Transfer Pricing Methods Explained – The Cost Plus method

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Transfer Pricing Methods Explained – The Cost Plus method.

This article is a series of article that aims to provide a background on transfer pricing methods.

In the previous article we described the CUP method and factors that should be considered in applying the CUP method. In this article we look at the Cost Plus (“CP”) method in detail.

What is the CP method?

The CP method forms part of the traditional transfer pricing approach used to determine the arm's length price for transactions between related parties, also known as controlled transactions.

In essence Cost Plus means adding a markup to the actual cost incurred by a Company in producing or acquiring a product or service.

From a transfer pricing perspective, the mark up charged on a controlled transaction is the transfer price in consideration that has to be determined whether it is at arm's length.

What shall I consider when applying the CP method?

Often the CP method is used on service transaction rather than a sale / purchase of goods. When applying the CP method, there are several important considerations to consider:

Considerations	Description
Cost incurred data	The CP method requires accurate and reliable data for cost incurred as not all cost of an entity may be attributable in the provision of services that are being provided. These data allows for a reliable allocation of cost to the service provided in order to determine an appropriate transfer price. The availability of cost data can be a challenge, especially in complex or highly specialised transaction.
Appropriate mark up	The mark up applied in a controlled transaction should be based on industry norms or the average mark up earned by comparable independent entities. In addition, the mark up should also take into account the specific circumstances of the transaction, such as the actual functions that are being provided, the level of risk involved, and the level of expertise required.
Comparable independent transactions	The CP method requires the identification of comparable transactions between unrelated parties in order to determine the appropriate arm’s length markup. A comparable transaction means that the transaction between unrelated parties should closely mirror to the transaction between the related parties. To achieve this, in transfer pricing we employ the comparability analysis which involves comparing factors such as: the nature of the goods or services; functional analysis; contractual terms; business strategies; and market and economic conditions.

These considerations demonstrate the importance of careful planning and analysis when applying the CP method as part of a transfer pricing strategy. By taking these considerations into account, multinational taxpayers can ensure that their transfer pricing policies and methods are in line with the arm's length principle and that they are not subject to transfer pricing disputes with tax authorities.

What else shall I consider in applying the CUP method?

The CUP method is at an advantage compared to other transfer pricing methods as it is relatively straightforward and easy to implement when data is readily available.

However, where there are limited or no comparable transactions available or where the controlled transaction is significantly different from the comparable transactions (i.e. in terms of the comparability factors mentioned above) then the CUP method can not be implemented in an effective manner.

Example

We provide an example below on how a CUP method could be applied.

Co A (based in US) and Co. B (based in Singapore) are related parties. Co. A sells goods to Co. B. Co. A also sells the same goods to unrelated cus tomers based in Asia Pacific.

Co. A sales good to its unrelated customers that range between USD 90 to USD 110.

A comparison of the comparability factors is carried out between the controlled transaction and comparable transactions to determine whether the transactions are comparable.

In this scenario the transactions are considered to be comparable.

If the price charged to Co. B is within the range of the comparable transactions (USD 90 to USD 110 in this case), it can be considered to be at arm's length.

This is just one example of how the CUP method could be applied, and the specific details of the method would vary depending on the specific circumstances of the transaction.

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