As we discussed in our previous articles that there are five methods to assess the transfer price, and the resale price method (RPM) is one of them. In the RPM, we determine the transfer price by doing the reverse working.
In the transfer pricing guidelines issued by the Organisation for Economic Cooperation and Development (OECD) the RPM has been defined as under:
“A transfer pricing method based on the price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise. The resale price is reduced by the resale price margin. What is left after subtracting the resale price margin can be regarded, after adjustment for other costs associated with the purchase of the product (e.g. custom duties), as an arm’s length price of the original transfer of property between the associated enterprises”
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 the related parties or with the connected persons. The adjustment factors are resale price margin and other costs directly associated with the purchase and sales price of the product. In simple words, we can say that the transfer price under the RPM is resale price less resale profit margin less costs directly associated with the purchase and sales of the goods and services.
If the reseller resells the products in a controlled environment, we would be required to apply “internal comparable” and/or “external comparable”, and wherever required, we would be liable to make the adjustment to assess the resale price.
It would be easy to assess the resale price but determining the resale price margin would be challenging. While assessing the resale price margin, we need to consider the operating cost, selling expenses, and an appropriate profit based on the activities and functions performed by the reseller. If the reseller performs more activities and functions, the resale price margin would be higher for that reseller and vice versa.
Where the reseller buys and sells goods and services without value addition, it would be quite easy to assess the resale margin. However, if the reseller is adding any value, like the reseller is taking the semi-finished products and then adding some material, labour and overheads to convert them into finished goods and reselling the finished goods, such reseller’s resale profit margin would be higher, and it would involve more time and calculations to assess the resale price margin.
Some reseller performs substantial commercial activities like advertising, marketing, distribution, issuing guarantees, financing the goods etc. in addition to the resale activity, and they expect a reasonable resale margin which need to be considered to assess the resale price margin.
If there is a chain of distribution of goods through the intermediate parties, then it would be important to consider the 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, then such reseller would be expecting a slightly higher price margin. Accounting practices (R&D capitalize by one party while other reseller is expensing it out) adopted by the reseller would be another key factor which may need adjustment 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 being manufactured by ABC in Japan. The cost of the products purchased from ABC is Dhs 100 per unit, while the sale 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. The functional analysis shows that XYZ and PQR perform similar functions. The gross profit ratio of PQR was found to be 10 per cent. XYZ bears warranty risks costing Dhs 10 per unit, while for the products sold by the QPR, warranty risk is borne by the ABC. Moreover, ABC provides marketing supports to PQR while XYZ bears its marketing and promotional expenses which cost them Dhs 20 per unit.
From the above example, it is clear that XYZ and PQR are performing similar functions, so we can assume their same resale price margin of 10 per cent. If PQR is earning 10 per cent of the resales price, then we can assume that XYZ will earn the same, which is Dhs 15 (150*10 per cent) per unit. XYZ is bearing extra promotional and warranty risk, so XYZ will charge a premium for this, which will lead to a total resale price margin of XYZ to Dhs 45 [15 (fair market margin)+10 (warranty risk premium+20(promotional cost premium]. If the uncontrolled resale price is Dhs 150, and the fair resale margin price is Dhs 45, then the purchase price would have been Dhs 105 per unit instead of Dhs 100 per unit (controlled price) at which goods have been bought from ABC.
The RPM is typically most appropriate for distributors and resellers. However, it involves information from third parties like the 10 per cent margin in the above example, which is difficult to get. Moreover, if the parties have divergent functions, activities etc., it is particularly challenging to assess the resale price margin.
Mahar Afzal is a managing partner at Kress Cooper Management Consultants. The above is not an official but a personal opinion of the writer based on the public consultation document on corporate tax and OECD transfer pricing guidelines. For any queries/clarifications, please write to him at email@example.com.
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