What is the resale price method for estimating transfer price? – New
When the reseller buys and sells goods and services without added value, it would be quite easy to assess the resale margin.
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As we have seen in our previous articles, there are five methods to assess the transfer price, and the resale price method (RPM) is one of them. In RPM, we determine the transfer price by doing the reverse work.
In the transfer pricing guidelines published by the Organization for Economic Co-operation and Development (OECD), RPM has been defined as follows:
“Transfer pricing method based on the price at which a product purchased from an associated enterprise is resold to an independent enterprise. The resale price is reduced by the resale price margin. What remains after subtracting the margin on the resale price can be considered, after adjusting for other costs associated with the purchase of the product (for example, customs duties), to be an arm’s length price of the initial transfer of ownership between the associated companies”
Under this method, the price at which the same product is resold to an independent buyer is adjusted to arrive at the transfer price between related parties or with related persons. The adjustment factors are the resale price margin and other costs directly associated with the purchase and sale price of the product. In simple terms, we can say that the transfer price under the RPM is the resale price minus the resale profit margin minus the costs directly associated with buying and selling the goods and services.
If the reseller resells the products in a controlled environment, we would be required to apply the “internal comparable” and/or the “external comparable”, and if applicable, we would be able to make the adjustment to assess the price of resale.
It would be easy to assess the resale price, but it would be difficult to determine the margin on the resale price. When evaluating the resale price margin, we must consider the cost of operation, selling expenses and an appropriate profit based on the business and functions performed by the reseller. If the reseller performs more business and functions, the resale price margin would be higher for that reseller and vice versa.
When the reseller buys and sells goods and services without added value, it would be quite easy to assess the resale margin. However, if the reseller adds value, such as the reseller takes the semi-finished goods and then adds material, labor, and overhead to convert them into finished goods and resell the finished goods, the margin that reseller’s resale profit would be higher, and it would take more time and calculations to assess the resale price margin.
Some resellers engage in significant business activities such as advertising, marketing, distribution, issuing warranties, financing goods, etc. in addition to the resale activity, and they expect a reasonable resale margin which should be taken into account when assessing the resale price margin.
If there is a chain of distribution of goods through intermediary parties, then it would be important to consider resale price, activities, functions, etc. of all intermediaries instead of the resale price and other activities and functions of the immediate reseller.
Wherever the reseller has exclusive territorial rights, that reseller would expect a slightly higher price margin. The accounting practices (R&D capitalized by one party while the other reseller expensed it) adopted by the reseller would be another key factor that may need to be adjusted to arrive at the resale price margin.
For example, the UAE subsidiary (XYZ) of a Japanese parent company (ABC) sells high quality products in the UAE, which are manufactured by ABC in Japan. The cost of products purchased from ABC is Dhs 100 per unit, while the selling price to the independent party is Dhs. 150 per unit. ABC also sells the same quality of products to an Independent Distributor (PQR) in the UAE. Functional analysis shows that XYZ and PQR perform similar functions. PQR’s gross margin ratio was found to be 10%. XYZ bears the warranty risk costing Dhs 10 per unit, while for products sold by QPR, the warranty risk is borne by ABC. Additionally, ABC provides marketing materials to PQR while XYZ bears its marketing and promotion expenses which cost them Dhs 20 per unit.
From the example above, it is clear that XYZ and PQR perform similar functions, so we can assume their same resale price margin of 10%. If PQR earns 10% of the resale price, we can assume that XYZ will earn the same, i.e. 15 Dhs (150*10%) per unit. XYZ bears additional promotional and warranty risk, so XYZ will charge a premium for this, which will lead to a total resale price margin of XYZ at 45 Dhs [15 (fair market margin)+10 (warranty risk premium+20(promotional cost premium]. If the uncontrolled resale price is 150 Dhs and the fair resale margin price is 45 Dhs, then the purchase price would have been 105 Dhs per unit instead of 100 Dhs per unit (controlled price) at which the goods were purchased from ABC.
RPM is generally more appropriate for distributors and resellers. However, it is information from third parties, such as the 10% margin in the example above, that is difficult to obtain. Also, if the parties have functions, activities, etc. divergent, it is particularly difficult to assess the margin on the resale price.
Mahar Afzal is Managing Partner at Kress Cooper Management Consultants. The above is not an official opinion but a personal opinion of the author based on the Public Consultation Paper on Corporate Tax and the OECD Transfer Pricing Guidelines. For any questions/clarifications, please write to him at [email protected]