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Comparison Methods in Transfer Pricing

Author: Oleksandra Konopatska
Date of publication: 26.04.2018

How is the transfer pricing documentation prepared? We are diving into 5 key comparison methods used when preparing TP documentation.

Comparable Uncontrolled Price Method (CUP)


We compare the price charged for the goods (work, services) within our controlled transaction with a range of market prices charged for identical goods (works, services) in comparable transactions (in such uncontrolled transactions which can be used for comparison with our controlled transaction).

In cases where we do not have any identical goods, comparable transactions involving homogeneous goods can be used. This type of goods is not easily identified; however, the Tax Code of Ukraine outlines the following criteria:

  • quality and business standing in the market;
  • presence of a trademark;
  • country of manufacture (origin);
  • manufacturer;
  • year of manufacture;
  • new or second-hand product;
  • expiration date.

Here’s a piece of practical advice: homogeneous goods can be used within the scope of this method to the extent that it can be demonstrated that the price charged for homogeneous goods does not differ statistically from the price for goods within controlled transaction.

The CUP should be used when:

  • taxpayer has both controlled and uncontrolled same-type transactions (involving identical or homogeneous goods);
  • product traded by the taxpayer is standard and common in the market and we can find "external" comparable transactions to make an assessment.

The Comparable Uncontrolled Price Method must be used when the goods are the stock exchange items (and are included in the list approved by the Decree of the Cabinet of Ministers No.616 dated September 8, 2016).

Resale Price Method (RPM)


We compare the price of controlled transaction and the market price: we compare the gross profit margin of controlled transaction with the market range of gross profit margin.

According to RPM, we take into consideration the gross profit margin earned by resale of the goods purchased in a controlled transaction.

The Resale Price Method is applied when:

  • the company which manufactures the product sells it to its affiliated distributor and independent distributors on the same terms;
  • the gross profit margin of a controlled transaction can be compared with the gross profit margin of external transactions or companies with a sufficient level of soundness.

Sufficient level of soundness can be achieved, for instance, by using for comparison the gross profit margin of the companies specializing in the bulk sale of the goods belonging to the same class.

Cost Plus Method (CPM)


We compare the price of controlled transaction and the market price: we compare the gross profit margin of the prime cost earned in controlled transaction with the market range of the gross profit margin of the prime cost.

According to CPM, we take into consideration the gross profit margin resulting from the resale of goods purchased in controlled transaction (and which were possibly additionally processed or packaged).

The Cost Plus Method is applied in the manufacturer-distributor transactions e.g. when:

  • the distributor company purchases comparable goods from affiliated manufacturer and independent manufacturers on the same terms.

The Cost Plus Method is statistically equivalent to the Resale Price Method.

Transactional Net Margin Method (TNMM)


We compare the net margin earned in controlled transaction with net margin in comparable uncontrolled transactions or for independent companies operating in a way which is comparable to the taxpayer’s operation within the scope of controlled transaction. Net margin is compared based on the relevant figures (expenses, sales and assets).

The Transactional Net Margin Method is applied when:

  • there is no or insufficient information to substantiate the sufficient comparability level of controlled and comparable transactions when using other methods.

By applying the TNMM, we find independent companies with comparable functional profile (in regard to controlled transaction) and compare the profitability of controlled transaction with the market range of comparable companies’ transaction profitability.

Profit Split Method (PSM)


We allocate to every affiliated company involved in controlled transaction a portion of the total profit resulting from transaction which non-affiliated company would receive when participating in comparable uncontrolled transaction.

The Profit Split Method is applied in cases where:

  • the controlled transaction is largely associated with other transactions of the parties, and there is no possibility to establish the contribution of the transaction to the overall profitability;
  • both parties own intangible assets which have a major impact on the pricing.

The PSM is the least used method in TP practice. That being said, it makes sense to apply it e.g. in case of a joint manufacture of a complex product by several companies.