Pyrotechnics Ghana Limited was established for the main purpose of providing marketing support services to Pyrotechnics UK Limited, its parent company. Pyrotechnics Ghana Limited’s expenses are reimbursed with a 5% mark-up, which constitutes its total revenue.
Required:
What is the best transfer pricing method that can be used to test this transaction? Justify your response and show how the method will be applied. (8 marks)
View Solution
The most suitable method for the transaction will be the Transaction Net Margin Method (TNMM). (2 marks)
Justification:
- The transactional net margin method examines the net profit margin relative to an appropriate base such as sales, costs or assets that a person realizes from a controlled transaction or transactions that it is appropriate to aggregate. This is compared with the result achieved by independent persons on a similar transaction(s). The main difference between the transactional net margin method and the profit split method is that the former is a one-sided method” that is applied only to one of the connected persons, whereas the latter is applied to all the relevant connected persons.
- The transactional net margin method requires the comparison of net margins obtained in its related party dealings against either:
The net margins of the person’s dealings with independent persons in comparable circumstances; or
The net margins earned in comparable dealings between two independent persons. - A search will be performed to identify a set of independent companies that could be used to determine an appropriate arm’s length range of return on marketing support services. The independent companies should be in the same industry/similar industry and in similar markets as the tested party, and services rendered should be similar.
- The search process will involve the examination of the companies in the database, the elimination of non-comparable companies, and the selection of those companies that are believed to be suitable as a benchmark for marketing support services. As a result of the search, a set of independent companies will be identified as comparable, which may be used as benchmark for the return that Pyrotechnics Ghana Limited should earn from the marketing support services.
(4 points @ 1.5 marks each = 6 marks)