Revised Guidance on the

Application on the Transactional

Profit Split Method
General
• The transactional profit split method seeks to establish arm’s
length outcomes or test reported outcomes for controlled
transactions in order to approximate the results that would
have been achieved between independent enterprises
engaging in a comparable transaction or transactions.
• The method first identifies the profits to be split from the
controlled transactions—the relevant profits—and then
splits them between the associated enterprises on an
economically valid basis that approximates the division of
profits that would have been agreed at arm’s length.
• As is the case with all transfer pricing methods, the aim is to
ensure that profits of the associated enterprises are aligned
with the value of their contributions and the compensation
which would have been agreed in comparable transactions
between independent enterprises for those contributions.
• The transactional profit split method is particularly useful
when the compensation to the associated enterprises can be
more reliably valued by reference to the relative shares of
their contributions to the profits arising in relation to the
transaction(s) than by a more direct estimation of the value
of those contributions.
• References to “profits” in this section should generally be
taken as applying equally to losses. That is, where a
transactional profit split method is determined to be the
most appropriate method, it should generally also apply, and
apply in the same way, regardless of whether the
transaction(s) result in a relevant profit or loss. Asymmetrical
splits of profits and losses (i.e. where the parties apply
different considerations depending on the results of the
transaction) might be arm’s length, but should be used with
caution and appropriately documented.
When is a transactional profit split method
likely to be the most appropriate method?
• The selection of a transfer pricing method always aims at
finding the most appropriate method for a particular case,
taking into account the respective strengths and weaknesses
of each method, its appropriateness in view of the nature of
the accurately delineated controlled transaction, the
availability of reliable information (in particular on
uncontrolled comparables) needed for application, and the
degree of comparability between the controlled and
uncontrolled transactions.
• Guidance on how to determine whether the transactional profit
split method is likely to be the most appropriate method is set out
below, including the identification of certain features of a
transaction which may be relevant. However it is important to
note that there is no prescriptive rule for establishing when a
particular transfer pricing method is the most appropriate method.
• While there is no requirement in these Guidelines to undertake
exhaustive analysis or testing of every method in each case, the
selection of the most appropriate method should take into
account the relative appropriateness and reliability of the selected
method as compared to other methods which could be used.
Strengths and weaknesses of the transactional
profit split method
• The main strength of the transactional profit split method is
that it can offer a solution for cases where both parties to a
transaction make unique and valuable contributions (e.g.
contribute unique and valuable intangibles) to the
transaction. In such a case independent parties might
effectively price the transaction in proportion to their
respective contributions, making a two-sided method more
appropriate.
• Furthermore, since those contributions are unique and
valuable there will be no reliable comparables information
which could be used to price the entirety of the transaction
in a more reliable way, through the application of another
method. In such cases, the allocation of profits under the
transactional profit split method may be based on the
contributions made by the associated enterprises, by
reference to the relative values of their respective functions,
assets and risks. The transactional profit split method can
also provide a solution for highly integrated operations in
cases for which a one-sided method would not be
appropriate.
• Another strength of the transactional profit split method is that
it can offer flexibility by taking into account specific, possibly
unique, facts and circumstances of the associated enterprises
that may not be present in independent enterprises. Moreover,
where there is a high degree of uncertainty for each of the
parties in relation to a transaction, for example in transactions
involving the shared assumption of economically significant risks
by all parties (or the separate assumption of closely related
economically significant risks), the flexibility of the transactional
profit split method can allow for the determination of arm’s
length profits for each party that vary with the actual outcomes
of the risks associated with the transaction.
• A further strength of the transactional profit split method is
that all relevant parties to the transaction are directly
evaluated as part of the pricing of the transaction, that is,
the contributions of each party to the transaction are
specifically identified and their relative values measured in
order to determine an arm’s length compensation for each
party in relation to the transaction.
• A weakness of the transactional profit split method relates to
difficulties in its application. On first review, the transactional
profit split method may appear readily accessible to both
taxpayers and tax administrations because it tends to rely less on
