Cost-based indicators should only be used in those cases where costs are a relevant indicator of the value of the functions performed, assets used and risks assumed by the tested party. In addition, the determination of what costs should be included in the cost base should derive from a careful review of the facts and circumstances of the case. Where the net profit indicator is weighted against costs, only those costs that directly or indirectly relate to the controlled transaction under review (or transactions aggregated in accordance to the principle at paragraphs 3.9-3.12) should be taken into account. Accordingly, an appropriate level of segmentation of a taxpayer’s accounts is needed in order to exclude from the denominator costs that relate to other activities or transactions and materially affect comparability with uncontrolled transactions. Moreover, in most cases only those costs which are of an operating nature should be included in the denominator. The discussion at paragraphs 2.86-2.91 above also applies to costs as denominator.
TPG2022 Chapter II paragraph 2.98
Posted on |
By OECD
Category: OECD Transfer Pricing Guidelines (2022), TPG 2022 Chapter II: Transfer Pricing Methods | Tag: Cost-based indicators, Denominator - costs, Net Profit Indicator/Profit Level Indicator (PLI), Relevant costs, Transactional net margin method (TNMM), Transactional profit methods, Transfer pricing methods
« Prev |
Next » Related Guidelines
- TPG2022 Chapter II paragraph 2.102The use of budgeted costs can also raise a number of concerns where large differences between actual costs and budgeted costs result. Independent parties are not likely to set prices on the basis of budgeted costs without agreeing on what factors are to be taken into account in setting the...
- TPG2022 Chapter II paragraph 2.99In applying a cost-based transactional net margin method, fully loaded costs are often used, including all the direct and indirect costs attributable to the activity or transaction, together with an appropriate allocation in respect of the overheads of the business. The question can arise whether and to what extent it...
- TPG2022 Chapter II paragraph 2.111By way of illustration, the example of cost plus at paragraph 2.59 demonstrates the need to adjust the gross mark-up arising from transactions in order to achieve consistent and reliable comparison. Such adjustments may be made without difficulty where the relevant costs can be readily analysed. Where, however, it is...
- TPG2022 Chapter II paragraph 2.105Other net profit indicators may be appropriate depending on the facts and circumstances of the transactions. For instance, depending on the industry and on the controlled transaction under review, it may be useful to look at other denominators where independent data may exist, such as: floor area of retail points,...
- TPG2022 Chapter II paragraph 2.104In cases where the net profit is weighted to assets, the question arises how to value the assets, e.g. at book value or market value. Using book value could possibly distort the comparison, e.g. between those enterprises that have depreciated their assets and those that have more recent assets with...
- TPG2022 Chapter II paragraph 2.103Returns on assets (or on capital) can be an appropriate base in cases where assets (rather than costs or sales) are a better indicator of the value added by the tested party, e.g. in certain manufacturing or other asset-intensive activities and in capital-intensive financial activities. Where the indicator is a...
- TPG2022 Chapter II paragraph 2.101Depending on the facts and circumstances of the case, actual costs, as well as standard or budgeted costs, may be appropriate to use as the cost base. Using actual costs may raise an issue because the tested party may have no incentive to carefully monitor the costs. In arrangements between...
- TPG2022 Chapter II paragraph 2.100Where treating costs as pass-through costs is found to be arm’s length, a second question arises as to the consequences on comparability and on the determination of the arm’s length range. Because it is necessary to compare like with like, if pass-through costs are excluded from the denominator of the...
- TPG2022 Chapter II paragraph 2.97One question that arises in cases where the net profit indicator is weighted against sales is how to account for rebates and discounts that may be granted to customers by the taxpayer or the comparables. Depending on the accounting standards, rebates and discounts may be treated as a reduction of...
- TPG2022 Chapter II paragraph 2.96A net profit indicator of net profit divided by sales, or net profit margin, is frequently used to determine the arm’s length price of purchases from an associated enterprise for resale to independent customers. In such cases, the sales figure at the denominator should be the re-sales of items purchased...
Supplemental Guidance
- Poland issues tax clarifications on transfer pricing – No. 4: Transactional Net Margin Method (TNMM)1 December 2021 the Polish Ministry of Finance issued Tax clarifications on transfer pricing No. 4: Transactional Net Margin Method (TNMM) Clarification on application of the TNMM is provided in these areas: A. Principles of TNMM use A.1. Scope of application of the method A.2. Tested party A.3. Determination of...