Hi, and welcome to the fourth video of the module on transfer pricing. In the last video we had a look at the traditional transfer pricing methods. In this video, I will move on to explain the transaction profit methods. There are certain situations when transaction profit methods are more appropriate than traditional transaction methods. An example is found in cases in which the presence of significant unique intangibles contributed by each of the parties to the control transaction, of the engagement in highly integrated activities. Makes a profit split more appropriate than a one sided method. Likewise, when there is no, or limited reliable information publicly available on the gross margin derived by third parties. Transactional profit methods become the most appropriate ones. We look in more detail at the transactional profit methods. First, we will discuss the transaction net margin methods, and secondly we address the profits break methods. The transactional net margin method works similarly to the resale price method and the cost plus method. What works at the level of the operating profit margin in relation to an appropriate base such as costs, sales, or assets. Operating profit is equal to the difference between gross profit and operating expenses. In this respect, a net profit margin analysis is found to be more reliable than a gross margin analysis. When there are material differences in functions between the tested and the uncontrolled transaction. In these first example, the tested party is the distributor and the operating profit margin is weighted on sales. The net margin realized by an independent distributor is 5%, given by an operating profit of 15 on sales of 300. The application of this percentage to the control distributor sales of 100, gives an operating profit of 5. This means in the case attend, the transfer price should 90. Generally, the transactional net margin method with an operating profit weighted on sales applies when the distributor is the simpler party in the intergroup transaction, and when the resale price method cannot be applied in an equally reliable manner. In the second example, the tasset party is the manufacturer, and the net profit margin is weighted on cost. The markup on total costs applied by an independent manufacturer is 9%, given by an operating profit of 25, on the sum of operating expenses of 25, and manufacturing costs of 250. The application of this percentage to the total cost of the control manufacturer of 55 gives an operating profit of 5. This means, that in the case of sales the transfer price should be 60. The transaction net margin method, weighted upon cost, applies when a manufacturer or a service provider is the party in an inter-group transaction, and the cost plus method cannot be applied in an equally reliable manner. The second transactional profit method, the profit split method, is based on the division of the total profit realized by related parties engaged in a controlled transaction. This method aims to split these profits, on an economically valid basis that reflects the division of profit. Would have been agreed between independent parties. As the example shows, the first step is to identify the consolidated profit, that is the profit to be split, of the parties involved in the control transaction. The second step is to then split those profit in a way that equates to what independent parties would have agreed upon under comparable circumstances. The third step is to apply the resulting present age to the combined operating profits. The determination of the split in percentage can be based on either comparables, or internal data, such as costs or head counts. The profit split method frequent returns to be the most appropriate method when both parties to the transaction own valuable intangibles, and when the parties are integrated with each other to generate joint efficiencies, such in economies of scale. That concludes this video in which we discussed the two transactional profit makers, the transactional net margin method and the profit split method. I hope you join us for the next video, when we will be looking at case study and some real life circumstances.
