Strengths & Weaknesses of Transactional Net Margin Method

Transfer pricing is a crucial aspect of international taxation that involves setting prices for transactions between associated enterprises, such as parent companies and their subsidiaries in different tax jurisdictions. When two subsidiaries of a multinational enterprise (MNE) that are located in different tax jurisdictions engage in a transaction, the prices should be at arm’s length.

It means the transactions between associated enterprises must be treated the same way they would between unrelated companies. The Transactional Net Margin Method (TNMM) is one of the transfer pricing methods recommended by the Organisation for Economic Co-operation and Development (OECD) for determining whether intercompany transactions are conducted at arm’s length prices.

Availing of transfer pricing consulting services in Dubai is the best way to determine whether TNMM is the most appropriate transfer pricing method. In this blog post, we will explore the strengths and weaknesses of TNMM, helping businesses and tax professionals better understand when and how to use this method effectively.

What is the Transactional net Margin Method?

The TNMM, also known as the Comparable Profits Method (CPM) in countries like the US, is one of the five transfer pricing methods outlined in the OECD guidelines. The TNMM comes under the Transactional Profit method.

In simple words, the TNMM evaluates whether the amount charged in a controlled transaction is at arm’s length based on profit level indicators derived from uncontrolled taxpayers who engage in similar business activities under similar circumstances.

Due to its simplicity, TNMM is one of the most widely used transfer pricing methods in many tax jurisdictions. Consult with transfer pricing consultants in Dubai for more insights on the TNMM.

How does the Transactional net Margin Method Operate?

The TNMM examines the net profit relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction. In this way, the TNMM operates similarly to the cost plus and resale price methods. Due to this similarity, TNMM needs to be used in a way that is consistent with the manner in which the resale price or cost-plus method is applied.

It means that the net profit indicator of the taxpayer from the controlled transaction should ideally be established by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, i.e. by reference to “internal comparables”.

Strengths of the Transactional net Margin Method

Choosing the most appropriate transfer pricing method can be challenging for businesses. However, it can be simplified by analyzing the strengths and weaknesses of each transfer pricing method. Such an analysis can be beyond the comprehension of business owners but transfer pricing advisers in Dubai can help them. The following are some of the strong areas where the TNMM excels:

• The net profit indicators are less affected by transactional differences than is the case with price, as used in the CUP method.
• Easier to implement because it relies on external financial data that is accessed using various public data sources.
• TNMM is particularly effective for transactions that involve the intercompany sale of products or the provision of intercompany services
• The TNMM is less sensitive to minor differences between comparable transactions

Weaknesses of the Transactional net Margin Method

The following are some of the key weaknesses of the TNMM:

• Finding truly comparable independent companies for benchmarking is challenging. Identifying companies with similar functions, assets, and risks can be tough, especially in industries with unique business models or intellectual property (IP)
• The quality and availability of financial data on comparable companies can vary significantly across industries and regions.
• TNMM is sensitive to market fluctuations in profitability, which can make it less reliable during economic downturns or in industries with volatile profit margins
• Selecting the appropriate profit level indicator (PLI) can be subjective and may impact the results of the analysis

Hire the Best Transfer Pricing Experts in Dubai, UAE

The OECD recommends five transfer pricing methods, and each one may deliver a different arm’s-length range for the same transaction. So, using the most appropriate one is critical to a successful analysis. The selection of the most appropriate transfer pricing method warrants the advice of the best transfer pricing advisers in Dubai such as Tax Gian.

Tax Gian is a brand of Jitendra Tax Consultants (JTC), comprising a team of highly qualified tax experts who can offer effective solutions to any complex transfer pricing concern. We offer bespoke transfer pricing consulting services in Dubai in line with regulatory expectations and aligned with our client’s global business goals. Tax Gian’s corporate tax professionals can guide you through complex areas of international tax to mitigate the risk of non-compliance.T