Transfer pricing refers to the prices at which associated entities within a multinational group trade goods, services, property or loans with each other. According to the arm’s length principle, these transactions must be comparable to those carried out by independent parties.

The net margin method (TNMM) is one of the methods approved by the OECD guidelines and is applied to determine whether the net margin realized by the taxpayer in a controlled transaction is similar to the margins realized by independent entities in comparable transactions.

I. Company Background

The fictitious company, ABC RO, is a subsidiary of a multinational group and is responsible for the distribution of electronic products on the Romanian market. ABC RO purchases products from the parent company located in another jurisdiction and resells them to local customers. It carries out mainly routine distribution activities, without assuming significant risks and without carrying out complex research and development activities.

The controlled transaction that is the subject of the case study is the purchase of electronic products by ABC RO from the parent company, a transaction followed by the resale of the purchased electronic products from the group to local customers. The transaction is of the tangible goods type, and the objective is to check whether the margins made by ABC RO comply with the market value principle.

II. Applying the net margin method with the rate of return on turnover (RRT)

The first step is to select the right transfer pricing method. For this case study, the net margin method is most appropriate given that ABC RO is an entity that does not take significant risks within the group. The company’s net margin is used as a basis for comparison with independent entities.

The second step consists in the selection of the financial indicator rate of return on turnover. For the application of TNMM, the financial indicator turnover rate of return is chosen, which is calculated as follows:

Rate of Return on Turnover = Operating Profit/Operating Turnover x 100

This indicator measures how profitable a company is in relation to its sales and is often used to evaluate the performance of companies engaged in the distribution or marketing of products.

The next step is to analyze the comparability by means of the benchmark. The process is normally carried out by accessing financial databases (such as Orbis, TP Catalyst) to extract data on companies that meet the following characteristics:

1. Similar economic activity:

• ABC RO is a distributor of electronic products, so the selected companies must operate in the same sector (relevant NACE codes: 4652 – Wholesale trade of electronic and telecommunications equipment).

2. Geographical area:

• Companies must operate in economically similar markets. In the presented situation, companies from Romania will be selected.

3. Size of the company:

• It is important that the size of the companies is comparable to that of ABC RO, to avoid distorting the results (large corporations with considerable bargaining power or micro-enterprises are not included).

4. Financial Data available:

• Only companies that have financial data available for at least 3 years will be selected in order to obtain a solid basis for analysis. Thus, the evolution of the margin over a relevant period of time can be analyzed.

After carrying out the study and obtaining an interquartile range, the net margin method is applied and the rate of return on turnover for the company ABC RO is calculated.

Assume that the resulting interquartile range from the exported and realized benchmark is between 3% (lower quartile) and 6% (upper quartile).

Step 1: RRT calculation for ABC RO

• Operating turnover: EUR 10,000,000;
• Operating profit: EUR 400,000.

RRT _{ABC Ltd.} = (400.000 / 10.000.000) ×100 = 4%

Step 2: Comparison with the market range

The result of 4% falls within the interquartile range of 3% – 6%, which indicates that the intra-group transaction of the purchase of electronic products made by the company ABC RO from the parent company complies with the market value principle.

III. Conclusions

Following the application of the net margin method (TNMM), respectively using the rate of return on turnover (RRCA), the company ABC RO demonstrated that its margins are aligned with those of independent companies. Thus, it can be concluded that the transfer prices applied by the company ABC RO in the purchase transaction of electronic products from the parent company are in accordance with the market value principle.