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Transfer pricing methods
Which transfer pricing methods are used in your jurisdiction and what are the pros and cons of each method?
Under Article 13 of the Corporate Income Tax Law, transfer pricing methods are defined as outlined below.
Comparable uncontrolled price method
The arm’s-length price is determined by comparing the company’s transfer price to the (market) price applied in comparable purchases and sales of goods or services between unrelated individuals or entities.
Cost plus method
The arm’s-length price is determined by applying an appropriate gross profit mark-up on costs incurred in supplying the goods or services. General Communiqué 1 on Transfer Pricing states that the cost plus method is the most appropriate method for manufacturing and services activities if it can be properly applied.
Resale price method
The arm’s-length price is determined by reducing an appropriate gross profit margin from the resale price applied when goods or services in question are resold to unrelated individuals or entities. General Communiqué 1 also states that the resale price method is the most appropriate transfer pricing method for distribution activities.
Transactional net profit margin method
The transactional net profit margin method (TNMM) relies on the examination of the net profit margin in a controlled transaction identified by the taxpayer relative to an appropriate base such as costs, sales or assets. Although the TNMM is in some ways similar to the application of cost plus and resale price methods, the difference between the TNMM and these methods is that the other two methods require calculation of the gross profit margin, whereas the TNMM requires the calculation of the net profit margin.
Profit split method
This is based on the allocation of total operating profit or loss attributable to one or more controlled transactions of related parties at the arm’s-length rates among the related parties by reference to the functions performed and risks undertaken. According to General Communiqué 1 on Transfer Pricing, this method should be used in cases when the traditional transaction methods are not feasible and particularly when there are no comparable transactions and the transactions between the related parties are inseparable from one another.
When none of the defined methods is conclusive in determining the arm’s-length price, other methods defined by the taxpayer as most appropriate for the true nature of the transactions can be applied. However, such method should also be based on the arm’s-length principle.
Preferred methods and restrictions
Is there a hierarchy of preferred methods? Are there explicit limits or restrictions on certain methods?
Article 13 of the Corporate Income Tax Law did not previously regulate transactional profit methods, but covered only so-called ‘traditional transaction methods’ – namely, the comparable uncontrolled price method, cost plus method and resale price method. However, transactional profit methods (ie, TNMM and profit split method) were included in Cabinet Decree 2007/12888 and General Communiqué 1 on Disguised Profit Distribution by means of Transfer Pricing.
Before the recent amendment by Law 6728 on the Improvement of the Investment Environment, traditional transaction methods prevailed over transactional profit methods, and this was openly stated in General Communiqué 1 on Transfer Pricing. In view of the new amendment, the hierarchy among the traditional methods and transactional methods was removed. Thus, the Corporate Income Tax Law now reflects the fact that the most appropriate method based on the nature of the transaction will be applied for controlled transactions. However, our understanding is that the traditional transaction methods will continue to prevail over transactional profit methods where traditional transaction methods and transactional profit methods are equally applicable, as stated in the 2010 OECD Transfer Pricing Guidelines.
What rules, standards and best practices should be considered when undertaking a comparability analysis?
According to Cabinet Decree 2007/12888 and General Communiqué 1 on Disguised Profit Distribution by means of Transfer Pricing, a comparability analysis is based on the comparison between the conditions of controlled transactions and uncontrolled transactions. For this reason, ‘comparability’ means that the differences between the situations being compared should not materially affect the condition or reasonably accurate adjustments can be made to eliminate the effect of any such differences.
Under Turkish transfer pricing legislation, the main elements for the comparability analysis are:
- the characteristics of the property or service transferred;
- the functional analysis of the controlled transaction under examination;
- the contractual terms of the transaction; and
- the economic circumstances of the transaction or business strategies of the parties.
Are there any special considerations or issues specific to your jurisdiction that associated parties should bear in mind when selecting transfer pricing methods?
Taxpayers should review whether the comparable uncontrolled price method is applicable based on the internal or external comparables. Also, where traditional transaction methods (ie, the comparable uncontrolled price method, cost plus method and resale price method) and transactional profit methods (TNMM and profit split method) are equally applicable, taxpayers should apply the traditional transaction methods for their related-party transactions. Where they are not equally applicable, the transactional profit methods may be selected as the most appropriate method for the related-party transaction in question.
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