What Are the Key Transfer Pricing Methods for Global Growth?

Transfer pricing is a critical aspect of international business, determining how companies price transactions between related entities and ensuring fair profit for each. As your company expands across borders, ensuring that your inter-company pricing complies with regulations like the OECD transfer pricing guidelines for multinational enterprises and tax administrations, including the arm’s length principle defined in these becomes increasingly important. This guide will help you understand the various transfer pricing methods and how they can help optimize your tax strategies while supporting sustainable growth.

Why Transfer Pricing Matters for International Growth

For any company involved in cross-border transactions, ensuring that you have the right transfer pricing strategies in place is essential. Transfer pricing regulates how profits are allocated between different subsidiaries of your company, ensuring compliance with global tax laws and preventing both overpayment and underpayment of taxes. The arm’s length principle requires that transactions between related parties be priced as if they were between unrelated, independent entities.

Failing to comply with these rules can lead to costly audits, penalties, and damage to your company’s reputation. This could become a significant burden for startups and scaleups with limited resources. However, understanding how to leverage the right transfer pricing methods can ensure your business thrives internationally while staying compliant with tax authorities.

Key Transfer Pricing Methods Explained

There are several approaches to determining the right price for inter-company transactions. Let’s explore the most common transfer pricing methods and their use cases:

Comparable Uncontrolled Price (CUP) Method

The CUP method compares the price of goods or services in a related-party transaction to the price in a comparable transaction between unrelated parties. For example, if your subsidiary in Germany sells a product, you would benchmark this sale against similar sales to unrelated customers in the same market.

This method is often preferred for its direct comparability, but it can be difficult to apply when reliable external benchmarks are not available, especially for unique products or intangible assets.

Resale Price Method (RPM)

The RPM method focuses on the margin earned by a reseller. For example, suppose your UK subsidiary buys products from your parent company and resells them in the local market. In that case, the appropriate transfer price is determined by subtracting the reseller's gross margin from the resale price. This method is commonly applied in distribution or retail businesses where the resale margin is easily benchmarked.

However, RPM may not be suitable for service-based businesses or complex transactions involving intangible assets, where profit margins differ significantly across industries.

Cost Plus Method

The Cost Plus Method works by adding an appropriate markup to the costs incurred by the supplier. For instance, if your subsidiary in India manufactures goods for your European entity, you would apply a markup on the manufacturing costs to determine the appropriate transfer price.

This method is often used for manufacturing and service operations, where direct costs like labor and materials can be easily tracked. However, it's less applicable for transactions involving intangible assets or high-value services, where costs may not fully reflect the value created.

Transactional Net Margin Method (TNMM)

TNMM compares the net profit margin achieved in a related-party transaction to those earned by independent companies in similar circumstances. It’s particularly useful for companies with complex or varied inter-company transactions, where finding direct comparable transactions may be difficult.

To apply TNMM effectively, companies use external databases to gather profitability data and select a relevant profit-level indicator (PLI), such as operating margin or return on assets. TNMM is widely used because it accommodates a range of transactions and is more flexible when exact comparables are hard to find.

Profit Split Method

When both entities in a related-party transaction contribute significantly to the overall profit, the Profit Split Method may be used. This method allocates the profits generated by the transaction between the parties based on their relative contributions to the value chain. It’s particularly useful for companies dealing with intangible assets or involved in highly integrated business models, such as joint ventures or R&D partnerships.

The profit split method is complex to implement and often requires detailed documentation and functional analysis to justify the allocation of profits between entities.

How to Use Transfer Pricing Methods Strategically

Transfer pricing is not just about compliance—it’s a powerful strategic tool that can enhance your business’s global operations. For instance, if your research and development (R&D) activities are concentrated in a high-cost country, you may set up an R&D organisation in a lower-tax jurisdiction and allocate a portion of the profits to an entity based on its contribution to R&D activity and value created. As long as this allocation reflects the arm’s length principle, you can use transfer pricing to optimize tax outcomes while complying with international tax rules.

At iVC Consulting, we understand that transfer pricing strategies must be tailored to each company’s unique business model and growth objectives. We work closely with startups and scaleups to develop solutions aligning with regulatory requirements and business goals, ensuring that transfer pricing becomes an enabler of sustainable growth.

The Critical Role of Documentation

Having the right transfer pricing strategy including the correct and helpful use of transfer pricing methods is only part of the puzzle. Without proper documentation, you leave your company vulnerable to audits and penalties. The OECD’s BEPS Action 13 mandates that companies maintain three levels of documentation: a Master File, Local File, and Country-by-Country Reporting (CbCR), the later applicable for large companies only.

Maintaining up-to-date documentation is crucial to demonstrate that your pricing structures align with the arm’s length principle. For startups and scaleups, keeping up with these documentation requirements can feel overwhelming, but it’s a necessary step in ensuring compliance.

At iVC Consulting, we help companies establish streamlined processes to efficiently manage their transfer pricing documentation. Our goal is to relieve the burden so you can focus on growing your business.

Why iVC Consulting?

Transfer pricing can be daunting, especially for companies just starting their international journey. At iVC Consulting, we see transfer pricing as more than a compliance exercise—it’s a tool for unlocking value creation. Whether you’re a startup entering new markets or a scaleup optimizing your global operations, our team provides tailored solutions designed to fit your business needs.

From strategy and implementation to documentation and defense, we guide you through every stage of the process. We don’t just help you comply with international rules; we help you use them to your advantage.

How Transfer Pricing Supports Growth

Transfer pricing is a critical component of your international business strategy. Understanding the different methods and how to apply them ensures that you’re compliant with global tax regulations while optimizing your tax efficiency.

At iVC Consulting, we specialize in helping businesses navigate the complexities of transfer pricing. Let’s work together to ensure your pricing strategies support your growth and ensure compliance. Contact us today to start a conversation about how we can optimize your transfer pricing.

For a concise comparison, including pros & cons of the methods you can also visit our detailed guide.