Arm’s length price determination process - [in (Malaysian) IRBM Transfer Pricing Guideline 2012]

(Con't from topic Arm’s Length Principle)

b.   Arm’s length price determination process:-

From IRBM Transfer Pricing Guideline 2012, Arm’s length price determination process are explained in details in Para 7, which included 6 steps in no particular order.

1. Analysis of transactions and functions
2. Characterization of business
3. Identification of comparable transactions
4. Tested Party  
5. Selection and application of Transfer Pricing Methodologies (TPM) 
6. Profit Level Indicator (PLI)

To ease reader expect, contain been summarized as follow:-

7.1 Analysis of transactions and functions

- understanding of the related party transactions, business operations, functions performed, assets employed and risks assumed to determine the characterization of the taxpayer's business.

7.2 Characterization of business

- nature of activity:-

(i) manufacturing: full-fledged, licensed, contract or toll;

(ii) distribution: full-fledged, limited risk;

(iii) service provider.

7.3 Identification of comparable transactions

- Transaction level to be compare:-

1. single transaction
2. bundle of transactions
3. results at gross margin level
4. results at net margin level
5. compare results by reference (Return on capital, Ratio of costs to gross margin)

Note:-

Arm’s length range to be considered on each level of comparable transaction. Where the “arm’s length range” refers to a range of figures that are acceptable in establishing the arm‟s length nature of a controlled transaction. [Para 14.1]

The arm's length principle should ideally be applied on a transaction-by-transaction basis – [Para 15.1]

7.4 Tested Party

- tested party is the one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables

- IRBM does not accept foreign tested parties where information is neither sufficient nor verifiable

Note: select a specific subject company which operate in the same/ similar industry

7.5 Selection and application of Transfer PricingMethodologies (TPM) 

[Please click on title for further details]

-  The following methodologies can be used in determining arm’s length price:

Traditional Method

1.      Comparable uncontrolled price method (CUP)

2.      Resale price method (RPM)

3.      Cost plus method (CPM)

Transactional Profit Method

      4.      Transactional Profit Method (TPM) /Profit split method

      5.      Transactional net margin method (TNMM)

[Para 11]

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Note : ‘Transactional profit methods’ be used only when traditional methods cannot be reliably applied or exceptionally cannot be applied at all.

7.6 Profit Level Indicator (PLI)

Factor considered: -

(i) characterization of the business;

(ii) availability of reliable comparable data; and

(iii) the extent to which the PLI is likely to produce a reliable measure of arm‟s length profit.

Common indicator:-

(i) Return on costs: cost plus margin and net cost plus margin.

(ii) Return on sales: gross margin and operating margin.

(iii) Return on capital employed: return on operating assets.