Contents - AL-Tax
Contents - AL-Tax Contents - AL-Tax
18 3 Overview and Critique of Existing Transfer Pricing Methods3.2.1 Circumstances when Resale Price and Cost PlusMethods ApplyThe resale price and cost plus methods (and, under the U.S. Temporary Regulations,the gross services margin method and the cost of services plus method) canbe applied under the following fact patterns:1. A single manufacturer sells similar products to both affiliated and unaffiliateddistributors;2. A single distributor sources similar products from both affiliated and unaffiliatedsuppliers;3. A single services provider renders similar liaison or agency services (in the caseof the gross services margin method) to both affiliated and unaffiliated companies,and, if relevant, utilizes the same intangible assets in doing so;4. A single services provider renders similar services (other than liaison services inthe case of the cost of services plus method) under the same contractual terms toboth affiliated and unaffiliated companies and utilizes the same intangible assets,if any, in doing so;5. Two or more manufacturers sell similar products, in one instance to affiliateddistributors, and in the other instances, to unaffiliated distributors;6. Two or more distributors source similar products, in one instance from affiliatedsuppliers and in the other instances, from unaffiliated suppliers; and7. A group member performs routine manufacturing or distribution functions andlicenses intellectual property from another group member.Given one of the above fact patterns, one’s choice between the resale price andcost plus methods depends principally on whether (a) one of the group membersengages in internal arm’s length transactions, and (b) the affiliated manufacturer orthe affiliated distributor is the least complex entity (and therefore, the designatedtested party). For example, under the first fact pattern, one would ordinarily applythe cost plus method, and under the second, the resale price method. As indicatedabove, the gross services margin method generally applies when the services at issueare intermediary in nature, and the cost of services plus method applies when thetested party renders the same services to both affiliated and independent companies.Under the fifth and sixth fact patterns, one’s choice between the resale price and costplus methods would be dictated by each group member’s ownership of intellectualproperty and the relative values thereof. Under the last fact pattern, the choice ofmethods depends on whether the licensee is a manufacturer or a distributor.The U.S. regulations impose higher standards of comparability under the resaleprice and cost plus methods, as compared to the CPM: Products must be “ofthe same general type (e.g., consumer electronics),” 11 and the parties being comparedshould perform similar functions, bear similar risks and operate under similarcontractual terms. As previously noted, the OECD Guidelines do not differentiate11 See Treas. Reg. Section 1.482-3(c)(3)(ii)(B).
3.2 Resale Price and Cost Plus Methods 19between transfer pricing methods in establishing comparability criteria to the samedegree as the U.S. regulations. Such criteria include the character of the propertyor service, the functions performed by the parties, contractual terms, economic circumstancesand business strategies.3.2.2 Description of Resale Price and Cost Plus MethodsBriefly stated, under the resale price method, one compares the captive distributor’sgross margin on product sourced from affiliated companies with its gross marginon product sourced from unaffiliated companies. If the captive distributor doesnot source similar products from both affiliated and unaffiliated companies, onecan compare its resale margin on products sourced from affiliated suppliers withthe resale margins reported by unaffiliated distributors that source similar productsfrom independent suppliers. An analogous comparison is made under the cost plusmethod and the cost of services plus method, except that the profit level indicatordiffers. More particularly, under the cost plus and cost of services plus methods, theprofit level indicator is equal to gross profits divided by cost of goods (or services)sold.3.2.3 Underlying Economic RationaleUnder one interpretation, the resale price method, applied to internal transactions,presupposes that individual distributors would pay similar purchase prices to theirmultiple suppliers on an arm’s length basis and charge their unrelated customerssimilar selling prices. This set of assumptions, in turn, implies that (a) suppliersoperate in the same competitive market or have no binding capacity constraintsand value the subject distributor’s business relatively highly, and (b) the distributorcannot (and is not forced to) differentiate among its customers in establishingits selling prices. If the resale price method depends on these assumptions for itsvalidity, gross margin comparisons would only be valid if the products generatingsuch margins are quite similar, not simply of the “same general type”. Similarly,the cost plus method, applied to internal transactions, may presuppose that individualmanufacturers are unable to differentiate among customers in establishing theirselling prices, and employ the same or similar technologies in producing productfor different customers. Again, under this rationale, the products on which markupsare being compared must be closely similar.Alternatively, the economic rationale for internal comparisons of resale marginsor cost plus markups may simply be that individual distributors and manufacturerswould necessarily earn a reasonably uniform gross margin or markup across transactions,consistent with the return that investors would require. As applied to externaltransactions, the only economic rationale for the resale price and cost plus methodswould seem to be that market forces will equalize resale margins and gross markupsacross firms.
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3.2 Resale Price and Cost Plus Methods 19between transfer pricing methods in establishing comparability criteria to the samedegree as the U.S. regulations. Such criteria include the character of the propertyor service, the functions performed by the parties, contractual terms, economic circumstancesand business strategies.3.2.2 Description of Resale Price and Cost Plus MethodsBriefly stated, under the resale price method, one compares the captive distributor’sgross margin on product sourced from affiliated companies with its gross marginon product sourced from unaffiliated companies. If the captive distributor doesnot source similar products from both affiliated and unaffiliated companies, onecan compare its resale margin on products sourced from affiliated suppliers withthe resale margins reported by unaffiliated distributors that source similar productsfrom independent suppliers. An analogous comparison is made under the cost plusmethod and the cost of services plus method, except that the profit level indicatordiffers. More particularly, under the cost plus and cost of services plus methods, theprofit level indicator is equal to gross profits divided by cost of goods (or services)sold.3.2.3 Underlying Economic RationaleUnder one interpretation, the resale price method, applied to internal transactions,presupposes that individual distributors would pay similar purchase prices to theirmultiple suppliers on an arm’s length basis and charge their unrelated customerssimilar selling prices. This set of assumptions, in turn, implies that (a) suppliersoperate in the same competitive market or have no binding capacity constraintsand value the subject distributor’s business relatively highly, and (b) the distributorcannot (and is not forced to) differentiate among its customers in establishingits selling prices. If the resale price method depends on these assumptions for itsvalidity, gross margin comparisons would only be valid if the products generatingsuch margins are quite similar, not simply of the “same general type”. Similarly,the cost plus method, applied to internal transactions, may presuppose that individualmanufacturers are unable to differentiate among customers in establishing theirselling prices, and employ the same or similar technologies in producing productfor different customers. Again, under this rationale, the products on which markupsare being compared must be closely similar.Alternatively, the economic rationale for internal comparisons of resale marginsor cost plus markups may simply be that individual distributors and manufacturerswould necessarily earn a reasonably uniform gross margin or markup across transactions,consistent with the return that investors would require. As applied to externaltransactions, the only economic rationale for the resale price and cost plus methodswould seem to be that market forces will equalize resale margins and gross markupsacross firms.
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