Selection of Most Appropriate Transfer Pricing Method

Nilesh PatelNilesh Patel    18 February 2021
Selection of Most Appropriate Transfer Pricing Method

HOW TO SELECT THE MOST APPROPRIATE TRANSFER PRICING METHOD?

1. Introduction

Under Transfer Pricing Bylaws of Saudi Arabia (KSA) - and most of the Countries in the World - we have to compute the price (Transfer Price) of transactions between Related Persons at Arm’s Length Price. The Arm’s Length Price is the price at which
a comparable transaction (Comparable Uncontrolled Transaction) is carried out by Independent Persons. To compute the Arm’s Length Price, the Transfer Pricing Bylaws of KSA approve of five Transfer Pricing Methods. These are the same methods which are recommended by the OECD and are discussed below.

2. Approved Transfer Pricing Methods

The KSA Transfer Pricing Bylaws approve of five Transfer Pricing Methods to determine Arm’s Length Price of a controlled transaction between Related Parties.

These methods are:

i. Comparable Uncontrolled Price (CUP)
ii. Resale Price Method (RPM)
iii. Cost Plus Method (CPM)
iv. Transactional Net Margin Method (TNMM)
v. Transactional Profit Split Method (PSM)

The first three methods (CUP, RPM and CPM) are known as Traditional Transaction Methods while the fourth (TNMM) and fifth methods (PSM) are known as Traditional Profit Methods.

The five methods set forth above are not enumerated in any particular order of preference.

It is not necessary to apply more than one method to determine the arm’s length remuneration for a given controlled Transaction

3. Brief Description of the Approved Transfer Pricing Methods

i. Comparable Uncontrolled Price (CUP)

The CUP compares the price charged for property or services transferred in Controlled Transaction to the price charged in Comparable Uncontrolled Transactions in comparable circumstances. When it is possible to identify Comparable Uncontrolled Transactions, CUP is the most direct and reliable way to apply the Arm’s Length Principle. The CUP requires a high degree of comparability of products and functions. The CUP is generally suitable for establishing an Arm’s Length Price for transfer of commodities between Related Persons.

ii. Resale Price Method (RPM)

The RPM evaluates whether the amount charged in a Controlled Transaction is at Arm’s Length by taking into consideration the gross profit margin that is realized in Comparable Uncontrolled Transactions.

The starting point to apply RPM is the price at which a product purchased from a Related Person and then is resold to an Independent Person. This price (the resale price) is then reduced by an appropriate gross margin (resale price margin). This gross margin represents the amount from which the reseller would seek to cover its selling and other operating expenses and considering the FAR (Functions performed, Assets used and Risks assumed) Profile, makes an appropriate profit at the gross profit level. The remaining amount left after subtracting the gross margin can be regarded, after adjustments for other costs associated with the purchase of the product (for example, custom duties), an Arm’s Length Price for original transfer of property between the Related Persons.

This method is generally most useful when it is applied to distribution and marketing operations performed by Related Persons.

iii. Cost Plus Method (CPM)

The CPM determines Arm’s Length Price by adding an appropriate mark-up to the costs. The CPM 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 cost plus mark-up (being a gross margin) is then added to this cost, so that the Related Supplier makes an appropriate profit in light of the functions performed and the market conditions. The amount arrived at after adding the cost plus mark-up to the cost incurred by the Related Supplier is regarded as an Arm’s Length Price of the original Controlled Transaction (supply of goods or services). Thus, CPM determines Arm’s Length Price by adding an appropriate mark-up to the costs. The CPM is most useful when semi-finished goods are sold between Related Persons, when Related Persons have concluded joint facility agreements or long term buy-and-supply arrangements, or when the Controlled Transaction is provision of services by one Related Person to another.

iv. Transactional Net Margin Method (TNMM)

The TNMM compares the net profit level between the Controlled Transaction and Uncontrolled Transactions. As such, TNMM examines the net profit relative to an appropriate net margin indicator.

The TNMM applies in a manner similar to RPM and CPM, and therefore must be applied in a manner consistent with the manner in which RPM or CPM is applied – the only difference is that TNMM examines net profit, while RMP and CPM examine gross profit.

To apply TNMM, a Profit Level Indicator (PLI) should be selected to determine the appropriate net margin indicator for the Controlled Transaction.

The TNMM is not reliable if each person to a transaction makes unique and valuable contributions. In such cases, generally PSM will be the more appropriate method. However, TNMM may be applied if only one of the Related Person makes all unique and valuable contributions involved in a Controlled Transaction while the other Related Person makes no unique and valuable contribution (such as using goods that are not unique, or providing services that are routine distribution services).

To read the full article, find the enclosed attachment

 

 

Disclaimer: Content posted is for informational & knowledge sharing purposes only, and is not intended to be a substitute for professional advice related to tax, finance or accounting. The view/interpretation of the publisher is based on the available Law, guidelines and information. Each reader should take due professional care before you act after reading the contents of that article/post. No warranty whatsoever is made that any of the articles are accurate and is not intended to provide, and should not be relied on for tax or accounting advice.

You can access Law including Guidelines, Cabinet & FTA Decisions, Public Clarifications, Forms, Business Bulletins for all taxes (Vat, Excise, Customs, Corporate Tax, Transfer Pricing) for all GCC Countries in the Law Section of GCC FinTax

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