information about independent enterprises.
• However, associated enterprises and tax administrations alike
may have difficulty accessing the detailed information required to
apply a transactional profit split method reliably. It may be
difficult to measure the relevant revenue and costs for all the
associated enterprises participating in the controlled transactions,
which could require stating books and records on a common basis
and making adjustments in accounting practices and currencies.
• Further, when the transactional profit split method is applied
to operating profit, it may be difficult to identify the
appropriate operating expenses associated with the
transactions and to allocate costs between the transactions
and the associated enterprises’ other activities. Identifying
the appropriate profit splitting factors can also be
challenging. Given the necessity of applying judgement in
determining each of the parameters for the application of
the transactional profit split method, it will be particularly
important to document how the method has been applied,
including the determination of the relevant profits to be
split, and how the profit splitting factors were arrived at.
• It is sometimes argued that a transactional profit split method is
rarely used among independent enterprises, and thus its
application in controlled transactions should be similarly rare.
Where such a method is determined to be the most appropriate,
this should not be a factor since transfer pricing methods are not
necessarily intended to replicate arm’s length behaviour, but
rather to serve as a means of establishing and/or verifying arm’s
length outcomes for controlled transactions. That said, where
there is evidence that independent parties in comparable
transactions apply a profit split method among themselves, such
evidence should be considered in determining whether a
transactional profit split method is the most appropriate method
for the controlled transactions.
Nature of the accurately delineated transaction
• The accurate delineation of the actual transaction will be important in
determining whether a transactional profit split is potentially
applicable. This process should have regard to the commercial and
financial relations between the associated enterprises, including an
analysis of what each party to the transaction does, and the context
in which the controlled transactions take place. That is, the accurate
delineation of a transaction requires a two-sided analysis (or a multi-
sided analysis of the contributions of more than two associated
enterprises, where necessary) irrespective of which transfer pricing
method is ultimately found to be the most appropriate.
• The existence of unique and valuable contributions by each
party to the controlled transaction is perhaps the clearest
indicator that a transactional profit split may be appropriate.
The context of the transaction, including the industry in
which it occurs and the factors affecting business
performance in that sector can be particularly relevant to
evaluating the contributions of the parties and whether such
contributions are unique and valuable.
• Depending on the facts of the case, other indicators that the
transactional profit split may be the most appropriate
method could include a high level of integration in the
business operations to which the transactions relate and /or
the shared assumption of economically significant risks (or
the separate assumption of closely related economically
significant risks) by the parties to the transactions. It is
important to note that the indicators are not mutually
exclusive and on the contrary may often be found together in
a single case.
• At the other end of the spectrum, where the accurate
delineation of the transaction determines that one party to
the transaction performs only simple functions, does not
assume economically significant risks in relation to the
transaction and does not otherwise make any contribution
which is unique and valuable, a transactional profit split
method typically would not be appropriate since a share of
profits (which may be impacted by the playing out of the
economically significant risks) would be unlikely to represent
an arm’s length outcome for such contributions or risk
assumption.
• A lack of closely comparable, uncontrolled transactions
which would otherwise be used to benchmark an arm’s
length return for the party performing the less complex
functions should not per se lead to a conclusion that the
transactional profit split is the most appropriate method.
Depending on the facts of the case, an appropriate method
using uncontrolled transactions that are sufficiently
comparable, but not identical to the controlled transaction is
likely to be more reliable than an inappropriate use of the
transactional profit split method.
• It may also be relevant to consider industry practices. For
instance, if information is available that independent parties do
commonly use profit splitting approaches in similar situations,
careful consideration should be given to whether the
transactional profit split method may be the most appropriate
method for the controlled transactions. Such industry practices
may be a pointer to the fact that each party makes unique and
valuable contributions, and/or that the parties are highly inter-
dependent upon each other. Conversely, if independent parties
engaged in comparable transactions are found to make use of
other pricing methods, this should also be taken into account in
determining the most appropriate transfer pricing method.
Unique and valuable contributions by each of
the parties to the transaction

