Transfer Pricing, according to the Guidelines of the Organization for Economic Cooperation and Development – OECD of July 2017, refers to the values agreed in commercial related-party transactions, either within the same country or among entities in different jurisdictional areas. They also cover transactions with companies located in tax havens. These prices are significant due to the influence on the allocation of profits among various sections of a multinational corporation and, therefore, on the taxes each nation can collect from that entity.
Analyzing agreed prices requires the selection of a methodology, which includes the Comparable Uncontrolled Price (CUP), Cost-Plus method (CP), Resale Price method (RP), Profit Split method (PS), and the Transactional Net Margin method (TNM). Herein, we will address the Resale Price method (RP).
The PR Method determines the acquisition price of a good from a related party using the data of the resale price of the same product from an independent third party and an appropriate gross margin on sales (market resale price margin). If the resale price margin corresponds to the market, the acquisition price to the related party is also at market value.
Thus, if the purchase price to the related party is P, the resale price to the third party is R, and the gross margin is M, then P= R*(1-M).
In fact, R is not known, and neither would it be necessary to know P. We will simply compare the gross margin of the product acquired from the related party and resold to the third-party M with the margins of the product acquired from a third party and sold to a third party by the same tested company (internal comparable) or alternatively the margin obtained by a third party from sales of similar products (external comparable). This comparison will indicate whether the agreed resale margin is within the market range, and if so, the acquisition price will also be considered at market price.
We will show below a practical illustration of the Resale Price application:
Let us suppose that company A buys a product X from a related company B at a price P and resells it to an unrelated company C at a price R, considering a gross margin on sales M.
On the other hand, let us suppose that the margins charged by independent companies are M1, M2, M3, M4, and M5.
The values are: M=25%, M1=26%, M2=24%, M3=27%, M4=22%, M5=26.5%, R=70.
Based on these data, we would conclude that the interquartile range with gross margins would be between 24.0% and 26.5%, demonstrating that the resale margin applied by the tested company regarding the product acquired at 25% would be within this range, complying with the Arm’s Length Principle.
In addition, with the formula P= R*(1-M), the acquisition price P would be 52.50.
On the other hand, employing the resale price of R=70, the margins M1=26%, M2=24%, M3=27%, M4=22%, M5=26.5%, and the formula P= R*(1-M); we would obtain the prices P1=51.80, P2=53.20, P3=51.10, P4=54.60, and P5=51.45.
Finally, based on these prices, we could obtain the interquartile range found between 51.45 and 53.20, demonstrating that the resale price regarding the purchase from the related party 52,50 would also be within the market range. The latter demonstrates that making a direct comparison of gross margins would enable you to check if the acquisition price is indeed within the market range.
After addressing the application of the RP methodology, we will discuss the main disadvantages of applying it.
This method requires the resale of the good to be free of added value, which could distort the resale price and the margin applied, requiring further adjustments for a correct application.
This method is not suitable for goods with valuable intangibles: It is not employed when the analysis involves any good with valuable intangibles. For example, if two resellers sell similar products and one of them is a globally recognized brand and has the latest technology, it will surely seek a higher profit, even though the tasks and functions performed are the same.
It is necessary to find comparable transactions under the OECD provisions: “An unrelated transaction is comparable to a related one (i.e., a comparable unrelated transaction) to apply the resale price method when one of the following two conditions is met: (a) None of the differences (if any) among the compared transactions or the companies performing those transactions influences the resale price margin on the open market significantly, or (b) They can be appropriately adjusted to eliminate the material effects that may arise from those differences.”
The comparison of resale margins with independent companies is frequently harder and less accurate than the comparison of resale margins of the same tested company regarding products acquired from third parties to sell to third parties.
The analysis of the resale price is more accurate when it has been shortly after the purchase, given that if the time of resale is much later, the margin earned could include other factors, such as seasonality, exchange rate, variations in the price of the product, etc.
The accounting practices between the analyzed transaction and the comparables could complicate the application of the method due to the necessary adjustments to the costs considered.
We conclude, based on the above, that the RP method offers a valuable tool, especially for available market data and comparable unrelated party transactions, in addition to the less exhaustive comparison of products than the CUP method when using margins. Conversely, its application may be limited in complex situations involving valuable intangibles, where other methods could be more suitable for determining accurate and fair transfer prices.