Transfer Pricing Methods: Choosing The Right Approach For Business Transactions

When your business operates across borders, you need to price transactions between your related companies fairly. Transfer pricing methods can help you do just that, helping you set consistent prices for goods and services and stay compliant in your intra-company transactions.

There are five main transfer pricing methods recognized by tax authorities worldwide to help you get this right, each with its own strengths and best-use scenarios.

Do you send and receive global payments?
Try Wise Business ->

Table of contents
1. Comparable Uncontrolled Price Method 2. Resale Price Method 3. Cost Plus Method 4. Transactional Net Margin Method (TNMM) 5. Profit Split Method

1. Comparable Uncontrolled Price Method

Think of the comparable uncontrolled price method (CUP) as the most straightforward way to set fair prices. You simply look at what independent companies charge each other for similar products or services, then use that as your benchmark.

Here’s how it works: Let’s say your US company sells smartphone screens to your German subsidiary. You’ll need to find what price unrelated companies charge for similar smartphone screens. This gives you a clear, market-based price to use, which acts as your benchmark.

There are two ways to apply CUP.

Internal comparison: Your company also sells the same smartphone screens to unrelated customers, so you can compare that price.

External comparison: Look at transactions between other independent companies in your industry.

Pros and cons

The appeal of CUP is its simplicity and directness. When you can find truly comparable transactions, this method gives you the strongest evidence that your pricing follows market rates.

However, CUP does have its challenges. Finding genuinely comparable transactions can be tough, especially if you’re dealing with unique products, specialized services, or custom business arrangements. Plus, companies often keep their pricing information confidential, making it hard to access the data you need.

Though there are hurdles, CUP remains the gold standard when you can find good comparable data. It’s the closest you can get to proving your pricing transactions just like independent companies would.¹

2. Resale Price Method

The resale price method (RPM) is when you work backwards from your final selling price to find the transfer price. It’s particularly useful when you have a distribution setup where one of your companies buys goods from a related company and resells them without major changes.

RPM works best for straightforward distribution operations. You’d start with the price charged to independent customers and subtract a reasonable gross profit margin that an independent distributor would earn. What’s left is your arm’s length transfer price.²

The key is understanding what functions your distributor performs. Are they just warehousing and shipping, or do they also handle marketing, customer service, and collections? The more activities they perform, the higher margin they should reasonably expect.

You’ll also need to consider the assets they use (warehouses, trucks, inventory) and the risks they take on (market risk, credit risk, inventory loss). Independent distributors doing similar work with similar assets and risks provide your best comparison points.

Pros and Cons

RPM becomes less reliable when your distributor adds significant value to products before reselling them, or when you can’t find good data on what independent distributors earn. However, the resale price method is still a practical and transparent method.

3. Cost Plus Method

The cost plus method takes a builder’s approach to transfer pricing. You start with the actual costs of making your product or service, then add a reasonable profit markup that independent companies would earn in similar situations.

First, you need to identify all relevant costs. These include:

• Direct costs: Material, labor
• Indirect costs: Factory overhead, utilities, management time

Getting your cost base right is crucial because everything else builds on this foundation.

Next, you determine what profit markup an independent company would add to these costs. This markup needs to reflect:

• The work being done
• The assets being used

The risks being takenA company performing routine manufacturing might earn a 5-10% markup, while one providing specialized technical services might justify 15-20% or more.

The cost plus pricing method works particularly well for manufacturing operations, especially contract manufacturing, where one company produces goods according to another company’s specifications.¹ It’s also useful for service companies providing support functions like IT services, administration, or research and development.

Pros and Cons

This method shines when you have clear, reliable cost data and can find good comparisons for markup rates. It’s transparent and relatively objective, where costs are facts, and you can often find industry data on typical profit margins.

The challenges come in determining which costs to include and how to allocate shared costs across different products or business units. You also need to find appropriate markup data from comparable independent companies, which isn’t always easy.

Market conditions matter too. Companies with superior efficiency or technology might justify higher markups, while those with excess capacity might accept lower returns. The key is finding the right balance that reflects what independent parties would agree to.

4. Transactional Net Margin Method (TNMM)

The transactional net margin method (TNMM), also called the comparable profits method, focuses on the bottom line—net profit margins. Instead of looking at prices or gross margins, TNMM transfer pricing looks at whether your company’s net profitability is in line with what independent companies earn.

TNMM works by picking one party in your controlled transaction (usually the one performing simpler functions or taking fewer risks), then comparing their net profit margin to similar independent companies. You might look at profit as a percentage of sales, costs, or assets—whatever makes most sense for the business.

