Accounting Guide: Transfer Pricing Methods with Examples

Transfer pricing is a rigorous undertaking for multinational corporations, as tax authorities worldwide demand absolute transparency regarding intra-group business transactions. These companies must navigate global regulations and the subjective valuation of internal dealings, which often creates a heavy administrative burden during audits.

Given these regulatory pressures, using the correct transfer pricing methodology is mandatory to meet OECD standards and minimise audit risk by ensuring that all intercompany transactions reflect market value.

What is Transfer Pricing?

Transfer pricing refers to the internal price-setting process for transactions between different branches or subsidiaries of the same parent company. Instead of letting market forces determine costs, the business must establish valuations for goods or services exchanged within the group. To remain compliant, these valuations must follow the arm’s-length principle, which ensures that internal charges reflect what two independent businesses would reach in an open market.

These internal exchanges typically encompass:

• Tangible Assets: Raw materials, finished products, and machinery.
• Intangible Property: IPs including patents, trademarks, brand names, and proprietary software.
• Intra-group services: Centralised management consulting, IT support, and technical assistance.
• Financial Arrangements: intercompany loans, credit guarantees, and interest payments.

When tax bodies scrutinise these deals, they focus on related parties with the capacity to influence pricing. Such relationships typically exist between the following:

• A parent firm and its subsidiaries.
• Sister companies under common ownership.
• A head office and its various overseas branches.

Because these entities share a unified control structure, there is a natural risk of preferential pricing or profit shifting. To prevent revenue loss, agencies like IRAS closely monitor these connections, ensuring every dollar is taxed in the jurisdiction where the actual economic activity occurred.

Transfer Pricing Regulations in Singapore

Singapore has reinforced its status as an international trade hub by maintaining a clear, fair tax framework, supported by the detailed Transfer Pricing Guidelines (TPG) provided by the Inland Revenue Authority of Singapore (IRAS).

To maintain a defensible tax position, businesses must satisfy the following statutory requirements:

• Mandatory Thresholds: Under Section 34F of the Income Tax Act, you are legally required to prepare and maintain transfer pricing documentation if your gross revenue exceeds $10 million for the relevant Year of Assessment (YA), or if you were required to prepare documentation for the immediate preceding period.
• Contemporaneous Documentation: Documentation must be prepared no later than the filing due date of your tax return. Records must justify your pricing and the selection of the specific methodology used.
• Exemption Thresholds: Even if the revenue threshold is met, specific transactions may be exempt from documentation if they fall below annual “safe harbour” limits. These include S$15 million for the purchase or sale of goods and loans, and $1 million (increasing to $2 million from YA 2026) for services, royalties, and other transactions.
• Income Tax Act Compliance: All filings must reflect accurate profit allocations to comply with Section 34D, which authorises IRAS to adjust profits that do not meet the arm’s length standard.

If IRAS determines that internal prices are not market-reflective, it has the authority to make upward profit adjustments, which result in higher tax liabilities. Beyond increased taxes, non-compliant businesses face several risks:

• 5% Surcharge: A mandatory surcharge is often levied on any transfer pricing adjustments made by IRAS, regardless of whether there is a tax loss.
• Fines for Documentation Failures: Companies failing to prepare or maintain adequate contemporaneous documentation can be fined up to $10,000 per offence.
• Double Taxation: Without proper justification, the same income may be taxed in both Singapore and the foreign jurisdiction, eroding profit margins.
• Increased Audit Scrutiny: Frequent compliance failures flag a company for more intensive and regular audits, draining internal resources and management time.

Methods of Transfer Pricing with Examples

There are several methods of transfer pricing that accountants use to verify the fairness of a transaction, and each has its own set of requirements.

Method 1: Comparable Uncontrolled Price (CUP) Method

The CUP method is the most direct application of the arm’s-length principle. It compares the price of a controlled transaction to that of a comparable transaction between independent parties.

While favoured by the OECD for its high reliability, finding perfectly matched transactions can be difficult due to minor differences in volume, delivery terms, or geographic markets that distort comparisons. Because of this high sensitivity, external CUP data is often complex to find for specialised products or niche services.

Example Scenario: A manufacturer in Singapore sells industrial valves to its Malaysian subsidiary for $50 each. If the same manufacturer also sells those identical valves to an unrelated distributor in Johor for $50 under the same shipping terms, the CUP method confirms the internal price is fair.

Method 2: Resale Price Method (RPM)

The RPM transfer pricing method determines an arm’s length price by subtracting an appropriate gross margin from the final selling price to an independent customer. This margin covers the distributor’s operating expenses and a reasonable profit, making it ideal for entities that perform distribution functions without adding significant value, such as those involved in basic repackaging.

However, the reliability of this method hinges on finding third-party comparables with nearly identical functional and risk profiles. For instance, a distributor investing heavily in marketing cannot be directly compared to one that does not without extensive financial adjustments.