• Contributions (for instance functions performed, or assets used or

contributed) will be “unique and valuable” in cases where (i) they are
not comparable to contributions made by uncontrolled parties in
comparable circumstances, and (ii) they represent a key source of
actual or potential economic benefits in the business operations. The
two factors are often linked: comparables for such contributions are
seldom found because they are a key source of economic advantage.
• It may be the case that in these situations, the risks
associated with the respective unique and valuable
contributions cannot be controlled by the other party or
parties. This may impact the assumption of risk under the
accurate delineation of the actual transaction. For example,
the developer and manufacturer of a key component of a
product together with the developer and manufacturer of
another key component that together with the first
component, form the ready-to-sell product, may both make
unique and valuable contributions in terms of functions and
intangibles that represent a key source of economic benefits.
Transactions involving unique and valuable
intangibles

• Where each party to the transaction legally owns unique and valuable
intangibles that are relevant to the transaction, it will also be
necessary to consider whether, under the accurate delineation of the
transaction, they each assume the economically significant risks
relating to those intangibles, e.g. risks related to development,
obsolescence, infringement, product liability and exploitation.
• In some cases, the transactional profit split method may be
the most appropriate method for a transfer of fully
developed intangibles (including rights in intangibles) where
it is not possible to identify reliable comparable uncontrolled
transactions. The transactional profit split method may also
be appropriate for transfers of partially developed
intangibles.
Highly integrated business operations

• Although most MNE groups are integrated to some extent, a

particularly high degree of integration in certain business operations
is an indicator for the consideration of the transactional profit split
method. A high degree of integration means that the way in which
one party to the transaction performs functions, uses assets and
assumes risks is interlinked with, and cannot reliably be evaluated in
isolation from, the way in which another party to the transaction
performs functions, uses assets and assumes risks.
• In contrast, many instances of integration within an MNE
result in situations in which the contribution of at least one
party to the transaction can in fact be reliably evaluated by
reference to comparable uncontrolled transactions.
• For example, where complementary but discrete activities
are undertaken by the entities, it may be the case that it is
possible to find reliable comparables since the functions,
assets and risks involved in each discrete stage may be
comparable to those in uncontrolled arrangements. This
needs to be borne in mind in considering which transfer
pricing method is the most appropriate in a particular case.
• In some cases the parties may perform functions jointly, use
assets jointly and/or share assumption of risks to such an extent
that it is impossible to evaluate their respective contributions in
isolation from those of others. As an example, the transactional
profit split method can be applied to the global trading of
financial instruments by associated enterprises.
• Another example may be where the integration between the
parties takes the form of a high degree of inter-dependency. For
instance, profit split approaches may be used by independent
enterprises engaged in long-term arrangements where each
party has made a significant contribution (e.g. of an asset)
whose value depends on the counterparty to the arrangement.
• In these kinds of cases, where each party makes such a
contribution, and is dependent on the other party (or where
the value of the contribution(s) of one party depends to a
significant degree on the contribution(s) of the other party),
some form of flexible pricing that takes into account, and
varies with, the outcome of the risks assumed by each party
arising from its dependence on the other party may be
observed.
• Where business operations are highly integrated, the extent
to which the parties share the assumption of the same
economically significant risks or separately assume closely
related economically significant risks will be relevant to the
determination of the most appropriate method and, if a
transactional profit split is considered the most appropriate
method, how it should be applied; in particular whether a
split of actual profits or of anticipated profits should be used.
• Where a party contributes to the control of economically
significant risk, but that risk is assumed by the other party to
the transaction, this may, in some cases, demonstrate that it
is appropriate for the first party to share in the potential
upside and downside associated with that risk,
commensurate with its contribution to control. However, the
mere fact that an entity performs control functions in
relation to a risk will not necessarily lead to the conclusion
that the transactional profit split is the most appropriate
method in the case.
• Where the contributions are highly inter-related or inter-
dependent upon each other, the evaluation of the respective
contributions of the parties may need to be done holistically.
That is, a high degree of integration may also affect whether
contributions by the enterprises are considered to be unique
and valuable. For instance, a unique contribution by one
party may have a significantly greater value when considered
in combination with the particular unique contribution of the
other party.
Shared assumption of economically significant
risks, separate assumption of closely related risks

