Applicable Methods:
- The Regulations provide guidance and methodology for determining arm’s length prices for the transfer of tangible property, license of intangible property, provision of services, and loans between related parties.
- The Regulations include specific methods to evaluate and determine arm’s length prices based on the facts and circumstances of each transaction.
- “Transactional Based” methods are those in which a transaction is directly compared to another transaction to determine an arm’s length price.
- “Profit Based” methods are those in which a transfer price is determined indirectly by comparing the margin a related-party transaction generates to the margins earned by independent businesses engaging in similar transactions, performing comparable functions and assuming comparable risks.
Priority of Methods:
- The best method rule requires that the arm’s length result of a controlled transaction should be determined using the method that provides the most reliable measure of the arm’s length result, based on the facts and circumstances of the transaction.
- The regulations guide determining which method may be the most reliable in a given situation.
- If two or more methods render inconsistent results, the more reliable method should be used.
- The reliability of a particular method depends on the degree of comparability between the controlled transaction and uncontrolled comparables, and the quality of data and assumptions used.
- Data based on the results of transactions between unrelated parties are presumed to provide the most objective basis for determining whether the results of a controlled transaction are at arm’s length.
- For tangible property transactions, specified methods include the CUP, RP, CP, PS, and CPM methods.
- For intangible property transactions, specified methods include the CUT, PS, and CPM methods.
- For service transactions, specified methods include the CPM, SCM, CUSP, GSMM, CSP, and PS methods.
- Transfer pricing economists may elect to use customized unspecified methods, but they must prove that the unspecified method produces the most reliable measure of the arm’s length result.
- An unspecified method must take into account the general principle that uncontrolled taxpayers evaluate the terms of a transaction by considering the realistic alternatives to that transaction.
Administrative Rules and Guidelines:
- A comparability analysis must be performed when selecting comparable transactions, taking into account the functional analysis of the parties and the contractual terms and economic conditions of the transaction.
- The use of multiple-year data is permitted where needed to take into account the facts of the case, but this is affected by the transfer pricing method used.
- Multiple-year data is generally not used with the CUP method.
- Other considerations for the use of multiple-year data include the existence of relevant data and whether the transactions examined are affected by multiple-year business cycles.
- It may be possible to justify a loss in one year by reference to a multiple-year analysis, according to the regulations.