Example Scenario: A logistics firm in Singapore buys high-end electronics from its parent company and resells them to local retailers for $1,000. If independent electronics distributors in the region operate on a 10% margin, the arm’s-length purchase price from the parent company would be $900.

Method 3: Cost Plus Method (CPLM)

CPLM establishes an arm’s-length price by adding a market-reflective markup to the supplier’s direct and indirect production costs. Commonly used for contract manufacturers and routine service providers, this approach ensures the performing entity earns a consistent return on its operational investment.

The reliability of this method of transfer pricing is often constrained by accounting inconsistencies across firms, as differing definitions of “cost of goods sold” can distort markup comparisons. Furthermore, obtaining granular internal cost data from competitors for accurate benchmarking remains a significant challenge.

Example Scenario: A subsidiary in Malaysia provides back-office accounting services to its headquarters in Singapore. If its total operating costs are $10,000 and the market markup for such support services is 5%, the transfer price charged to the Singapore office would be $10,500.

Method 4: Profit Split Method (PSM)

The PSM transfer pricing method is applied when businesses are intricately linked, making it impossible to isolate their individual contributions. By assessing the total venture profit and allocating it based on the relative economic value each party provides, this methodology offers a holistic solution for groups managing high-value intellectual property or shared innovations.

While PSM ensures that profits generated by collective efforts are distributed fairly, it is often viewed as a last resort due to the inherent difficulty in quantifying intangible contributions. Assigning weight to different functions, such as research versus marketing, remains highly subjective and is frequently a primary focus of disputes with tax authorities.

Example Scenario: Two sister companies co-develop a new software platform. One handles coding, while the other handles global branding. Since both contribute intangible value, they split the final sales profits 60/40 based on an analysis of their respective development costs and risks.

Choosing the Right Transfer Pricing Method

Selecting the best transfer pricing method for your company depends on the specific commercial circumstances and the quality of available market evidence. Because no single framework is universally applicable, the choice must be guided by the degree of comparability between intercompany deals and third-party market transactions.

For example, a straightforward distributor might rely on the Resale Price Method. In contrast, a group with shared intellectual property would require a more complex model to allocate profits accurately.

When determining the most suitable approach, businesses should evaluate the following considerations:

• Availability of Comparable Data: The feasibility of a method depends on whether accessible, reliable third-party transaction data is available for comparison.
• Complexity of the Business: Highly integrated operations or those involving unique value drivers may require methods that evaluate total profit rather than individual transaction prices.
• Nature of Intercompany Transactions: The specific characteristics of the goods, services, or intangible assets being exchanged dictate which framework provides the most accurate market reflection.
• Regulatory Expectations: Adherence to local IRAS guidelines and international OECD standards is necessary to ensure the chosen approach remains defensible.

Common Transfer Pricing Risks and How to Manage Them

Transfer pricing risks often stem from a misalignment between commercial operations and tax documentation. To protect against financial and legal repercussions, businesses must proactively identify and mitigate these exposures:

• Lack of Comparable Data: Insufficient evidence of market rates makes it difficult to defend pricing during an audit, leading to profit adjustments.
• Misapplication of Methodology: Selecting an inappropriate framework for the business model often invites IRAS intervention and challenges.
• Inadequate Documentation: Failing to maintain contemporaneous records that justify the chosen pricing method results in non-compliance penalties.
• High-Risk Profiles: Companies involving complex supply chains or cross-border intellectual property transfers face heightened scrutiny from tax authorities.

To protect against financial and legal repercussions, businesses should adopt the following management strategies:

• Maintain Contemporaneous Records: Prepare and update documentation at the time of the transaction to meet statutory requirements and avoid non-compliance penalties.

• Align Method with Function: Conduct a functional analysis to ensure the chosen methodology accurately mirrors the economic reality of the business operations.
• Conduct Proactive Risk Assessments: Periodically review intercompany transactions to identify potential red flags before being flagged by tax authorities.
• Perform Benchmarking Studies: Regularly source reliable third-party data to provide a solid foundation for market-reflective pricing.
• Monitor High-Scrutiny Areas: Implement stricter controls for complex supply chains or cross-border intellectual property transfers to satisfy heightened regulatory expectations.

Navigate Transfer Pricing with Confidence with AG Singapore

As your business expands, staying aligned with international standards protects your bottom line and your brand’s integrity. While the rules may seem technical, expert support can transform this compliance requirement into a strategic advantage.

As a trusted accounting company in Singapore, AG specialises in providing practical solutions for growing enterprises. Our team understands the intricacies of local tax laws and the expectations of regional regulators. Whether you need help in preparing for an audit, optimising transfer pricing, or streamlining multi-currency accounting, we offer the professional advice you need to keep your operations seamless.

Let AG handle the technicalities of your transfer pricing strategy so you can focus on scaling your business across the region.