What is transfer pricing?
When a parent company sells to its subsidiary in another country, the price it charges decides how much profit is taxed in each country. Transfer pricing rules stop groups from shifting profit to low-tax countries through artificial prices.
The arm's length principle
Related parties should price transactions as independent businesses would. This principle is set out in the OECD Transfer Pricing Guidelines and applied by most tax authorities.
Common transfer pricing methods
- Comparable uncontrolled price (CUP): compare with prices between unrelated parties.
- Resale price method: start from the resale price and subtract a normal margin.
- Cost plus method: add a normal markup to costs.
- Transactional net margin method (TNMM): compare net profit margins with comparable companies.
- Profit split method: divide combined profits based on each party's contribution.
What's covered
- Sale of goods between group companies
- Management and shared service fees
- Royalties for brands, software and patents
- Intra-group loans and guarantees
Compliance
Many countries require transfer pricing documentation, such as a master file, local file and, for large groups, country-by-country reporting. Penalties for non-compliance can be significant. See also [holding company](/glossary/holding-company).