In a world where indirect, comparables-based transfer pricing methods like the Comparable Profits Method (CPM) reign supreme, don't forget about the Profit Split Method.
Let's start with a crash course on the two referenced methods. The CPM evaluates whether the amount charged in a controlled transaction is arm's length based on objective measures of profitability derived from uncontrolled taxpayers that engage in similar business activities under similar circumstances.
The PSM, by contrast, starts with overall profits of a group; PSM allocates the profits derived from a controlled transaction between the transaction participants. It aims for an arm's-length "split" of profits, reflecting the contributions of each party.
There are a host of reasons that this historically neglected method is becoming increasingly relevant to multinational enterprises (MNEs) in a wide array of industries, transaction categories, and sizes. For example:
- Increased complexity and ambiguity in the relative functions, assets, and risks undertaken by parties to intercompany transactions in today's MNE contexts.
- A keener and more explicit interest among jurisdictional and supranational organizational authorities in allocating taxable income in more economically appropriate, often top-down, ways.
- A trend toward misinterpretation/misapplication of the CPM among tax administrations, who use qualitative and financial arguments to assert higher fixed returns for distributors, service providers, and the like.
A confession: I'd set out drafting this post with the explicit goal of making it through an entire submission without once mentioning tariffs - and I'm about to fail in that mission. In addition to the above, the PSM can help explain and/or justify erratic or unexpected results due to the allocation of tariff and other unique, jurisdiction-specific expenses.
Taxpayers should consider the PSM as a primary or corroborative method for its ability to paint a holistic picture of a MNE's value chain and profit allocation.
Chad Martin directs Eide Bailly's Transfer Pricing Services practice.
