4. Arm's length principle
• Arm's length principle requires the transaction between
two associated enterprises to be commercially at par with
that of a similar transaction between two independent
enterprises entered in uncontrolled conditions.
• Arm’s length principle is most popular globally.
• Maximizing profits by lowering tax liability.
• Reduce custom duty
• Transferring funds to locations to suit working capital
• ‘Window dressing’ operations to improve the apparent
financial position of the company
7. Methods of Transfer Pricing
8. Comparison between the two
• The traditional transaction methods look at individual
transaction while the transactional profit methods look at
the company’s profits as a whole.
• There’s no right or wrong method—only the one that best
fits a company’s business model.
10. Comparable Uncontrolled Price
• Compares the price and conditions of products or services in a
controlled transaction with those of an uncontrolled transaction
between unrelated parties.
• Comparable Data being a pre-requisite.
• The uncontrolled transaction must meet high standards of
11. Internal CUP Method
• The internal CUP relies on examples of comparable
transactions the company has made with unrelated third
12. Internal CUP Method
• Co. A & Co. B are affiliated entities and Co. C is an
unrelated party. X sells a common product to both AE as
well as to the non-related party.
• In this case internal CUP can be applied by comparing
the price charged from Co. B with the price charged from
Co. C. However, any contractual difference between the
two sale contracts must be adjusted
13. External CUP Method
• The external CUP looks at pricing of comparable
transactions made between two unrelated third parties
Company A Company B
Company X Company Y
14. External CUP Method
• Co. A is engaged in sale of a particular product to its AE,
i.e. Co. B. An unrelated entity, Co. X sells the identical
product to Co. Y
• In this case external CUP can be applied by comparing
the price charged by Co. A with price charged by Co. X.
However, adjustments must be made with regard to any
differences in volume, geography contractual terms.
15. The Resale Price Method
• The resale price method (RPM) uses the selling price of a
product or service, otherwise known as the resale price.
• This number is then reduced with a gross margin,
determined by comparing the gross margins in
comparable transactions made by similar but unrelated
• Then, the costs associated with purchasing the product—
such as customs duties—are deducted from the total.
• The final number is considered an arm’s length price for a
controlled transaction made between affiliated
16. The Internal Resale Price
• Internal RPM can be applied by comparing the gross
profit margin realized on goods procured from Co. Y with
the gross profit margin realized on goods procured from
17. The External Resale Price
• External RPM may be applied when an independent party is engaged in trading of similar goods as traded
by tested party in uncontrolled circumstances.
• In the illustration company X resells the goods procured from related party, Co. Y while company P is
reselling the similar goods procured from Co. Q, an unrelated party.
• In this case external RPM may be applied by comparing the gross margins realized by Co. P vis-a-vis the
gross margins realized by Co. X
18. The Cost Plus Method
• The cost plus method (CPLM) works by comparing a
company’s gross profits to the overall cost of sales.
• It starts by figuring out the costs incurred by the supplier
in a controlled transaction between affiliated companies.
• Then, a market-based markup—the “plus” in cost plus—is
added to the total to account for an appropriate profit.
• A company must identify the markup costs for
comparable transactions between unrelated
19. The Internal CPM
• Internal CPM can be applied by comparing the gross
profit margin realized on goods supplied to Co. Y with the
gross profit margin realized on goods supplied to Co. A
20. The External CPM
• In this case external CPM may be applied by comparing the gross markup
realized by Co. P vis-a-vis the gross markup realized by Co. X
21. Transactional Profit Methods
It measures the net operating profits from controlled
transactions and compare them to the profits of third-party
companies making comparable transactions. This is done to
ensure all company markups are arm’s length.
23. The Comparable Profits Method
• The comparable profits method (CPM), also known as the
transactional net margin method (TNMM), helps determine
transfer prices by looking at the net profit of a controlled
transaction between associated enterprises.
• This net profit is then compared to the net profits in comparable
uncontrolled transactions of independent enterprises.
• The method is fairly easy to implement because it only requires
financial data. and is really effective for product manufacturers
with relatively straightforward transactions.
• CPM a one-sided method that often ignores information
on the counterparty to the transaction.
• CPM is not a good match for organizations with complex
business models, such as high-tech companies with
• A U.S.-based clothing company with global reach
establishes a Canadian distribution affiliate. The U.S.
parent company supplies products, sets business
strategies, finances the global operations, and owns the
intellectual property (trademarks, designs, and
operational know-how) for its global affiliates. The parent
company needs to determine how much profit the
Canadian distributor should earn for its operations.
26. The Profit Split Method
• In some cases, associated enterprises engage in
transactions that are interconnected—meaning they can’t
be observed on a separate basis.
• For example, two companies operating under the same
brand might use the profit split method (PSM). Typically,
the related companies agree to split the profits, and that’s
where the profit split method comes in.
• A pharmaceutical company affiliate performs research and development (R&D) to
bring a new drug to market. The affiliate bears the costs and risks of launching
the new drug. The two related parties need to determine the right profit split and
decide that they’ll use the contribution PSM to divide profits from sales of the new
• The two parties have invested a total of $500 million in bringing the medication to
market. The R&D company invested $375 million—or 75% of the total
investment. Therefore, 75% of the profits will go to the R&D company, with the
remaining 25% going to the pharmaceutical manufacturer.
• The concept has eliminated improper pricing of related
party transactions between associate enterprises, making
way for the elimination of tax evasion through such
methods assisting the government and tax authorities.
• However, as this concept is relatively new, various
changes need to be made to provisions over time based
on its nature of the use to make it a globally accepted