Understanding the Resale Price Method in Transfer Pricing
This article relates to the following articles:
- Essential Components of Transfer Pricing Documentation
- The Importance of Thorough Economic Analysis in Transfer Pricing
The Resale Price Method in Transfer Pricing is a fundamental approach used by multinational enterprises (MNEs) to ensure compliance with international tax regulations. This method is crucial for determining the arm’s length price of transactions between related entities. In this guide, we will delve into the specifics of the Resale Price Method, providing detailed examples and best practices to help you understand its application and significance.
What is the Resale Price Method?
The Resale Price Method (RPM) is one of the traditional transaction methods used in transfer pricing to determine the arm’s length price of goods sold between related parties. It focuses on the resale price of a product when sold to an independent third party, subtracting an appropriate gross margin to cover the reseller’s costs and profits.
Key Elements
- Resale Price: The price at which a product that has been purchased from a related party is resold to an independent third party.
- Gross Margin: The difference between the resale price and the cost of goods sold, representing the profit margin.
- Comparable Uncontrolled Transactions (CUT): Transactions between independent entities that are used as benchmarks to determine the appropriate gross margin.
How the Resale Price Method Works
The RPM is typically applied in situations where the reseller does not add significant value to the goods or services. It is most effective with reliable data on comparable transactions and gross margins.
The RPM involves the following steps:
- Identify the Resale Price: Determine the price at which the goods or services are resold to an independent third party.
- Determine the Gross Margin: Analyze comparable uncontrolled transactions to establish a gross margin. This involves reviewing industry standards, historical data, and financial statements of similar companies.
- Calculate the Arm’s Length Price: Subtract the appropriate gross margin from the resale price to arrive at the transfer price.
- Adjust for Differences: If there are differences between the controlled and uncontrolled transactions, make necessary adjustments to ensure comparability.
When to Use the Resale Price Method
The RPM is most appropriate in scenarios where:
- The reseller does not add significant value to the product.
- Comparable gross margins are available for similar transactions.
- The product is resold within a short time frame after purchase.
Benefits of the Resale Price Method
- Simplicity: RPM is relatively straightforward to apply when comparable gross margins are available.
- Reliability: It provides a reliable measure of arm’s length pricing for distributors and resellers.
- Compliance: Helps in maintaining compliance with international tax regulations, thereby reducing the risk of tax disputes.
Challenges and Limitations
- Data Availability: Requires reliable data on comparable gross margins, which may not always be available.
- Product Comparability: Less effective if the products sold undergo significant modifications or if there are substantial differences in functions performed by the reseller.
- Market Conditions: Changes in market conditions over time can affect the resale price and gross margins, complicating the analysis.
Best Practices for Implementing the Resale Price Method
Data Collection
- Industry Analysis: Conduct a thorough analysis of the industry to identify relevant gross margins.
- Comparable Selection: Choose comparables that closely match the functions, assets, and risks of the controlled transaction.
- Documentation: Maintain detailed documentation of the methodology, data sources, and adjustments made to support the transfer pricing analysis.
Regular Review
- Monitor Market Conditions: Regularly review and update the gross margin data to reflect current market conditions.
- Adjust for Changes: Adjust the transfer pricing policy for any significant changes in the business model or market environment.
Examples of the Resale Price Method
Example 1
Consider a U.S. company that purchases running shoes from a related entity in Ireland and similar shoes from an unrelated supplier. The U.S. company sells these shoes to independent retailers. To apply the RPM:
- Identify the Resale Price: The resale price to independent retailers is $100.
- Determine the Gross Margin: The gross margin earned on sales to independent retailers is 30%.
- Calculate the Arm’s Length Price: The arm’s length price for the shoes purchased from the related entity would be calculated as follows:
- Arm s Length Price=Resale Price×(1−Gross Margin)Arm s Length Price=Resale Price×(1−Gross Margin)
- Arm s Length Price=100×(1−0.30)=70Arm s Length Price=100×(1−0.30)=70
I this example, to comply with the arm’s length principle, the U.S. company should pay $70 per pair of shoes to its related entity in Ireland.
