as well as the conditions of the market.
Transaction net margin method – this method examines the net profit indicator (that is the relative ratio of net profit to a given base such as costs and sales) which a taxpayer offloads from a given controlled transaction with the net profit earned in a comparable uncontrolled transaction. This will help to determine the arm’s length net profit indicator of the taxpayer.
The transactional profit split method – this approach is adopted by first identifying the combined profit to be split for associated enterprise from a controlled transaction in which the associated enterprises have engaged in. In some cases, the obtained combined profit will be a residual profit that has been drafted to represent the profit which cant be readily assigned one of the parties from the application of a different transfer pricing method.