• A transactional profit split may be found to be the most

appropriate method where, according to the accurately
delineated transaction, each party to the controlled
transaction shares the assumption of one or more of the
economically significant risks in relation to that transaction
• A transactional profit split may also be found to be the most
appropriate method where, according to the accurately
delineated transaction, the various economically significant
risks in relation to the transaction are separately assumed by
the parties, but those risks are so closely inter-related and/or
correlated that the playing out of the risks of each party
cannot reliably be isolated.
• The relevance of this factor as an indicator for the
transactional profit split method will depend in large
measure on the extent to which the risks concerned are
economically significant such that a share of relevant profits
would be warranted for each party. The economic
significance of the risks should be analysed in relation to
their importance to the actual or anticipated relevant profits
from the controlled transaction(s), rather than in respect of
their importance to any one of the associated enterprises
whose business operations may extend beyond those
covered by the relevant profits.
• If each party shares the assumption of economically significant
risks or separately assumes inter-related, economically
significant risks, and a transactional profit split is considered to
be the most appropriate method, it is likely that a split of
actual profits, rather than anticipated profits, will be
warranted since those actual profits, i.e. the actual relevant
profits to be split, will reflect the playing out of the risks of
each party. Conversely, a profit split of anticipated profits will
tend to concentrate the playing out of economically significant
risks on one party. That is, the transfer pricing outcome—a
sharing of actual or anticipated profits—should align with the
accurate delineation of the transaction.
Availability of reliable information
• In general, it will tend to be the case that the presence of factors
indicating that a transactional profit split is the most appropriate
method will correspond to an absence of factors indicating that
an alternative transfer pricing method—one which relies entirely
on comparables—is the most appropriate method. Put another
way, if information on reliable comparable uncontrolled
transactions is available to price the transaction in its entirety, it
is less likely that the transactional profit split method will be the
most appropriate method. However, a lack of comparables alone
is insufficient to warrant the use of a transactional profit split.
• While the transactional profit split method can be applied in
cases where there are no uncontrolled comparables,
information from transactions between independent parties
may still be relevant to the application of the method, for
example to guide the splitting of relevant profits, or where a
residual analysis approach is used.
Guidance for application - in general
• These Guidelines do not seek to provide an exhaustive catalogue
of ways in which the transactional profit split method may be
applied. Application of the method will depend on the facts and
circumstances of the case and the information available, but the
overriding objective should be to approximate as closely as
possible the split of profits that would have been realised had
the parties been independent enterprises.
• Under the transactional profit split method, the relevant
profits are to be split between the associated enterprises on
an economically valid basis that approximates the division of
profits that would have been anticipated and reflected in an
agreement made at arm’s length. In general, the
determination of the relevant profits to be split and of the
profit splitting factors should:
Be consistent with the functional analysis of the controlled
transaction under review, and in particular reflect the assumption
of the economically significant risks by the parties, and
Be capable of being measured in a reliable manner.
• In addition,
If the transactional profit split method is used to set transfer pricing in
controlled transactions at the outset, it would be reasonable to expect
the life-time of the arrangement and the criteria or profit splitting factors
to be agreed in advance of the transaction,
The person using the transactional profit split method (taxpayer or tax
administration) should be prepared to explain why it is regarded as the
most appropriate method in the circumstances of the case, as well as the
way it is implemented, and in particular the criteria or profit splitting
factors used to split the relevant profits, and
The determination of the relevant profits to be split and of the profit
splitting factors should generally be used consistently over the life-time of
the arrangement, including during loss years, unless the rationale for
using differing relevant profits or profit splitting factors over time is
supported by the facts and circumstances and is documented.
Approaches to splitting profits
• There are a number of approaches to the application of the
transactional profit split method, depending on the
characteristics of the controlled transactions, and the
information available. As has been described above, the method
seeks to split the relevant profits from controlled transactions on
an economically valid basis, in order to approximate the results
that would have been achieved between independent
enterprises in comparable circumstances.
• This may be done by considering the relative contributions of
each party (a “contribution analysis”). Where the
transactional profit split method is the most appropriate
method but at least one party also makes some less complex
contributions which are capable of being benchmarked by
reference to comparable, uncontrolled transactions, a two-
stage “residual analysis” may be appropriate.
Approaches to splitting profits
• There are a number of approaches to the application of the
transactional profit split method, depending on the
characteristics of the controlled transactions, and the
information available. As has been described above, the method
seeks to split the relevant profits from controlled transactions on
an economically valid basis, in order to approximate the results
that would have been achieved between independent
enterprises in comparable circumstances.
• This may be done by considering the relative contributions of
