CUP Method

Internal CUP

Tai Co of Taiwan sold 500 units DVD player to its related party wholesaler BDCo, of Bangladesh for $20 each on c.i.f. basis. DVD
players are sold with remote control, and connection cable. BDCo sells DVD player at its own brand name "Best Video"; brand
name is labeled locally for $1 for 4 players (BDCo bear the cost of labeling). BDCo sold each DVD player for $25.

TaiCo also sold 600 units of the same DVD player to Best Electronics, an independent importer @10 each on f.o.b. basis. A brand
name "B+B26E" was labeled by TaiCo. The price of DVD player does not include remote control and connection cable. Remote
controls are procured locally for $1 each, and connection cable costs $2 for each dozen. Transportation cost from Taiwan to
Chittagong port is $1 for each DVD player.

Answer:

Arm's length price determination for transaction between TaiCo and BDCo

Amount
Unit price charged to BDCo (AE) $20.00

Unit price charged to DE (Third party) $10.00

Add. Cost of Remote control $1.00
Add. Cost of Connection cable $0.17
Add. Transport cost per unit $1.00
Deduct. Labeling cost ($0.25)
Adjusted unit price* $11.92

Arm's length price per unit using internal CUP $13.75

Transfer pricing adjustment in US$ (500*($20-$13.75)) $3,125.00

Transfer pricing adjustment in BDT (1 US$ = 82 Taka) 256,250.00

*If insurance cost can be quantified, this cost must be adjusted (added) with price charged to Dhaka Electronics.

External CUP

let's assume external quoted price is avaiable in asian DVD player market. These prices are available in different key market in
Asia. (Note: In reality quoted prices of some standard goods like gas, oil, ammonia etc are avaiable in open market.)

Quoted price
Market (only DVD
player)
India $17.00
China $13.00
Japan $25.00

Answer:

Arm's length price determination for transaction between TaiCo and BDCo

There is no specific guidance on how to determine External CUP using external quoted price when multiple quoted prices are
available. Common practice is using average of quoted prices.

Usine average quoted price of the above three market:

Amount
Arm's length price per unit using external CUP (Average Price) $18.33
Unit price charged to BDCo by AE (A) $20.00
Less. Remote control and connection cable price (B) $3.00
Adjusted unit price charged to BDCo by AE (A-B) $17.00

Transfer Pricing adjustment is not required because AE charged lower price than the external quoted prices of similar DVD player.
Note 1: Remote control and connection cable prices are adjusted with unit price charge by AE because external quoted prices of
DVD player are exclusive of these prices.
Resale Price Method

DhCo, a distributor, is a Bangladesh subsidiary of HKCo (Hong Kong). DhCo distributed 500 units of DVD players manufactured by
HKCo. The purchase price of DhCo is $19 per unit. DhCo resells DVD players to independent parties for $20. City Electronics of
Bangladesh purchased 600 units of similar products from HKCo. The gross margin ratio of City Electronics is 10%.

DhCo gives 1 year warranty for the products. Warranty risk is borne by DhCo. City Electronics does not bear any warranty risk.
Warranty cost is estimated at $1 for 5 units.

HKCo provides packing materials to City Electronics, while DhCo procures packing materials locally for $1 per unit.

Answer:

Arm's length price determination for transaction between HKCo and DhCo

Amount
Resale price per unit $20.00
Comparable gross margin 10% (earned by City Electronics) $2.00
Arm's length Price $18.00
Deduct. Warranty cost ($0.20)
Deduct. Packing material cost ($1.00)

Adjusted Arm's length Price $16.80

Price charged by HKCo $19.00

Transfer pricing adjustment in US$ (500*($19-$16.80)) $1,100.00

Transfer pricing adjustment in BDT (1 US$ = 82 Taka) 90,200.00
Cost Plus Method
Co A of country A sells all of its manufactured goods to Co B (35 taka) of country B and Co B sells those products to unrelated
parties of country B.
in Taka
Particulars Co A FS Comparable FS
Sales 35 50
COGS (25) (30)

Gross Profit 10 20
Operating expenses (10) (15)

Operating Profit - 5

All the manufacturing costs (direct and indirect) of both Co A and comparable Co are of similar nature except the situations
described below (I, II and III). Determine the arm's length price of transaction between Co A and Co B using Cost-plus method.
I) Co A charged warranty cost of taka 5 in COGS and Comparable Co charged same cost of taka 5 in operating expenses.
II) Co A charged warranty cost of taka 2 in COGS and Comparable Co charged some cost (exact amount can’t be determined) in
operating expenses.
III) Co A charged warranty cost in COGS and Comparable Co charged same cost in operating expenses (both amount can’t be
determined).

