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Transfer pricing verification methods – the resale price method

The resale price method (hereafter: MCO) is one of the five methods indicated by the CIT Act that can be used in transfer pricing examinations. The applicability of this method should be verified, as with the other methods, in the first instance. It is therefore worth familiarising yourself with the assumptions of this method, as it may prove to be the best choice when examining the transfer price in a related party transaction.

Basic assumptions of the resale price method

The resale price method is applied to verify the price in transactions where a related party purchases goods or services from related parties and then resells them to unrelated parties.

Under this method, the purchase price of goods or services should be calculated by reducing the selling price of that good or service to an unrelated party by the resale price margin. Importantly, the resale price margin should ensure that the direct and indirect costs associated with the resale of the reseller’s good or service are covered and that an appropriate profit is made in relation to the reseller’s functions and the assets or risks involved. Thus, it will apply to so called distributors.

Under direct costs, all costs directly related to the specific good/service to which the controlled transaction relates should be recognised. Indirect costs, on the other hand, should be allocated appropriately using an allocation key to the specific good or service. It is also possible to include overheads within the costs in this method.

Criteria for comparability of the MCO method

When proceeding to the verification of the transfer price using the resale price method, it should be noted that under this method the characteristics of the goods and services are less important. Instead, functional comparability and consideration of the distribution of functions, assets and risks between the parties to the transaction are important.

The application of the method should always be preceded by a functional analysis of the parties to the controlled transaction. The functional profile determines the role of the entity in the transaction, e.g. a distributor with limited functions and risks, a manufacturer with extensive functions and risks, etc. As also indicated by the  Official Explanation re Transfer Pricing of 24 March 2023. No. 5 , it is the level of complexity of the functional profile that is the key factor in deciding whether to apply the MCO method.

Transactions in which the MCO method is applied:

  • trading of goods between related parties, i.e. between a manufacturer and a distributor, also between two distributors,
  • resale of routine services with low added value, e.g. HR or IT.

Also in this method, it is possible to make comparisons in an internal comparison (based on internal data on comparable transactions with unrelated parties) as well as in an external comparison (based on external data on transactions by unrelated parties).

Problems and challenges of the MCO method

Among the problems and challenges of the method, the importance of the time elapsed between purchase and resale to an unrelated party can be pointed out first. The MCO method is more reliable if this time was as short as possible. The longer the period between purchase and sale, the greater the risk of changes in market conditions, including interest rates, exchange rates, which may involve, for example, increased costs. If the period is longer, the resale price has to be taken into account when calculating the margin, so that the margin does not cover costs and does not give an adequate profit to the distributor.

Another problem may be obtaining sufficiently comparable data on transactions. This is because it is difficult to obtain reliable data on functional profiles, in particular with regard to the risks incurred by the entities, the assets involved or the functions performed, or to obtain reliable data due to different accounting treatment.

In summary, the MCO method gives the greatest comparability if we have functional comparability of entities, a short time interval between purchase and resale to unrelated parties, and the subject of the transaction has not changed significantly. It is certainly worth reading the Official Explanation issued by Ministry of Finance Tax Notes before applying this method, where we can also find a comparison of this method with the other methods indicated in the Act.