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.
This 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 : –
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.
For details of other methods of Transfer Pricing, please click here https://arinjayacademy.com/transfer-pricing-methods/