Select Transfer Pricing Method
Choose the method that best matches your transaction type and available data.
OECD Transfer Pricing Guidelines Framework
The Arm's Length Principle
The arm's length principle — codified in Article 9 of the OECD Model Tax Convention and elaborated in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022) — is the international standard for pricing transactions between associated enterprises. It requires that conditions between related parties reflect those that would be agreed between independent enterprises in comparable transactions and comparable circumstances. Over 140 countries apply the arm's length principle through their domestic legislation, making transfer pricing compliance a universal obligation for multinationals.
Method 1 — Comparable Uncontrolled Price (CUP)
The CUP method (OECD ¶2.14–2.20) compares the price charged in a controlled transaction to the price charged in comparable uncontrolled transactions. It is the most direct and reliable method when true comparables exist. Formula: Arm's Length Price = Comparable Uncontrolled Price (adjusted for comparability differences).
Best applications: commodity pricing (with published exchange prices per ¶2.18–2.20), intercompany loan interest rates (using market reference rates — EURIBOR, SOFR), and known royalty rates where comparable license agreements exist. The CUP method requires a high degree of comparability between the controlled and uncontrolled transactions — differences in product characteristics, contractual terms, economic conditions, and business strategies must be minor or capable of reliable adjustment.
Method 2 — Cost Plus
The Cost Plus method (OECD ¶2.39–2.55) starts with the costs incurred by the supplier in a controlled transaction and adds an arm's length markup to arrive at the transfer price. Formula: Transfer Price = Cost Base × (1 + Markup%).
Best applications: contract manufacturing where the manufacturer produces to the principal's specifications, routine intragroup services (IT support, accounting, HR administration), and management fees. The cost base should include both direct and indirect costs attributable to the transaction. The arm's length markup is benchmarked against markups earned by independent companies performing comparable functions with comparable risk profiles.
Method 3 — Transactional Net Margin Method (TNMM)
TNMM (OECD ¶2.58–2.107) is the most widely used transfer pricing method globally. It compares the net profit margin of the tested party — the least complex entity in the transaction — to the margins of comparable independent companies. The net profit indicator (PLI) must be selected based on the tested party's characteristics:
- Operating Margin = Operating Profit ÷ Revenue — standard for distributors and manufacturers with pricing authority
- Net Cost Plus = Operating Profit ÷ Total Costs — preferred for toll manufacturers and service providers operating on a cost-plus basis
- Berry Ratio = Gross Profit ÷ Operating Expenses — useful for intermediaries and service providers where costs are predominantly personnel
- Return on Assets = Operating Profit ÷ Operating Assets — appropriate for capital-intensive entities where asset base drives returns
Interquartile Range Calculation
Per OECD ¶3.55–3.62, the arm's length range is typically defined as the interquartile range (IQR) — spanning the 25th percentile (Q1) to the 75th percentile (Q3) of the comparable dataset. This tool uses the PERCENTILE.INC method (equivalent to Excel's PERCENTILE.INC function) for calculating Q1, median, and Q3 using linear interpolation between data points.
The IQR methodology: (1) collect comparable data from independent transactions or companies, (2) sort the data in ascending order, (3) calculate Q1 (25th percentile), median (50th percentile), and Q3 (75th percentile) using interpolation, (4) compare the tested party's result to the IQR, (5) if within Q1–Q3, no adjustment required (¶3.60); if outside, adjust to the median (¶3.62). The full range (minimum to maximum) provides context but is not the definitive arm's length range in most jurisdictions.
ISA 550 — Audit Context for Transfer Pricing
ISA 550 (Related Parties) requires the auditor to obtain an understanding of the entity's related party relationships and transactions (ISA 550.11–18), and to evaluate whether related party transactions are at arm's length when the applicable financial reporting framework requires or permits such disclosure (ISA 550.19–24). Transfer pricing benchmarking analysis with IQR computation provides the quantitative evidence that auditors need to support their assessment under ISA 550.
