Editing Transfer pricing (section)

===Testing of prices===
Tax authorities generally examine prices actually charged between related parties to determine whether adjustments are appropriate. Such examination is by comparison (testing) of such prices to comparable prices charged among unrelated parties.  Such testing may occur only on examination of tax returns by the tax authority, or taxpayers may be required to conduct such testing themselves in advance of filing tax returns.  Such testing requires a determination of how the testing must be conducted, referred to as a transfer pricing method.<ref>OECD Guidelines 2.5, 26 CFR 1.482-.</ref>

====Best method rule====
Some systems give preference to a specific method of testing prices.  OECD and U.S. systems, however, provide that the method used to test the appropriateness of related party prices should be that method that produces the most reliable measure of arm's length results.<ref>OECD Guidelines 1.68-1.70, 26 CFR 1.482-1(c), [http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:6.0.1.1.1.0.8.189&idno=26 26 CFR 1.482-8].</ref>  This is often known as a "best method" rule.  Factors to be considered include comparability of tested and independent items, reliability of available data and assumptions under the method, and validation of the results of the method by other methods.

====Comparable uncontrolled price (CUP) method====
The comparable uncontrolled price (CUP) method is a transactional method that determines the arm's-length price using the prices charged in comparable transactions between unrelated parties.<ref>OECD Guidelines 2.13.</ref> In principle, the OECD<ref>OECD Guidelines 2.3, 2.14.</ref> and most countries that follow the OECD guidelines<ref>See, for example, [http://www.cra-arc.gc.ca/E/pub/tp/ic87-2r/ic87-2r-e.html Canada Revenue Agency (CRA) Information Circular 87-2R] at [http://www.cra-arc.gc.ca/E/pub/tp/ic87-2r/ic87-2r-e.html#P196_20259 paragraphs 52-53], and [http://law.ato.gov.au/atolaw/view.htm?Docid=TXR/TR9720/NAT/ATO/00001 Australian Taxation Office (ATO) Taxation Ruling 97/20] at [http://law.ato.gov.au/atolaw/view.htm?Docid=TXR/TR9720/NAT/ATO/00001#P3.15 paragraph 3.15].</ref> consider the CUP method to be the most direct method, provided that any differences between the controlled and uncontrolled transactions have no material effect on price or their effects can be estimated and corresponding price adjustments can be made. Adjustments may be appropriate where the controlled and uncontrolled transactions differ only in volume or terms; for example, an interest adjustment could be applied where the only difference is time for payment (e.g., 30 days vs. 60 days). For undifferentiated products such as commodities, price data for arm's-length transactions ("external comparables") between two or more other unrelated parties may be available. For other transactions, it may be possible to use comparable transactions ("internal comparables") between the controlled party and unrelated parties.

The criteria for reliably applying the CUP method are often impossible to satisfy for licenses and other transactions involving unique intangible property,<ref>OECD (2015). [http://www.oecd.org/tax/aligning-transfer-pricing-outcomes-with-value-creation-actions-8-10-2015-final-reports-9789264241244-en.htm Aligning Transfer Pricing Outcomes with Value Creation, Actions 8-10 - 2015 Final Reports] ("OECD actions 8-10") at para. 6.146.</ref> requiring use of valuation methods based on profit projections.<ref>OECD actions 8-10 at para. 6.153.</ref>

====Other transactional methods====
Among other methods relying on actual transactions (generally between one tested party and third parties) and not indices, aggregates, or market surveys are:
*[[Cost-plus]] (C+) method:  goods or services provided to unrelated parties are consistently priced at actual cost plus a fixed markup.  Testing is by comparison of the markup percentages.<ref>OECD Guidelines 2.32-48, 26 CFR 1.482-3(d), 26 CFR 1.482-9(e).</ref>
*Resale price method (RPM):  goods are regularly offered by a seller or purchased by a retailer to/from unrelated parties at a standard "list" price less a fixed discount.  Testing is by comparison of the discount percentages.<ref>OECD Guidelines 2.14-2.31, 26 CFR 1.482-3(c), 26 CFR 1.482-9(d).</ref>
*Gross margin method:  similar to resale price method, recognised in a few systems.

====Profit-based methods====
Some methods of testing prices do not rely on actual transactions.  Use of these methods may be necessary due to the lack of reliable data for transactional methods.  In some cases, non-transactional methods may be more reliable than transactional methods because market and economic adjustments to transactions may not be reliable.  These methods may include:
*Comparable profits method (CPM):  profit levels of similarly situated companies in similar industries may be compared to an appropriate tested party.<ref>26 CFR 1.482-5.</ref>  See U.S. rules below.
*[[Transactional net margin method]] (TNMM):  while called a transactional method, the testing is based on profitability of similar businesses.  See OECD guidelines below.<ref>OECD Guidelines 3.26-3.33.</ref>
*Profit split method:  total enterprise profits are split in a formulary manner based on econometric analyses.<ref>OECD Guidelines 3.5-3.25, [http://ecfr.gpoaccess.gov/cgi/t/text/text-idx?c=ecfr&rgn=div8&view=text&node=26:6.0.1.1.1.0.8.187&idno=26 26 CFR 1.482-6].</ref>

CPM and TNMM have a practical advantage in ease of implementation.  Both methods rely on microeconomic analysis of data rather than specific transactions. These methods are discussed further with respect to the U.S. and OECD systems.

Two methods are often provided for splitting profits:<ref>OECD Guidelines 3.5.</ref>  comparable profit split<ref>26 CFR 1.482-6(c)(2).</ref> and residual profit split.<ref>26 CFR 1.482-6(c)(3).</ref>  The former requires that profit split be derived from the combined operating profit of uncontrolled taxpayers whose transactions and activities are comparable to the transactions and activities being tested.  The residual profit split method requires a two step process:  first profits are allocated to routine operations, then the residual profit is allocated based on nonroutine contributions of the parties.  The residual allocation may be based on external market benchmarks or estimation based on capitalised costs.

====Tested party and profit level indicator====
Where testing of prices occurs on other than a purely transactional basis, such as CPM or TNMM, it may be necessary to determine which of the two related parties should be tested.<ref>OECD Guidelines 3.43, 26 CFR 1.482-5(b)(2).</ref>  Testing is to be done of that party testing of which will produce the most reliable results.  Generally, this means that the tested party is that party with the most easily compared functions and risks.  Comparing the tested party's results to those of comparable parties may require adjustments to results of the tested party or the comparables for such items as levels of inventory or receivables.

Testing requires determination of what indication of profitability should be used.<ref>OECD Guidelines 3.41, 26 CFR 1.482-5(b)(4).</ref>  This may be net profit on the transaction, return on assets employed, or some other measure.  Reliability is generally improved for TNMM and CPM by using a range of results and multiple year data.<ref>OECD Guidelines 3.43, 3.44, 26 CFR 1.482-1(e)(2).</ref>
this is based on circumstances of the relevant countries.