Resale Price Method

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An arm's length gross margin for the reseller

The resale price methodResale price methodA method that starts from the price a distributor resells at and subtracts an arm's length gross margin to get the transfer price.Open in the Glossary looks at the reseller's side. Start with the price the reseller gets from independent customers. Take off the gross margin that pays for its work and risks. What is left is the arm's length price it pays its related supplier.

Arm's length price = resale price − (resale price × arm's length gross margin)

It fits a reseller that does not change the goods. Packaging, labelling or minor assembly are fine. Heavy processing, or the reseller's own valuable brand or patents adding much of the value, are not. The gross margin should come from comparable deals, best of all an internal comparableInternal comparableA 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.Open in the Glossary: the same reseller buying and reselling the same kind of goods with outsiders. Otherwise use independent distributors that do similar work, carry similar risks and have similar contracts. In practice there are several of them, so the US rule takes the arm's length range of their margins, usually the interquartile rangeInterquartile 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.Open in the Glossary, and moves a result outside it to the median.

Differences change the margin. If the comparables do more than the Distributor, such as their own marketing, they earn a higher gross margin than it deserves. A comparability adjustmentComparability adjustmentA 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.Open in the Glossary takes that out. The adjustment is an estimate of what the extra work is worth in gross margin, which is not always the same as what it costs, and you make it only when you can measure it reasonably well. The US regulations name marketing and advertising, warranties, stock levels and contract terms as examples.

The catch is the accounting. Gross margin depends on which costs a company puts above the gross profit line. If one distributor counts delivery as part of the cost of its goods and another counts it as an operating cost, their gross margins are not comparable until you move the delivery costs to the same place. The US regulations ask for the same treatment of items such as discounts, returns, transportation, insurance and packaging. Public accounts rarely show those details, which is why resale price is used less than you might think.

The story's real policy is different. The Distributor earns a 3% operating margin on its $10.0m of sales, tested under the CPMComparable 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.Open in the Glossary. That is an operating marginOperating marginOperating profit divided by sales. It is the most common profit level indicator for distributors.Open in the Glossary: profit after the Distributor's own costs, as a share of sales. It does not care where a company books delivery, and public data for it is easy to find. The trade-off: it is also moved by things other than price, such as how efficient a company is. So when good gross margin data exists, resale price can be the more direct test. Usually it does not.

Source: Treas. Reg. § 1.482-3(c), the resale price method, adjustments and consistency in accounting; § 1.482-5, the comparable profits method