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HMRC internal manual

International Manual

HM Revenue & Customs
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Transfer pricing: operational guidance: examining transfer pricing reports: OECD methods

Comparable Uncontrolled Price

Although no absolute hierarchy exists within the OECD guidance, it is generally accepted that a comparable uncontrolled price (CUP) or comparable uncontrolled transaction (CUT) is the most effective way of assessing the arm’s length price (see also the final paragraph of INTM421010).

INTM421030 provides a detailed explanation of the method but in particular when reviewing a transfer pricing report it is worth considering whether sufficient efforts have been made to identify a CUP.

In particular a CUP may be available from transactions that a group has with third parties, such as distributors in territories where the group does not have an affiliate.

Whether a true CUP exists will be dependent upon a full understanding of the affiliated business and an equal understanding of the CUP, which is often difficult to establish from available information.

Traditional methods

Resale Minus

Resale minus is most commonly used to consider the arm’s length price of goods purchased by an affiliated distributor in a connected transaction, by identifying the gross margin achieved by comparable independent distributors. A detailed explanation is available at INTM421050.

The most common difficulty with this method is the availability of reliable financial information on the comparable entities.

Cost Plus

The OECD suggests three situations where cost plus may be appropriate:

  • transfers of semi-finished goods,
  • joint facility/long term buy and supply arrangements and
  • intra-group services.

Detailed consideration of this method and the three situations in question can be found at INTM421060.

The three key areas to consider when reviewing a transfer pricing report where cost plus has been applied are:

  • whether the functions of the affiliate support the application of a cost plus methodology,
  • whether all appropriate costs have been considered in the cost base and
  • whether the plus is arm’s length based on a review of available comparables.

Transactional methods

Transactional Net Margin Method

The transactional net margin method (TNMM) is often a popular methodology because it is less sensitive to inconsistencies in accounting practices between the affiliate and comparable independent entities but there still remains a rigid dependence on comparability as seen in cost plus and resale minus.

An explanation of the method is available at INTM421080.

Profit split

A profit split method is often applied for highly integrated operations where both parties make unique and valuable contributions. It may also be used where the transaction or transactions are sufficiently complex and interrelated that it is impossible to find sufficient comparables.

When reviewing this method in a transfer pricing report, case teams need to be certain that a search for appropriate comparables has been suitably exhausted.

Profit split can be a complex and difficult method to apply. Further guidance is available at INTM421070.