each party (a “contribution analysis”). Where the
transactional profit split method is the most appropriate
method but at least one party also makes some less complex
contributions which are capable of being benchmarked by
reference to comparable, uncontrolled transactions, a two-
stage “residual analysis” may be appropriate.
Contribution analysis
• Under a contribution analysis, the relevant profits, which are the
total profits from the controlled transactions under examination,
are divided between the associated enterprises in order to arrive
at a reasonable approximation of the division that independent
enterprises would have achieved from engaging in comparable
transactions. This division can be supported by comparables data
where available.
• In the absence thereof, it should be based on the relative
value of the contributions by each of the associated
enterprises participating in the controlled transactions,
determined using information internal to the MNE group, as
a proxy for the division that independent enterprises would
have achieved. In cases where the relative value of the
contributions can be measured, it may not be necessary to
estimate the actual market value of each party’s
contributions.
• It can be difficult to determine the relative value of the
contribution that each of the associated enterprises makes
to the relevant profits, and the approach will depend on the
facts and circumstances of each case. The determination
might be made by comparing the nature and degree of each
party’s contribution of differing types (for example, provision
of services, development expenses incurred, assets used or
contributed, capital invested) and assigning a percentage
based upon the relative comparison and external market
data.
Residual analysis
• Where the contributions of the parties are such that some can be
reliably valued by reference to a one-sided method and
benchmarked using comparables, while others cannot, the
application of a residual analysis may be appropriate. A residual
analysis divides the relevant profits from the controlled
transactions under examination into two categories. In the first
category are profits attributable to contributions which can be
reliably benchmarked: typically less complex contributions for
which reliable comparables can be found.
• Ordinarily this initial remuneration would be determined by
applying one of the traditional transaction methods or a
transactional net margin method to identify the remuneration of
comparable transactions between independent enterprises. Thus,
it would generally not account for the return that would be
generated by a second category of contributions which may be
unique and valuable, and/or are attributable to a high level of
integration or the shared assumption of economically significant
risks. Typically, the allocation of the residual profit among the
parties will be based on the relative value of the second category
of contributions of the parties in the same way as in the
application of the contribution analysis outlined above and in
accordance with the guidance
Guidance for application - Determining the
profits to be split
• The relevant profits to be split under the transactional profit split
method are those of the associated enterprises arising as a result
of the controlled transactions under review. It is essential to
identify the level of aggregation. In determining the relevant
profits, it is therefore essential to first identify and accurately
delineate the transactions to be covered by the transactional
profit split method, and from this identify the relevant income
and expense amounts for each party in relation to those
transactions.
• Where the relevant profits to be split are comprised of
profits of two or more associated enterprises, the relevant
financial data of the parties to the transaction to which a
transactional profit split is applied need to be put on a
common basis as to accounting practice and currency, and
then combined. Because accounting standards can have
significant effects on the determination of the profits to be
split, accounting standards should, in cases where the
taxpayer chooses to use the transactional profit split
method, be selected in advance of applying the method and
applied consistently over the lifetime of the arrangement.
• Differences in accounting standards may affect the timing of
revenue recognition as well as the treatment of expenses in
arriving at profits. Material differences between the accounting
standards used by the parties should be identified and aligned.
• Financial accounting may provide the starting point for
determining the profit to be split in the absence of harmonised
tax accounting standards. The use of other financial data (e.g.
cost accounting) should be permitted where such accounts
exist, are reliable, auditable and sufficiently transactional. In
this context, product-line income statements or divisional
accounts may prove to be the most useful accounting records.
• However, except in circumstances where the total activities
of each of the parties are the subject of the profit split, the
financial data will need to be segregated and allocations
made in accordance with the accurately delineated
transaction(s) so that the profits relating to the combined
contributions made by the parties are identified. For
example, a product supplier in a profit split with an
associated enterprise engaged in European marketing and
distribution would need to identify the profits arising from its
production of goods for the European market, and exclude
the profits arising from the production of goods for other
markets.
• The exercise may be relatively simple if the same goods are
supplied to all markets, but will be more complex if different
goods with different production costs or with different embedded
technology, for example, are supplied to different markets.
Similarly, if the associated enterprise engaged in European
marketing and distribution buys products from other sources, it
will need to segregate its financial data in a way that reflects the
revenues, costs, and profits relating to the goods purchased from
the associated product supplier in the profit split. Experience
suggests that this initial stage in performing a profit split can in
some circumstances be extremely complex, and the method of
identifying the profits relevant to the transaction and any
assumptions made in doing so need to be documented.
Transactional profit splits of actual or
anticipated profits

