Transfer pricing template

Transfer pricing isn’t just an issue for global companies trading with each other across borders. It’s based on the principle that transactions for goods or services sold between related parties, such as between two connected companies or between a company and a director, should be accounted for on an “arm’s length” basis. So you may well need to establish what a transfer price should be.

Relevancy

If you carry out inter-company business or transact with related parties, ensure you reflect the transactions in your management accounts at their open market value. This means that the amount charged by one related party to another for a given product must be the same as if the parties were not related. An arm’s length price for a transaction is, therefore, what the price of that transaction would be on the open market.

The arm’s length basis has been adopted by the Taxman as his standard for tax purposes for companies’ related party transactions (although there are some exemptions for inter-company transactions in small and medium-sized groups). Even if your company is an exempt group, accounting for transfer prices is still relevant for your management accounts in order to reflect the “true” profits in each company.

Arm’s length prices

Usually, the best way to calculate transfer prices is by using the comparable uncontrolled price method (CUP). This uses the price your company normally buys or sells that item for, in those quantities, to its customers.

But how do you determine the arm’s length transfer price charged to your company for distributing a product on behalf of a group company that manufactured the product? In this case, you could use the resale price method (RPM). This takes the selling price you charge your customer and deducts a gross margin that reflects those earned by group companies or competitors on similar transactions. The margin should recover your operating costs and leave a reasonable profit.

Unfortunately, it’s not always going to be possible to discover or calculate the information you need to use the CUP or RPM methods. The most common solution will be to use the profit split method (PSM). With this you calculate the total operating profit (before interest and tax) earned across the group on the transaction. Then split the profits across the group in proportion to the value added by each entity. When apportioning the profits, don’t forget to take into account the assets used and risks borne by the respective group companies.

Whichever method(s) you use, ensure that you document them so that you can justify the prices used, if asked. Our Transfer Pricing Template has separate sheets for calculating the CUP, RPM and PSM methods.