(upbeat music)
-: Under the OECD Guidelines,
they are five methods that can be used to help determine
if the relations are at an arm's length.
The first three are traditional transaction methods,
whereas the last two are transactional profit methods.
When one of the traditional transaction methods
cannot be used, one of the two transactional profit methods
should be used.
In this clip,
we explore the two transactional profit methods.
The first is the profit split method or PSM.
This method potentially applies
where associated entities in a cross-border transaction
have something unique to offer to a transaction.
And there is also an economically valid basis
for splitting the profits between the entities.
The aim is to approximate the way
their profits would have been split
between independent parties acting at arm's length.
For example, Aircon Proprietary Limited
is an Australian company that develops technology
that will assist in the building of air conditioners
that are more efficient than others currently in the market.
It provides its technology,
which is subject to intellectual property laws
to its German parent company.
The German company, using the supply technology,
as well as its own technology and precision machinery
manufacturers highly efficient air conditioners.
If under this arrangement,
an economically valid basis could be found
for allocating the profit between Aircon and its parents,
the PSM could be used.
The transactional net margin method is the second approach.
This uses the net margin
of a comparable independent cross-border transaction.
It then applies this net margin
to the taxpayer's cross-border transaction
with the related party.
The comparable transaction
can either be one that the taxpayer
has with an independent cross-border entity
or one that the third party has
with an independent cross-border entity.
Note that when using this method,
a choice needs to be made about what to apply
the net margin against as an appropriate base.
This requires the calculation of an appropriate ratio.
For example, the taxpayer might use the net margin
to assets, to costs, to sales, or to shareholders' funds
as an appropriate base.
Further, when utilising the net margin figure,
a decision should be made
regarding where they should exclude some costs
from the net margin, such as tax and interest
in order to prove its compatibility.
For example, an Australian company Comfort Limited
has found a way of processing wool that makes it feel softer
than most existing woollen garments.
The company makes woollen garments and sells them
to its Korean associate.
Comfort cannot obtain data
that would make it able to accurately calculate
the comparable and controlled price on equivalent garments.
However, it is able to obtain information
on the net profit to sales ratio
of an Australian competitor.
This competitor sells similar garments
to an independent Korean entity.
Comfort could use this ratio
to determine the comparable arm's length price
it sells the garments to relate to Korean entity.
Comfort in doing so might need to take into account
any differences between its competitors and itself,
such as different business strategies
and funding arrangements.
To recap, there are five methods
that can potentially be used
to determine the arm's length price
of a cross-border related party transaction.
Which technique to use in any situation
depends on the nature of a taxpayer transaction,
as well as what information it has access to.
If there is sufficient information to use
one of the traditional transaction methods,
then one of those methods should be used.
The transactional profit methods should be used
where profits between related parties
can be split on a valid basis
or a net margin profit ratio
can be applied from a comparable transaction.