ISA 550.23 specifically requires evaluation of the business rationale of significant related party transactions that appear to be outside the entity's normal course of business. ISA 550.A38 notes that transactions which lack an apparent logical business reason may indicate fraud risk factors relevant to ISA 240. Transfer pricing documentation — demonstrating arm's length pricing through comparable analysis — directly addresses these audit requirements.
Worked Example: European Contract Manufacturer (TNMM)
Scenario: A Dutch principal entity contracts production of electronic components to a subsidiary in the Czech Republic. The Czech entity performs routine assembly using IP owned by the Dutch parent. We benchmark the Czech entity's operating margin against 12 independent European contract manufacturers from an Amadeus search.
Tested party financials: Revenue €12,000,000 | COGS €9,600,000 | Operating Expenses €1,800,000 | Operating Profit €600,000 | Operating Margin: 5.0%
Comparable set (sorted operating margins): 2.8%, 3.2%, 3.8%, 4.1%, 4.8%, 5.3%, 5.7%, 6.1%, 6.5%, 7.0%, 7.8%, 8.4%
Statistical summary: Count: 12 | Min: 2.8% | Q1: 3.88% | Median: 5.50% | Q3: 6.88% | Max: 8.4%
Result: The tested party's operating margin of 5.0% falls within the interquartile range (Q1: 3.88% – Q3: 6.88%). No adjustment is required under OECD ¶3.60.
Interpretation: The box-and-whisker chart shows the tested party's result (green marker) positioned within the IQR box, confirming arm's length pricing. If the result had been 2.5% (below Q1), an adjustment to the median of 5.50% would have been suggested, resulting in an additional €360,000 of operating profit [(5.50% − 2.5%) × €12,000,000].
How to Read the Box-and-Whisker Chart
The box-and-whisker chart is the primary visualization for transfer pricing analysis. It displays the full range of comparable data and the position of the tested party's result within that range:
- Whiskers (horizontal lines) extend from the minimum to the maximum of the comparable dataset, showing the full range.
- Box (filled rectangle) represents the interquartile range — from Q1 (25th percentile) to Q3 (75th percentile). This is the arm's length range.
- Median line (vertical line inside the box) marks the 50th percentile — the adjustment target if the tested party falls outside the IQR.
- Tested party marker (diamond) shows where the tested party's result falls. Green = within IQR (pass), yellow/amber = within full range but outside IQR (caution), red = outside full range (fail).
A well-conducted benchmarking study should produce a box plot where the IQR is reasonably narrow (the Q3–Q1 spread should generally not exceed 20 percentage points) and the tested party's marker falls comfortably within the box. If the IQR is very wide, consider whether your comparable set needs refinement — wider ranges indicate greater comparability uncertainty.
Decision Guide: Choosing the Right TP Method
The OECD does not prescribe a hierarchy of methods but requires the selection of the "most appropriate method" for each transaction (¶2.1–2.12). In practice:
Use CUP when: You have directly comparable uncontrolled transactions — same or very similar products, similar markets, similar terms. Most practical for commodity transactions (using published exchange prices), intercompany loans (using market reference rates), and royalties (using comparable license agreements). CUP is the most reliable method when good comparables exist.
Use Cost Plus when: The tested party provides services or manufactures goods to specification, the cost base is identifiable and reliable, and the transaction is fundamentally cost-driven. Most practical for contract manufacturing, routine intragroup services, and management fees where the service provider does not bear significant commercial risk.
Use TNMM when: Reliable comparable transaction data is not available for CUP, the tested party performs routine functions without unique intangibles, and sufficient comparable company data exists. TNMM is the default method for most distribution, manufacturing, and service transactions because comparable company data is abundant in databases like Amadeus and Orbis.
Limitation: This tool does not implement profit split or transactional profit methods (OECD ¶2.108–2.145). Profit split is required where both parties contribute unique intangibles or where the transactions are highly integrated. For profit split analysis, consult a transfer pricing specialist.