COST PLUS METHOD (“CPM”)
Under Cost plus method, the arm’ s length price is determined by adding appropriate gross profit margin, also known as the cost plus mark up, (considering the function performed, return on capital and risk assumed by an entity) to the AE’s cost of producing goods/ providing services.
In other words, ALP =
Cost Plus Method is most suitable in cases, where a manufacturer sells tangible goods to both related and unrelated parties.
As per the Organisation for Economic Co-operation and Development (OECD), Cost Plus Method is applicable when,
- Semi-finished goods are sold between Associated Enterprises,
- There are long term supply and purchase agreements between Associated Enterprises,
- Provision of services between Associated Enterprises,
- Agreements relating to contract manufacturing, between Associated Enterprises.
STEPS INVOLVED IN COST PLUS METHOD
STEP 1: – Direct and indirect costs of production
Determine the direct and indirect costs of production in a tested party transaction.
STEP 2: – Determine normal gross profit mark-up to such costs
Determine the amount of a normal gross profit mark-up to such costs, arising from the transfer or provision of the same or similar goods or services : –
- by the enterprise itself, (i.e., transfer of similar goods or services by the enterprise – Internal Comparable), or
- by an unrelated enterprise to another unrelated enterprise (i.e., transfer of similar goods or services between unrelated parties) – External Comparable,
in a comparable uncontrolled transaction, or a number of such transactions.
STEP 3: –
The normal gross profit mark-up determined above shall be adjusted to account for the functional and other differences.
STEP 4 in Cost Plus Method : –
The costs referred to in Step 1, shall be increased by the adjusted profit mark-up calculated in Step 3 leads to arm’s length price.
JUDICIAL RULINGS ON THE SELECTION OF CPM
For details of other methods of Transfer Pricing, go through