Essentially, the analysis of transfer pricing for tax purposes revolves around the Arm’s Length Principle. The idea that this principle is applied when the prices or margins obtained in a transaction with a related party are consistent with those agreed by independent third parties may seem simple. However, putting this principle into practice is a situation sometimes complex. This problem has been addressed through a number of methods that have evolved over time. In this sense, and in the Transfer Pricing and Multinational Enterprises Report of the Organization for Economic Cooperation and Development (OECD) published in 1979, in the first chapter “Summary of Problems,” we can see how the difficulties of applying the transfer pricing methods are displayed, especially in the case of the so-called traditional transactional methods.
The Comparable Uncontrolled Price method (CUP) is defined in the glossary of the OECD Transfer Pricing Guidelines for multinational enterprises and tax administrations (OECD Guidelines) as comparing the price for property or services transferred in a controlled transaction to the price charged for property or services transferred in a comparable uncontrolled transaction in comparable circumstances. The Transfer Pricing and Multinational Enterprises Report mentions that in practice, it often happens that prices for comparable transactions are not available or are impractical to collect them together, or there may be arguments about whether the prices quoted are comparable or not.
The other traditional transactional methods are:
These two methods were also discussed in the Transfer Pricing and Multinational Enterprises Report, to mention that their application is often necessary when there is no useful evidence of uncontrolled transactions available. That report also mentions some considerations in the application of transfer pricing methods for the transfer of goods, technology transfer and brands, certain intra-group services, and loans.
Since the business of multinational companies have continued to evolve, the issues addressed by the aforementioned report have been extended through the OECD Guidelines published in 1995 and their updates. Regarding the RPM, the guidelines mention that this method is probably most useful where it is applied to marketing operations. Also, the resale price method of the reseller in the controlled transaction may be determined with reference to the resale price margin that the same reseller earns on items purchased and sold in comparable uncontrolled transactions (internal comparable) or otherwise by said margin obtained by an independent enterprise may serve as a guide (external comparable).
In addition, among the advantages of applying this method with respect to the CUP, the guidelines stress that when making comparisons, fewer adjustments are normally needed to account for the product differences that between products, since the compensation for performing similar functions would tend to be equalized across different activities. They also mention some of the aspects that could affect their application: The use of unique assets (tangible or intangible), material differences in the ways associated enterprises and independent enterprises carry out their business and chain of distribution, exclusive rights, differences in the classification of costs and expenses, among others.
In the case of CP, the guidelines state that it is probably most useful where semi-finished goods are sold between related parties, where the parties have entered into long-term buy-and-supply arrangements and the provision of services, among others.
This method has similar advantages to those of RPM. However, among the issues that could affect its implementation, the guidelines highlight differences in the cost basis (considering classification of costs and expenses and accounting consistency), current assets, occupancy levels, among others.
With regard to the implementation of CUP, the OECD guidelines of 1995 and their update in 2010 emphasize that to use comparable transactions, two conditions must be met:
Because of the BEPS Action Plan and the Report of Actions 8 to 10, entitled “Aligning Transfer Pricing Outcomes with Value Creation,” some considerations were developed on the implementation of CUP to transactions involving commodities. Such considerations were included in the 2017 update of the OECD Guidelines. In this sense, the updated guidelines establish certain recommendations for their implementation, and confirms that the CUP is generally the most appropriate method for establishing the Arm’s Length price in the transfer of commodities.
Despite the observed evolution of the OECD Guidelines in relation to the traditional transactional methods, the increasing integration of multinational companies has made more difficult to identify comparable transactions. This makes less common the application of these methods and opens the door to applying methods based on profitability, without detriment to perform the due process of evaluating the method that best applies to the analysis of the taxpayer’s specific transaction.