The OECD recognizes five transfer pricing methods for pricing intercompany transactions: CUP, RPM, CPM, TNMM, and PSM. A sixth method – not formally part of the OECD framework – applies to commodity transactions in several jurisdictions. Choosing correctly, and documenting that choice, is critical for any multinational group.
How to Select a Transfer Pricing Method
Before examining each method, it helps to understand how the selection process works. The following steps apply to most intercompany transactions:
- Analyze the transaction. Identify what is being transferred – goods, services, intangibles, or financing – and assess what each party does, owns, and risks.
- Assess data availability. Determine which method can be supported by reliable comparable data or publicly available market prices.
- Apply the most appropriate method. Select the method that produces the most reliable arm’s length result. Document the reasoning behind that choice.
What Are the Five OECD Transfer Pricing Methods?
When related entities within a multinational group transact across borders, they must price those transactions at arm’s length. The arm’s length principle requires related parties to price transactions as independent parties would. The OECD Transfer Pricing Guidelines (2022 edition) recognize five methods for achieving this standard.
These five methods fall into two categories. Traditional transaction methods focus on the price of a specific transaction. Transactional profit methods focus on the net profitability of the parties involved.
Comparable Uncontrolled Price (CUP)
The CUP method compares the price charged in a related-party transaction to the price in a comparable independent transaction. It is generally considered the most reliable method when a truly comparable transaction can be found.
Finding one is rarely straightforward. Even minor differences in timing, product quality, or contract terms can affect comparability and weaken the analysis. Where a clean comparable exists, the CUP is the preferred starting point.
Resale Price Method (RPM)
The RPM starts with the resale price a distributor charges to an independent customer. A standard gross margin is subtracted to arrive at the arm’s length transfer price.
This method works best where a distributor adds limited value to the goods it sells. It becomes less reliable where the distributor holds significant intangibles – such as proprietary brands or patents – because those assets affect the margin independently of the transfer price.
Cost Plus Method (CPM)
The CPM begins with the costs a supplier incurs in producing a product or delivering a service. A reasonable mark-up is then added to reach the arm’s length price.
This method is well suited to manufacturers supplying related parties and to in-group service providers. The central challenge is determining what constitutes a “reasonable” mark-up – and that assessment must be grounded in comparable data.
Transactional Net Margin Method (TNMM)
The TNMM measures net profit earned from related-party transactions, expressed relative to costs, sales, or assets. That margin is then compared to net margins earned by comparable independent companies.
The TNMM is the most widely used transfer pricing method globally. Net margin data is generally more accessible than specific transaction price data, which makes this method practical for a wide range of situations. It is, however, less precise than the CUP. It measures overall profitability rather than individual transaction prices.
Profit Split Method (PSM)
The PSM applies where transactions are highly integrated, or where both parties contribute unique and valuable intangibles. It examines the combined profit from a controlled transaction and allocates it between the parties based on their relative contributions.
The PSM can produce equitable results in complex situations. In practice, it is often the most difficult method to apply, particularly where contribution analysis involves subjective judgment about intangible value.
What Is the Sixth Transfer Pricing Method?
Several countries have introduced a “sixth method” specifically for commodity transactions. It targets goods such as wheat, coffee, copper, oil, and gas – products with publicly quoted market prices.
Argentina was the first to legislate this approach, introducing it through Law 25,784 in 2003, in response to concerns about profit shifting through low-substance commodity intermediaries. Ten Latin American countries now apply it, including Argentina, Bolivia, Brazil, Costa Rica, the Dominican Republic, Ecuador, Guatemala, Paraguay, Peru, and Uruguay. Beyond Latin America, Zambia, Malawi, and India have also adopted it.
The sixth method is a variant of the CUP. It prices a commodity transaction by reference to the quoted market price at the date of shipment – not the price agreed between related parties. The aim is to prevent multinationals from using intermediary entities to shift commodity export profits into low-tax jurisdictions.
The OECD has not formally included the sixth method in its Guidelines, though it acknowledges the approach. Its advantages are simplicity and transparency for tax authorities. Its principal risk is double taxation: if the importing country does not recognize the sixth method, the same income may be taxed twice in two jurisdictions.
How Do You Choose the Right Transfer Pricing Method?
Selecting a transfer pricing method is not a matter of preference or convenience. The OECD Guidelines require taxpayers to use the method that produces the most reliable arm’s length result for each specific transaction.
Several factors guide that selection:
- Nature of the transaction – Is it a goods sale, a service, a license, or a financial transaction?
- Functional analysis – What does each party do, what assets does it use, and what risks does it bear?
- Data availability – Can reliable comparable data be found to support the method?
- Local compliance rules – Some jurisdictions specify method preferences or impose particular documentation requirements.
In practice, the TNMM is most commonly applied because comparable net margin data is relatively accessible. The CUP remains the preferred option where a genuinely comparable uncontrolled transaction can be identified.
Whatever method is selected, the reasoning must be documented clearly. Tax authorities will scrutinize not only the pricing result but the logic behind the choice. A defensible method selection is as important as the pricing outcome itself.
Conclusion
Transfer pricing is one of the most closely reviewed areas of international tax. The method a multinational group selects for each intercompany transaction shapes both its tax position and its audit exposure.
Selecting the right method requires a clear-eyed functional analysis, reliable data, and an understanding of how local rules interact with OECD guidance. For commodity-heavy businesses, the sixth method adds a further layer of complexity that demands specific attention – particularly where cross-border double taxation is a realistic risk.
TP Tax works with multinational groups to identify the right method for each transaction, build documentation that holds up to scrutiny, and manage compliance across jurisdictions. If you have questions about your transfer pricing position or want a second opinion on your current approach, contact us to start the conversation.
Frequently Asked Questions
What are the five OECD transfer pricing methods?
The five methods are CUP, RPM, CPM, TNMM, and PSM. They fall into two groups: traditional transaction methods and transactional profit methods.
Which transfer pricing method is most commonly used?
The TNMM is the most widely applied method globally. Comparable net margin data is more accessible than specific transaction price data, which makes it practical across a wide range of situations.
What is the sixth transfer pricing method?
The sixth method is a variant of the CUP, applied to commodity transactions. It prices the deal by reference to the quoted market price at the date of shipment – not the agreed contract price between related parties.
When should a company use the Profit Split Method?
The PSM is most appropriate where transactions are highly integrated or where both parties contribute unique, valuable intangibles. Standard benchmarking is often insufficient in those cases.
What is the arm’s length principle in transfer pricing?
The arm’s length principle requires related-party transactions to be priced as if the parties were independent. It is the international standard recognized by the OECD and incorporated into most tax treaty frameworks.
What are the risks of the sixth transfer pricing method?
The primary risk is double taxation. If the importing country does not recognize the sixth method, the same income may be taxed in both jurisdictions simultaneously.