Example 2
Consider a multinational company, ABC Corp, that sells electronic gadgets. ABC Corp’s subsidiary in Country A purchases these gadgets for resale in Country A’s market. The subsidiary resells the gadgets to independent retailers.
- Identify the Resale Price: The subsidiary sells the gadgets to retailers for $150 each.
- Determine the Gross Margin: Based on comparable uncontrolled transactions, the industry-standard gross margin for electronic gadgets is 30%.
- Calculate the Arm’s Length Price:
- Gross Margin = 30% of $150 = $45
- Arm’s Length Price = $150 – $45 = $105
- Adjust for Differences: If the subsidiary provides additional services (e.g., warranty, after-sales support), adjustments might be needed to reflect these differences.
In this example, the arm’s length price at which the subsidiary should purchase the gadgets from the parent company is $105.
International Court Cases Involving Resale Price Method
There have been a number of significant judgments around the globe highlighting the Resale Price Method, especially involving manufacturing companies and their distributors. Here are a few to look at:
Coca-Cola Company Case (2021):
The U.S. Tax Court ruled on Coca-Cola’s transfer pricing, focusing on using the resale price method and the comparability of gross margins for its international distribution entities. The court upheld the IRS’s adjustments, emphasising the importance of economic substance and the correct application of transfer pricing methods.
Click here to read our summary of this case
Ferragamo France Case (2020):
The French distribution affiliate of Salvatore Ferragamo SPA faced a dispute with French tax authorities over the application of the RPM. The French tax authorities argued that the affiliate’s operating expense-to-sales ratios were higher than those of third-party distributors. Initially, the Paris Administrative Court ruled in favour of Ferragamo. Still, this decision was overturned by France’s Supreme Administrative Court, which ruled that the affiliate’s higher operating expenses were intended to increase the brand’s value and were not justified by arm’s length margins.
Click here to read our summary of this case
Toyota Motor Europe (2021):
The European Commission reviewed Toyota Motor Europe’s transfer pricing arrangements involving its European distribution subsidiaries. The case highlighted the application of the RPM in determining the appropriate transfer prices for vehicles and parts sold by Toyota’s central purchasing entity to its European distributors. The review found that the applied margins were consistent with the arm’s length principle.
GlaxoSmithKline (Canada) Case (2012):
This case involved GlaxoSmithKline’s use of RPM for its Canadian distribution operations. The Canadian Revenue Agency challenged the appropriateness of the gross margins used, leading to a reassessment of the transfer prices applied to pharmaceutical products sold to the Canadian subsidiary. The courts ultimately sided with GlaxoSmithKline, affirming the use of RPM in this context.
Click here to read our summary of this case
Eaton Corporation Case (2017 & 2022):
The IRS’s cancellation of Eaton’s Advance Pricing Agreements (APAs) led to litigation over transfer pricing methodologies, including the resale price method. The Sixth Circuit ruled in favour of Eaton, highlighting the importance of consistency in applying transfer pricing methods and documenting compliance.
Click here to read our summary of this case
Why Consult Experts
Given the complexities and potential risks associated with transfer pricing, consulting with experts like the team at Tax Risk Management (TRM) can provide valuable insights and ensure compliance with international tax regulations.
- Risk Mitigation: They can help identify and mitigate potential tax risks, reducing the likelihood of disputes with tax authorities.
- Documentation: Proper documentation is crucial for defending transfer pricing strategies during audits. Experts can assist in preparing comprehensive and compliant documentation.
- Strategic Advice: They offer strategic advice tailored to your business needs, helping you optimize your global tax position.
Closing Points
The Resale Price Method in Transfer Pricing is valuable for ensuring that intercompany transactions are conducted at arm’s length.
Businesses can better manage their transfer pricing strategies by understanding their application, benefits, and limitations. Consulting with experts like TRM can provide the necessary expertise and support to navigate the complexities of transfer pricing, ensuring compliance and mitigating risks.
References
