- Traditional methods v. transactional profit methods

 

"[172] Two classes of transactional profit methods are recognised by the OECD Guidelines. The following three are commonly referred to as "Traditional Methods".

(1) The "CUP method" compares the price charged for goods or services in a related party transaction to that charged in a comparable third-party transaction in comparable circumstances (i.e., market price). This method uses property or service transactions between unrelated parties to determine arm's length consideration for similar transfers between related parties. This method evaluates whether the amount charged in a controlled transaction is arm's length, by reference to the amount charged in a comparable uncontrolled transaction. The CUP method was relied on by HMRC;
(2) The Resale Price method ("the RPM") (also referred to as 'resale minus') is used in sales and distribution transactions. This method is used to determine the arm's length consideration to be earned by the purchaser in an intercompany transaction when it resells to unrelated parties. This method evaluates whether the amount charged in a controlled transaction is 'arm's length' by reference to the gross profit margin realised in comparable uncontrolled transactions. The RPM measures the value of the function performed and is ordinarily used in cases where the reseller has not added any significant value to the product by physically altering it before resale; and
(3) The "Cost Plus method" (or "the CPM") determines the arm's length consideration that the seller should earn in an intercompany sale, based on the gross profit mark-up earned by sellers in comparable uncontrolled transactions. The appropriate mark-up is derived by referencing gross profit margins earned by comparable companies, operating under comparable circumstances, in uncontrolled transactions.
[173] The Traditional Methods rely on actual transactions, and compare the terms and conditions in the related party transactions with those of third parties in comparable transactions.

[174] The following two are commonly referred to as "Transactional Profit Methods":

(1) The "Profit-Split method" (or "the PSM") determines arm's length transfer pricing on the basis of the relative value of each controlled taxpayer's contribution to the combined profit or loss in a particular controlled transaction, or set of controlled transactions. These contributions should correspond to the division of profit or loss that would result from an arrangement between uncontrolled taxpayers, each performing functions similar to those of the various controlled taxpayers engaged in the relevant business activity. The OECD Guidelines identify two approaches in applying the PSM: the 'residual analysis' and the 'contribution analysis'. Under the residual profit-split analysis, profit is first allocated to each of the related entities, in accordance with their routine functions, services and intangibles. The residual profit not accounted for by the routine contributions is then allocated to each entity based on each of the related parties' contributions of non-routine intangible property. Under the contribution analysis, uncontrolled taxpayers' proportions of the combined operating profit, or loss, in situations similar to the controlled transaction are used to allocate the related parties' combined operating profit or loss; and
(2) The TNMM determines arm's length transfer pricing by reference to a measure of net profitability of unrelated companies that engage in similar activities, under similar circumstances. The method measures the total return derived from the controlled taxpayer's most narrowly defined business activity, for which reliable data incorporating the controlled transactions under review are available. The TNMM examines the net profit relative to an appropriate base (e.g., costs, sales, assets) that a taxpayer realises from a controlled transaction. Thus, the TNMM operates in a manner similar to the CPM and the RPM. The TNMM method is that which was utilised by the Appellant (a 'one-sided' method).
[175] The Transactional Profit Methods rely on the profit levels to determine arm's length prices, measuring the net operating profits of related party transactions, and comparing this to that of independent companies engaged in similar comparable transactions.

[176] In addition to the five methods referred to above, the UN Manual includes a sixth method, or "Commodity Rule". This is similar to the CUP method, is used for commodities transactions and relies on the commodities market to price commodity transactions between related parties." (Lifeplus Europe Ltd v. HMRC [2026] UKFTT 797 (TC), Judge Manyarara)

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