INTM463040 - Transfer Pricing: OECD and methodologies: Resale minus
The OECD Transfer Pricing Guidelines recommend this method of establishing a transfer price as being most useful where a company purchases goods for distribution from a connected party. You could also use resale minus to examine the transfer prices charged by a manufacturing company, since the manufacturer appears in the same chain. The OECD Transfer Pricing Guidelines say this for one very good reason: resale minus resembles how parties engaged in distribution set their prices in practice. Chapter 2 of the Guidelines defines the method thus:
The resale price method begins with the price at which a product that has been purchased from an associated enterprise is resold to an independent enterprise. This price (the resale price) is then reduced by an appropriate gross margin (the "resale price margin") representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit. What is left after subtracting the gross margin can be regarded, after adjustment for other costs associated with the purchase of the product (e.g. customs duties), as an arm's length price for the original transfer of property between the associated enterprises. This method is probably most useful where it is applied to marketing operations.
You will commonly see that where goods are distributed ultimately through retail outlets, those goods will have a recommended retail-selling price. The company buying these goods from the manufacturer or first tier distribution operation - it may be a retailer or a wholesaler - will be offered a price based on this end selling price less a discount. Out of this discount it must cover own operating costs and, it hopes, make a profit. If it can, the company might charge its customers less than the recommended selling price - perhaps in order to gain market share by undercutting the competition. However, its room to manoeuvre will be limited by its own overheads and desire for short-term or long-term profit. It is also not unknown for suppliers to restrict or refuse to distribute goods to retail outlets which aim to charge less than the recommended retail price. This is with the intention of maintaining the retail price and the exclusivity of the brand. Other retailers might push distributors for greater discounts off retail price, so that they in turn can drop the price charged to the high street customer, in order to match the street prices charged by competitors with smaller overheads or more aggressive selling strategies. In general, both distributors and retailers have an interest in maintaining the recommended retail-selling price, since any cut in the retail price threatens to reduce the margins available for both distributor and retailer.
As with all the OECD methods, you will only be able to apply the resale minus method successfully if you consider any differences in function between the tested party and any potential comparable companies and assess how those differences might affect the price that would be paid between independents.
See the OECD Transfer Pricing Guidelines from Para 2.21 - 2.38 (2.14 - 2.31).