Answer:

Situation I:

Amount
Comparable Co manufacturing costs (direct and indirect) 30.00
Add. Warranty cost (to make the cost base same as Co A) 5.00
Adjusted Comparable manufacturing costs (direct and indirect) 35.00
Adjusted gross profit 15.00
Cost plus mark-up 42.86%

Mark up 10.71
Arm's length price of transaction between Co A and Co B will be 35.71
Transfer pricing adjustment will be 0.71

Situation II:

Amount
Comparable Co manufacturing costs (direct and indirect) 30.00
Gross profit 20.00
Cost plus mark-up 66.67%

Co A manufacturing costs (direct and indirect) 25.00

Deduct. Warranty cost (to make the cost base same as Comparable Co) 2.00
Adjusted Co A manufacturing costs (direct and indirect) 23.00

Arm's length price of transaction between Co A and Co B will be 38.33

Transfer pricing adjustment will be 3.33

Situation III:

In this situation adjustment can't be made accurately to the cost bases to turn them into similar cost bases. That's why cost-plus
method can’t be applied here to determine the arm's length price of the transaction between Co A and Co B. It is recommended to
use TNMM in this situation to determine arm's length price.
Profit Split Method

Co A of country A sells all of its manufactured goods to Co B of country B (AE of Co A) and after further processing Co B sells those
products to unrelated parties of country B.
Profit & Loss Statement of Co A and Co B
in Taka
Particulars Co A Co B
Sales 50 100
Purchase (10) (50)
Manufacturing costs (15) (20)

Gross Profit 25 30

R&D (15) (10)

Operating expenses (10) (10)

Operating Profit - 10

It is established, for both jurisdictions, that third-party comparable manufacturers without unique and valuable intangibles
earn a return on manufacturing costs (excluding purchases) of 10% (ratio of net profit to the direct and indirect costs
of manufacturing).

Recalculate Arm's length profit of Co A and Co B using profit split method.

Answer:

Calculation of residual profit:

Particulars Amount
Total operating profit earned by Co A and Co B 10.00

Return on manufacturing costs by Co A 1.50

Return on manufacturing costs by Co B 2.00

Residual profit 6.50

Allocate residual profit

Total R&D costs borne by Co A and Co B 25

Proportion of R&D expense borne by Co A 60%
Proportion of R&D expense borne by Co B 40%

Recalculation of profits

Co A's operating profit would be 5.40

Co B's operating profit would be 4.60

Profit & Loss Statement of Co A and Co B (Adjusted)

Particulars Co A Co B
Sales 55.40 100.00
Purchase (10.00) (55.40)
Manufacturing costs (15.00) (20.00)

Gross Profit 30.40 24.60

R&D (15.00) (10.00)

Operating expenses (10.00) (10.00)

Operating Profit 5.40 4.60

Transactional Net Margin Method

Particulars Tax Payer FS Comparable FS

Sales 2,000 2,500
COGS* 1,600 2,000
Gross Profit 400 500
Operating expenses 320 350
Operating Profit 80 150

Operating Margin 4% 6%

*Tax payer is a trading company and COGS includes only goods purchased from AE.

Transfer Pricing Adjustment Calculation

Particulars Tax Payer FS

Sales 2,000
COGS* 1,560
Gross Profit 440
Operating expenses 320
Operating Profit 120

Operating Margin 6%

*Adjusted price of goods purchased from AE will be 1,560 taka and transfer pricing adjustment will be 40 taka.
Note 1: Transfer pricing adjustment need to be shown in tax payer corporate tax calculation not in FS.
Note 2: Only upward transfer pricing adjustment is permissible.