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 PricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... is a fundamental approach used by multinational enterprisesWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include... (MNEsWhat are Multinational Enterprises (MNEs)? Multinational Enterprises, commonly referred to as MNEs, are corporations that operate in multiple countries through various subsidiaries, branches, or affiliates. These entities maintain a central management structure while leveraging diverse resources, labour markets, and customer bases across borders. The fundamental aspect that distinguishes MNEs from other corporate forms is their cross-border activity, which can include...) to ensure compliance with international tax regulationsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public.... 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 pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... 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

1. Resale Price: The price at which a product that has been purchased from a related party is resold to an independent third party.
2. Gross Margin: The difference between the resale price and the cost of goods sold, representing the profit margin.
3. 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:

1. Identify the Resale Price: Determine the price at which the goods or services are resold to an independent third party.
2. 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.
3. Calculate the Arm’s Length Price: Subtract the appropriate gross margin from the resale price to arrive at the transfer priceTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of....
4. 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 regulationsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public..., thereby reducing the risk of tax disputesTax Disputes arise when there is a disagreement between taxpayers and tax authorities regarding the interpretation or application of tax laws. These disputes may concern various issues such as the accuracy of a tax return, the eligibility for tax deductions or credits, the correct amount of tax liability, or transfer pricing adjustments. Tax disputes can lead to lengthy legal proceedings....

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

1. Industry Analysis: Conduct a thorough analysis of the industry to identify relevant gross margins.
2. Comparable Selection: Choose comparables that closely match the functions, assets, and risks of the controlled transaction.
3. Documentation: Maintain detailed documentation of the methodology, data sources, and adjustments made to support the transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... analysis.

Regular Review

1. Monitor Market Conditions: Regularly review and update the gross margin data to reflect current market conditions.
2. Adjust for Changes: Adjust the transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... 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:

1. Identify the Resale Price: The resale price to independent retailers is $100.
2. Determine the Gross Margin: The gross margin earned on sales to independent retailers is 30%.
3. 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.

1. Identify the Resale Price: The subsidiary sells the gadgets to retailers for $150 each.
2. Determine the Gross Margin: Based on comparable uncontrolled transactions, the industry-standard gross margin for electronic gadgets is 30%.
3. Calculate the Arm’s Length Price:
   • Gross Margin = 30% of $150 = $45
   • Arm’s Length Price = $150 – $45 = $105
4. 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 pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of..., 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 pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... 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 pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... 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)Advance Pricing Agreements (APAs) are formal arrangements between a taxpayer, usually a multinational enterprise (MNE), and one or more tax authorities. These agreements pre-emptively establish the transfer pricing methods for a set of cross-border transactions over a specified period. APAs aim to provide certainty in tax outcomes by mitigating the risk of disputes and double taxation, which are common challenges... led to litigation over transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... methodologies, including the resale price method. The Sixth Circuit ruled in favour of Eaton, highlighting the importance of consistency in applying transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... 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 pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of..., consulting with experts like the team at Tax Risk Management (TRM) can provide valuable insights and ensure compliance with international tax regulationsTax laws form the backbone of any nation’s revenue system, setting the rules that govern how individuals and corporations contribute financially to support government functions. These laws define the types of taxes, the applicable rates, and the regulations regarding payment and compliance. They also outline the rights and obligations of taxpayers, ensuring a balanced and fair approach to funding public....

• Risk Mitigation: They can help identify and mitigate potential tax risksTax Risk refers to the uncertainty surrounding the potential financial or reputational impact of tax-related decisions and events on a business or individual. This risk arises due to various factors, such as complex tax regulations, inconsistent tax authority interpretations, or evolving international tax laws. Effective tax risk management involves identifying, assessing, and mitigating potential tax-related threats to prevent financial penalties,..., reducing the likelihood of disputes with tax authorities.
• Documentation: Proper documentation is crucial for defending transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... 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 PricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... is valuable for ensuring that intercompany transactionsIntra-Group Transactions are interactions between entities within the same multinational enterprise (MNE). Such transactions form the backbone of related-party dealings and are essential in managing global operations and aligning business objectives across jurisdictions. Understanding intra-group transactions is critical in international tax and transfer pricing, as they directly impact a company's tax obligations, profitability, and compliance standing. Tax professionals, accountants, lawyers,... are conducted at arm’s length.

Businesses can better manage their transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... 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 pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of..., ensuring compliance and mitigating risks.

References

• OECD Transfer Pricing Guidelines
• IRS Transfer Pricing Documentation
• Tax Risk Management
• Valentiam
• Rödl & Partner