Glossary

Plain-English definitions of the transfer pricing terms used across the tools and guides.

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57 terms

A

Advance pricing agreement (APA): An agreement between a taxpayer and one or more tax authorities that sets the transfer pricing method for certain transactions for future years. It gives certainty in exchange for upfront work and disclosure.
Allocation key: A measure used to share a cost among the group companies that benefit, such as headcount, sales or number of invoices. A good key reflects how much each company uses or benefits from the service.
Arm's length principle: The rule that related companies should price their dealings the way unrelated companies would in the same situation. It is the foundation of both Section 482 and the OECD Guidelines.
Arm's length range: The range of results from reliable comparables. A tested result inside the range is treated as arm's length.

B

Benchmark / comparables: A benchmark is a study of independent companies or transactions (the comparables) that are similar enough to the tested party. Their results form the arm's length range.
Benefit test: The test for whether an intra-group service can be charged at all. The OECD asks whether an independent company in the same position would pay for the activity or do it itself (para 7.6). The US asks whether it gives the recipient a reasonably identifiable increase in economic or commercial value (Treas. Reg. § 1.482-9(l)(3)).
BEPS / Action 13: BEPS (base erosion and profit shifting) is an OECD and G20 project against tax planning that shifts profit to low-tax places. Action 13 created the three-tier documentation: Master File, Local File, and Country-by-Country report.
Berry ratio: Gross profit divided by operating expenses. It is often used for distributors and service providers whose value comes mainly from their operating activities.
Best method rule: The US rule that the arm's length result must be set using the method that gives the most reliable measure on the facts. There is no strict order of methods (Treas. Reg. § 1.482-1(c)).
Business judgment rule: A condition of the US services cost method. A service can be charged at cost only if the company reasonably concludes, in its business judgment, that the service does not contribute significantly to the group's key competitive advantages, core capabilities, or fundamental risks of success or failure (Treas. Reg. § 1.482-9(b)(5)).

C

Comparability adjustment: A change made to a comparable's price or results to remove the effect of a difference from the tested deal, such as freight, payment terms or working capital. It should only be made when the effect can be measured reliably.
Comparable profits method (CPM): A US method that tests a company's operating profit against the operating profit of comparable companies, using a profit level indicator such as operating margin (Treas. Reg. § 1.482-5). It is close to the OECD's TNMM.
Comparable uncontrolled price (CUP): A method that compares the related-party price with the price charged in a comparable deal between unrelated parties. It is the most direct method when good comparables exist.
Constituent entity: Any company or permanent establishment that is part of a multinational group for CbC reporting or Pillar Two purposes. Each one is listed in the group's CbC report.
Contract manufacturer: A company that makes goods for another group company, to that company's orders and specifications, often using its technology. It bears little risk and earns a routine return, usually a markup on its costs.
Contribution analysis: A way to apply a profit split: divide the combined profit between the companies by the relative value of what each contributes, such as functions performed, assets used and risks assumed. The OECD Guidelines describe it next to the residual analysis (para 2.150).
Cost plus method: A method that adds an arm's length gross markup to the supplier's cost of goods. It is common for manufacturers and service providers.
Comparable uncontrolled transaction (CUT): The US method for intangibles that compares the royalty in a related-party license with the terms of a comparable license between unrelated parties (Treas. Reg. § 1.482-4(c)). It is the intangibles version of CUP.
Country-by-Country (CbC) report: An annual report that large multinational groups file showing revenue, profit, tax, employees, and assets for each country where they operate. It applies to groups with consolidated revenue of EUR 750 million or more (USD 850 million in the US).
CTA (cumulative translation adjustment): The part of equity that collects gains and losses from translating a foreign subsidiary's books into the parent's reporting currency. It stays out of profit until the subsidiary is sold or liquidated (ASC 830).

D

DEMPE: Development, Enhancement, Maintenance, Protection, and Exploitation of intangibles. Under the OECD Guidelines, the entities that perform and control these functions should share in the return from the intangible.

E

ETR (effective tax rate): Total income tax expense divided by pre-tax income. A group ETR shows the overall tax burden across all countries.

F

FAR (functions, assets, risks): The analysis of what each company does, what it owns, and what risks it bears. It decides which entity is routine and which is the principal, and drives method selection.
Functional currency: The currency of the main economic environment a company operates in: the one it mostly earns and spends cash in. It is usually the currency the company keeps its books in. Amounts in any other currency are foreign currency and create exchange gains and losses (ASC 830).

G

Gross margin: Gross profit (sales less the cost of the goods sold) divided by sales. It is the measure the resale price method compares.
Gross markup: Gross profit divided by the cost of the goods or services sold. It is the measure the cost plus method compares. Unlike a net markup, it is measured before operating expenses.

