Pricing methods

Accepted methods

What transfer pricing methods are acceptable? What are the pros and cons of each method?

The regulations generally break down the acceptable transfer pricing methods into a number of categories, including transfer of tangible property, use or transfer of intangible property, and services. In all instances, method selection is subject to the best-method rule, which requires selection of the method that produces the most reliable measure of an arm’s-length result. 

The arm’s-length amount charged in a controlled transfer of tangible property must be determined under one of the following six methods:

  • the comparable uncontrolled price (CUP) method;
  • the resale price method;
  • the cost-plus method;
  • the comparable profits method;
  • the profit split method; and
  • unspecific methods.

 

The arm’s-length amount charged in a controlled transfer of intangible property must be determined under one of the following four methods:

  • the comparable uncontrolled transaction (CUT) method;
  • the comparable profits method;
  • the profit split method; and
  • unspecified methods.

 

The arm’s-length amount charged in a controlled services transaction must be determined under one of the following seven methods:

  • the services cost method;
  • the comparable uncontrolled services price method;
  • the gross services margin method;
  • the cost of services plus method;
  • the comparable profits method;
  • the profit split method; and
  • unspecified methods.

 

Loans and advances must be priced according to the arm’s-length standard. The regulations contain safe harbours for certain loans with an interest rate at between 100 and 130 per cent of the applicable federal rate and certain intercompany transactions conducted in the ordinary course of business.

The transactional methods (the CUP and the CUT) are favoured by US federal courts but are not always available. Additionally, the Internal Revenue Service (IRS) typically challenges the use of the transactional methods on audit despite the fact that these methods will generally yield the most reliable measure of the arm’s-length result. The comparable profits method is typically the easiest method to apply, but it can lead to some questionable results and may not always be appropriate given the controlling facts. The residual profit split method considers both parties to the transactions but can present issues around determining the correct data and assumptions to use.

Cost-sharing

Are cost-sharing arrangements permitted? Describe the acceptable cost-sharing pricing methods.

The regulations permit cost-sharing arrangements that comply with specific structural and reporting requirements. A cost-sharing arrangement is an arrangement by which controlled participants share the costs and risks of developing cost-shared intangibles in proportion to their reasonably anticipated benefits (RAB shares). A controlled participant’s RAB share is equal to its reasonably anticipated benefits divided by the sum of the reasonably anticipated benefits of all the controlled participants.

In addition, all controlled participants must make arm’s-length payments to each controlled participant that provides a platform contribution, which includes any resource, capability or right that a controlled participant has developed, maintained or acquired externally to the cost-sharing arrangement that is reasonably anticipated to contribute to developing cost-shared intangibles. The appropriate methods for valuing a platform contribution, which must be applied in accordance with the best-method rule, include:

  • the CUT method;
  • the income method;
  • the acquisition price method;
  • the market capitalisation method;
  • the residual profit split method; and
  • unspecified methods.
Best method

What are the rules for selecting a transfer pricing method?

The regulations provide that the arm’s-length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm’s-length result (the best-method rule). There is no strict priority of methods, and no method will invariably be considered to be more reliable than others. However, the CUT method will generally yield the most reliable measure of the arm’s-length result if an uncontrolled transaction involves the transfer of the same intangible under the same or substantially similar circumstances. If two or more methods provide inconsistent results, the arm’s-length result must be determined under the method that, under the facts and circumstances, provides the most reliable measure of the arm’s-length result.

Taxpayer-initiated adjustments

Can a taxpayer make transfer pricing adjustments?

A taxpayer may generally make transfer pricing adjustments until the date its US income tax return is due. This includes reporting the results of its controlled transactions based upon prices different from those actually charged. However, the regulations provide that no untimely or amended returns will be permitted to decrease US taxable income based on allocations or other adjustments in respect of controlled transactions.

Safe harbours

Are special ‘safe harbour’ methods available for certain types of related-party transactions? What are these methods and what types of transactions do they apply to?

The regulations provide a limited number of safe harbour provisions for certain related-party transactions. In relation to services, the services cost method evaluates whether the amount charged for services is arm’s-length by reference to the total services costs with no markup. If a taxpayer applies this method, then it will be considered the best method, and the IRS’s allocations will be limited to adjusting the amount charged for those services to properly determine the amount of the total services costs. The services cost method only applies to certain enumerated services or low margin covered services for which the comparable markup on the total services costs is less than or equal to 7 per cent.

In relation to loans and advances, an interest rate of between 100 and 130 per cent of the applicable federal rate is considered an arm’s-length rate of interest. The regulations also allow certain intercompany transactions in the ordinary course of business to be interest-free for a set amount of time.

In relation to all transactions, if the taxpayer has a written agreement in place before the transactions are entered into, the IRS will generally respect it if its terms are consistent with the economic substance of the underlying transaction.

Law stated date

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26 June 2020.