Transfer Pricing Methods Explained – The Resale Price 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 Cost Plus (“CP”) method and factors that should be considered in applying the CP method. In this article we will explore the Resale Price Method (“RPM”) and see how this differs to the other traditional methods.

What is the RPM?

The RPM is the last method that forms part of the traditional transfer pricing approach used in determining the arm's length price for transactions between related parties (or controlled transactions).

Specifically, the RPM is a transfer pricing method used to determine the appropriate transfer price for a reseller of products (i.e. a product that is purchased by a related party from an associated enterprise and then resold to an independent party).

The RPM may theoretically be applied to a service transaction, but it is not considered appropriate given that the RPM is primarily designed for testing the prices of tangible goods and given the intangible nature of services the value of the services is often more difficult to determine.

How does the RPM work?

Under the RPM, the transfer price between related parties is calculated by looking at the Gross Profit Margin (“GPM”) that is earned by independent parties. The GPM earned by independent parties are the arm’s length GPM that the related party reseller should earn in the controlled transaction. Therefore in a controlled transaction related parties work backwords in identifying the arm’s length price. The example below illustrates this point in better clarity.

Example

We provide an example below on how the RPM could work.

Facts

RPA and RPB are related parties. RPA sales biscuits to RPB. RPB aims to sale biscuits at USD 10.

In order to ascertain the arm’s length transfer price, the related parties identified independent resellers of biscuits and found that independent resellers earn a GPM of 20% on their sales.

Resale Price workpaper

Working backwords from the market price and the GPM earned by the independent party resellers the transfer price will be USD 2 (or a 20% GPM), as shown below.

Steps	Description	USD
A	Sale of 1 packet of biscuit	10
B = A x 20%	Gross margin earned by independent party resellers (20% of USD 10) or Profit to be earned by RP B	2
C = A-B	Transfer Price	8

The GPM is intended to reflect the functions performed by the reseller and therefore the transfer price should be set so that the reseller earns a reasonable profit on the resale of the products.

Other consideration

The RPM is often used in situations where the reseller does not perform any significant value-adding activities to the product before reselling it to independent third parties. Therefore, it is imperative that an evaluation of the functions performed, risks assumed and assets utilised of the related parties be ascertained for a better application of the transfer pricing method.

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