New on FinoLib · Volume III: Finance Encyclopedia
I have just published a new article on FinoLib, my free finance education library: Transfer Pricing Methods Explained: CUP, TNMM and More. It is part of Volume III: Finance Encyclopedia. Below is a summary of the topic in plain, expert language, so you can follow the idea even before you open the full article.
The idea in plain words
Five OECD methods test whether a group’s internal prices are fair: comparable uncontrolled price, resale price, cost plus, the transactional net margin method (TNMM) and profit split. TNMM, known in the US as the comparable profits method, dominates because the margins of comparable companies are available. Profit split is used when both sides contribute something unique.
Key points
■TNMM tests the simpler party with a profit level indicator, such as markup on total costs, against a range of comparables.
■US rules use the interquartile range and adjust results outside it to the median.
■CPM/TNMM was used for 86% of the tangible and intangible transactions in APAs the IRS executed in 2025.
■In the worked example, pricing below the range pays only if the chance of challenge is under 16%.
A closer look
Applying the arm’s length principle in practice requires an actual methodology for determining what an independent party would have charged. Several standard methods exist, each suited to different types of intercompany transactions.
The first three are traditional transaction methods, which test prices or gross margins; TNMM and profit split are transactional profit methods, which test operating profit. The US regulations use slightly different names: the comparable profits method (CPM) is the US counterpart of TNMM, and the comparable uncontrolled transaction (CUT) method is the CUP for intangibles. Neither system imposes a strict order. The OECD asks for the “most appropriate method” and the US for the “best method,” meaning the one that gives the most reliable measure on the facts. In practice the one-sided margin method dominates: in the IRS’s report on APAs executed in 2025, CPM/TNMM was used for 86% of the tangible-property and intangible-property transactions covered.
A worked example
Worked Example — Compare the Scenarios: Setting a Contract Manufacturer’s Markup Under TNMM
Facts (illustrative). A US parent buys components from its contract-manufacturing subsidiary in Country F, which taxes profit at 25%; the US rate is 21%. The subsidiary’s total costs are $200 million a year and the group’s combined pre-tax profit is $50 million. The subsidiary is the tested party; the profit level indicator is markup on total costs. Ten independent contract manufacturers earned: 3.1%, 4.2%, 4.8%, 5.5%, 6.0%, 6.4%, 7.1%, 7.8%, 8.5% and 9.6%. Assume Country F uses the interquartile range and adjusts to the median, as the US does. The range. 25th percentile: 10 × 25% = 2.5, so the 3rd value, 4.8%. 75th percentile: 10 × 75% = 7.5, so the 8th value, 7.8%.
Decision rule
Choose the method from the facts, then set the price at the middle of the range. If an identical product or license trades between unrelated parties on similar terms, use CUP (CUT for intangibles). If one party performs only routine functions, test that party with TNMM/CPM, using markup on costs for manufacturers and service providers and operating margin on sales for distributors. If both parties contribute unique intangibles or the operations are so integrated that neither can be tested alone, use a residual profit split.
The costliest mistake
Setting prices in January and never checking them. Standard intercompany prices are fixed before the year starts; actual costs then drift. In the worked example, a subsidiary priced for a 6.2% markup whose costs overrun can finish the year at 2.0%, outside the range. The tax authority adjusts it back to the median, an $8.4 million adjustment, and unless the other country gives relief the group pays tax twice on it: 21% × $8,400,000 = $1,764,000 of double tax in a single year, before interest and penalties.
Edge Cases: When the Standard Answer Changes
The default (benchmark the simpler party with TNMM, accept the range) bends in these situations, all addressed in the OECD Transfer Pricing Guidelines 2022. Situation What changes Why A routine entity reports losses year after year Authorities adjust it back to a positive routine return The Guidelines state that simple or low-risk functions are not expected to generate losses for a long period; independent firms would stop Low value-adding services (payroll, IT help desk, bookkeeping) A simplified cost plus 5%…
Recap
CUP, resale price, cost plus, TNMM and profit split are the five OECD methods; TNMM (the US comparable profits method) dominates, and profit split applies when both sides contribute something unique. The worked example shows why pricing below the comparable range pays only if the chance of challenge is low (16% there), so target the median and true up before year-end.
What the full article covers
The full article includes worked examples, a clear decision rule, the one mistake that costs people the most, a recap, a reveal-on-click quiz and the official sources behind every figure.
Volume III: Finance Encyclopedia
Read the full article on FinoLib
The complete article, Transfer Pricing Methods Explained: CUP, TNMM and More, with every worked example, diagram, quiz and source, is free to read in Volume III, Finance Encyclopedia on finolib.com.
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