The TNMM forms part of the transactional transfer pricing approach used in determining the arm's length price for transactions between related parties (or controlled transactions).

Specifically, the TNMM compares profitability of the least complex related party to the controlled transaction to the profitability of independent parties. It is somehow similar to the RPM but instead of looking at the Gross Margins, the TNMM will look at bottom-line profit indicators such as the Operating Margin, Net Cost Plus and other similar profit indicators.

In other words, the TNMM diverts from RPM as the TNMM does not work out the transfer price, but instead measures the profitability of a related party to the profitability of independent parties.

In order to ensure that a robust TNMM application it is imperative that the following steps are carefully considered:

• Identification of the controlled transaction and the tested party
• Determination of an appropriate level of aggregation (or grouping) of transactions
• Selection of years for comparison
• Selection of a reliable Profit Level Indicator (PLI or profit indicators)
• Selection of reliable comparable companies
• Analysis of comparability factors
• Construction of an arm's length range of results
• Analysis of the net margins results

A healthy TNMM application include the steps outlined above. These are briefly outlined, however, each step has to be carefully considered as a slight deviation may render the TNMM as non-comparable.

The TNMM is a widely used transfer pricing method by tax authorities and multinational companies because it is considered to provide a more accurate outlook of the profitability of independent companies in an industry and how a tested party has performed in this pool.

That said, the TNMM requires careful analysis and selection of comparable companies and data, and its application can be complex in certain cases.