Determination of arm's length price under section 165

Methods (sub-rule 1). The most appropriate of the following is used.

• (a) Comparable uncontrolled price. Identify the price in a comparable uncontrolled transaction; adjust it for differences that could materially affect price in the open market; the adjusted price is the arm's length price.
• (b) Resale price. Take the price at which property or services bought from an associated enterprise are resold to an unrelated enterprise; reduce it by a normal gross profit margin from comparable uncontrolled transactions; reduce it by the expenses directly connected with the purchase; adjust for functional and other differences; the result is the arm's length price of the purchase.
• (c) Cost plus. Determine the direct and indirect costs of production for property or services supplied to an associated enterprise; determine the normal gross profit mark-up in comparable uncontrolled transactions, adjusted for differences; add the adjusted mark-up to the costs; the sum is the arm's length price of the supply.
• (d) Profit split, mainly where the transaction involves unique intangibles or unique and valuable contributions by each enterprise, or multiple inter-related transactions that cannot be evaluated separately. Two approaches: contribution profit split (split the combined net profit in proportion to relative contributions, judged on functions performed, assets employed and risks assumed and on reliable external market data) and residual profit split (first allocate each enterprise an arm's length return for contributions that can be reliably benchmarked, then split the residual in proportion to relative contributions).
• (e) Transactional net margin. Compute the net profit margin from the controlled transaction against a base (costs, sales, assets or another relevant base); compute the margin in comparable uncontrolled transactions on the same base and adjust it for material differences; the established margin is used to arrive at the arm's length price.
• (f) Any other method as provided in rule 78.

Comparability factors (sub-rule 2). The characteristics of the property or services; the functions performed, with assets employed and risks assumed; the contractual terms, whether formal or not; and the market conditions, including geographical location, depth and size of markets, laws and orders in force, costs of labour and capital, overall economic development, level of competition and whether the markets are wholesale or retail.

When transactions are comparable (sub-rule 3). If none of the differences are likely to affect price, cost or profit materially in the open market, or reasonably accurate adjustments can eliminate their material effects.

Which year's data (sub-rules 4 and 5). The data of the financial year in which the transaction took place (the "current year"). For the resale price, cost plus and transactional net margin methods, the current year's data, or the first preceding year's data if the current year's is not available when the return is furnished; if current-year data later becomes available during assessment, it is used for determining the arm's length price.