TNMM offers real, practical advantages. It’s less picky about product differences than other methods since it focuses on profit margins rather than specific prices.¹ Net profit data is usually easier to find in public databases than detailed pricing information.

The method can also handle complex situations where companies perform multiple functions or deal with various products.

Pros and Cons

Its flexibility makes the transactional net margin method (TNMM) popular for many types of businesses. Manufacturers, distributors, and service providers all commonly use this approach when other methods are difficult to apply.

However, net profit margins can be influenced by factors beyond transfer pricing. A company might have unusually high or low profits due to business strategy, operational efficiency, or market position rather than transfer pricing issues. This means you need to be careful about selecting truly comparable companies and understanding what drives their profitability.³

Economic cycles also affect net profits more than gross margins. You might need to average results over several years to smooth out temporary fluctuations and make adjustments for differences in accounting methods or business circumstances.

That said, TNMM transfer pricing is often the most practical method available. It produces a workable solution when traditional methods fall short, and the data needed is generally more accessible than for other approaches.

5. Profit Split Method

The profit split method takes a partnership approach to transfer pricing. Instead of trying to price individual transactions, it looks at the combined profits from related activities and splits them based on each company’s contribution to creating that profit.

This method is particularly valuable when you have highly integrated operations where multiple related companies work together to create value in ways that can’t be easily separated.¹ Think of global development projects, integrated supply chains, or situations involving valuable shared intellectual property.

There are two main ways to apply the profit split method:

• Contribution analysis approach: Directly allocates profits based on each entity;s relative contribution, such as their functions, assets, and risks.
• Residual analysis approach: Gives routine returns to companies performing routine functions, then splits any remaining “excess” profits based on contribution to unique value creation.

Pros and Cons

The profit split method shines in complex situations where traditional methods just don’t capture the economic reality. When multiple entities contribute unique and valuable assets or perform critical functions that can’t be easily benchmarked against independent companies, profit splitting may be your best option.

However, this method requires extensive analysis and documentation. You need to thoroughly understand each entity’s role in value creation and have access to detailed financial information from all parties involved. This can be challenging when entities operate in different countries with varying disclosure requirements.⁴

The profit splitting factors you choose, whether based on headcount, assets, costs, or other measures, need to reflect genuine value creation. It often involves subjective judgments that can be difficult to support with hard data, making this method more complex to defend. But, despite the challenges, the profit split method gives the framework for addressing the more complex transfer pricing situations.

Why Smart Pricing Matters Across Borders

Now, to recap, let's look at the different scenarios:

Situation	Recommended Method
Standard goods with market prices	Comparable uncontrolled price method (CUP)
Distribution without modification	Resale price method (RPM)
Routine services or manufacturing	Cost plus method
Complex operations, no good comparables	Transactional net margin method (TNMM)
Interdependent activities with intangibles	Profit split method

Choosing the right transfer pricing method depends on your specific situation, considering the nature of your transactions, the quality of available comparison data, and how well different methods capture your business reality. The goal is always transparency and fairness, ensuring your transfer prices reflect what independent companies would agree to in similar circumstances.

Save Time and Money On Overseas Payments With Wise Business

Wise Business can help you save big time on international payments.

Wise is not a bank, but a Money Services Business (MSB) provider and a smart alternative to banks. The Wise Business account is designed with international business in mind, and makes it easy to send, hold, and manage business funds in currencies.

Signing up to Wise Business allows access to BatchTransfer which you can use to pay up to 1000 invoices in one go. This is perfect for small businesses that are managing a global team, saving a ton of time and hassle when making payments.

Use Wise Business >>

Some key features of Wise Business include:

• Mid-market rate: Get the mid-market exchange rate with no hidden fees on international transfers

• Global Account: Send money to countries and hold balances in multiple currencies, all in one place. You can also get major currency account details for a one-off fee to receive overseas payments like a local

• Access to BatchTransfer: Pay up to 1000 invoices in one click. Save time, money, and stress when you make 1000 payments in one click with BatchTransfer payments. Access to BatchTransfer is free with a Wise Business account

• Auto-conversions: Don't like the current currency exchange rate? Set your desired rate, and Wise sends the transfer the moment the rate is met

• Free invoicing tool: Generate and send professional invoices

• No minimum balance requirements or monthly fees: US-based businesses can open an account for free. Learn more about fees here

---

Sources:

1. Choosing the right transfer pricing method | Exactera
2. The Resale Price Method: A Practical Approach to Transfer Pricing | Commenda
3. Understanding the Transactional Net Margin Method (TNMM) in Transfer Pricing | Tax Risk Management
4. Understanding the Profit Split Method (PSM) in Transfer Pricing | Tax Risk Management