I

Intangible: Something of value that is not a physical or financial asset, such as a patent, brand, software or know-how, that a company can own or control and use in its business. Using another company's intangible is usually paid for with a royalty.
Intercompany price: The price one company in a group charges another company in the same group, for example for goods, services or the use of IP. It decides how much of the group's profit, and so its tax, lands in each country. Tax rules require it to be an arm's length price: the price unrelated companies would agree in the same situation.
Internal comparable: A comparable deal between one of the related companies and an unrelated party, such as the same seller selling the same goods to an outsider. Its facts are easy to check, so it is often, but not always, the most reliable comparable.
Interquartile range (IQR): The middle 50% of comparable results, from the 25th to the 75th percentile. The US rule (Treas. Reg. § 1.482-1(e)(2)(iii)(C)) picks actual comparable results or averages two of them, while Excel's PERCENTILE.INC interpolates between values, so the two can give slightly different ranges.

L

Local File: The country-specific transfer pricing report that describes the local entity, its intercompany transactions, and the analysis supporting their prices.
Low value-adding services: The OECD term for routine support services, such as payroll or accounts payable, that are not part of the group's core business. Groups can choose a simplified approach that charges them at cost plus 5% with no benchmark study, where the countries involved accept it (OECD Guidelines 7.43 to 7.65).

M

Master File: A group-wide overview of the business, its intangibles, financing, and overall transfer pricing policies. Countries that follow BEPS Action 13 can ask for it; the US does not require one.
Median adjustment: If a US taxpayer's result falls outside the interquartile range, the IRS will ordinarily adjust it to the median of the comparables (Treas. Reg. § 1.482-1(e)(3)).

N

Net cost plus: Operating profit divided by total costs (cost of sales plus operating expenses). It is the usual profit level indicator for routine manufacturers and service providers.

O

Operating margin: Operating profit divided by sales. It is the most common profit level indicator for distributors.

P

Pillar Two / GloBE: A global minimum tax of 15% for groups with consolidated revenue of at least EUR 750 million in 2 of the 4 prior years. The rate is tested per country using a blended rate for all entities there, and the substance-based income exclusion (SBIE) shields a return on local payroll and tangible assets from top-up tax.
PLI (profit level indicator): A ratio used to compare profits, such as operating margin, net cost plus, or the Berry ratio. The right PLI depends on the tested party's functions and the data available.
Principal: The group company that makes the key decisions, owns or controls the valuable assets such as IP, and bears and controls the main business risks. It keeps the residual profit or loss.
Profit split method: A method that splits the combined profit from a transaction between the parties based on their contributions. It suits deals where both sides make unique, valuable contributions.

R

Resale price method: A method that starts from the price a distributor resells at and subtracts an arm's length gross margin to get the transfer price.
Residual profit: The profit left after every routine function has been paid its routine return. It usually goes to the principal.
Return on assets: Operating profit divided by the operating assets a company uses. It is a profit level indicator sometimes used for manufacturers whose assets drive their profit. US rules call it the rate of return on capital employed.
Routine return: A modest, steady profit for low-risk activities such as contract manufacturing, distribution, or support services, set by reference to comparable companies.
Royalty: A fee paid for the right to use another company's intangible, such as a patent, brand or software. It is usually a percentage of the user's sales.

S

Secondary adjustment: A follow-on adjustment after a transfer pricing adjustment, so the cash matches the corrected profit. For example, the extra amount may be treated as a deemed dividend or capital contribution, or repaid.
Section 482: The US Internal Revenue Code section that lets the IRS reallocate income between related companies to reflect arm's length results. Its Treasury regulations are binding in the US.
Section 6662 penalties: US penalties on tax underpayments from transfer pricing adjustments: 20% for a substantial misstatement and 40% for a gross misstatement. Contemporaneous documentation can protect against them.
Services cost method: A US option to charge certain routine support services at cost with no mark-up. It covers services on the IRS list (Rev. Proc. 2007-13) and services whose usual mark-up is 7% or less, but not excluded work such as R&D or manufacturing, and not services that are key to the business's success (Treas. Reg. § 1.482-9(b)).
Shareholder activity: Work a parent does only because it owns its subsidiaries, such as its own shareholder meetings, stock exchange filings or raising its own capital. The subsidiaries get no benefit, so the parent cannot charge them for it.

T

Tested party: The company in a transaction whose results are compared with comparables. It is usually the simpler, less complex party, such as a routine distributor or manufacturer.
TNMM (transactional net margin method): The OECD method that tests a company's net profit against comparable companies using a profit level indicator. It is the OECD equivalent of the US CPM.
Traditional transaction methods: The OECD name for the CUP, resale price and cost plus methods. They test the price, or the gross margin, in the deal itself. The other family, transactional profit methods, covers the TNMM and profit split.
Transfer pricing: The rules and methods for setting prices on transactions between companies in the same group, such as goods, services, IP, and loans. Those prices decide how much profit, and tax, lands in each country.
True-up: An adjustment, usually at year end, that moves an entity's actual profit back to its target transfer pricing result. In the US, a true-up can be reported on a timely filed return, but a late or amended return cannot be used to lower taxable income this way (Treas. Reg. § 1.482-1(a)(3)).

U

UPE (ultimate parent entity): The company at the top of a multinational group that is not controlled by another company. It usually files the CbC report.

W

Withholding tax / foreign tax credit: Withholding tax is tax the paying country takes from cross-border payments such as royalties, interest, or dividends. A foreign tax credit lets the receiving company reduce its home-country tax by the foreign tax paid, within limits.

Definitions are simplified for learning. See the Regulations Reference for the source rules.