• The determination of the profits to be split, including

whether those profits are actual profits or anticipated
profits, or some combination thereof, should be aligned with
the accurately delineated transaction.
• Where the transactional profit split method is found to be the
most appropriate, the splitting of actual profits, i.e. profits which
have been affected by the playing out of economically significant
risks, would only be appropriate where the accurate delineation
of the transaction shows that the parties either share the
assumption of the same economically significant risks associated
with the business opportunity or separately assume closely
related, economically significant risks associated with the
business opportunity and consequently should share in the
resulting profits or losses. These kinds of risk assumption may
occur in scenarios where the business operations are highly
integrated and/or each party makes unique and valuable
contributions.
• Alternatively, if the transactional profit split is found to be
the most appropriate method (e.g. because each party to the
transaction makes unique and valuable contributions) but
one of the parties does not share in the assumption of the
economically significant risks which might play out after
entering into the transaction, a split of anticipated profits
would be more appropriate.
• In any application of a transactional profit split, care should be
exercised to ensure that the method is applied without
hindsight. That is, irrespective of whether a transactional profit
split of anticipated or actual profits is used, unless there are
major unforeseen developments which would have resulted in a
renegotiation of the agreement had it occurred between
independent parties, the basis upon which those profits are to
be split between the associated enterprises, including the profit
splitting factors, the way in which relevant profits are calculated,
and any adjustments or contingencies, must be determined on
the basis of information known or reasonably foreseeable by the
parties at the time the transactions were entered into.
• This is so notwithstanding the fact that in many cases, the
actual calculations can necessarily only be performed some
time afterwards, where, for example they apply profit
splitting factors determined at the outset to the actual
profits. Additionally, it should be remembered that the
starting point in the accurate delineation of any transaction
will generally be the written contracts which may reflect the
intention of the parties at the time the contract was
concluded.
Different measures of profits
• Most commonly, the relevant profits to be split under the
transactional profit split method are operating profits.
Applying the transactional profit split method in this manner
ensures that both income and expenses of the MNE are
attributed to the relevant associated enterprise on a consistent
basis. However, depending on the accurate delineation of the
transaction, it may be appropriate to split a different measure
of profits such as gross profits, and then deduct the expenses
incurred by or attributable to each relevant enterprise
(excluding expenses already taken into account).
• In such cases, care must be taken to ensure that the expenses
incurred by or attributable to each enterprise are consistent with the
accurate delineation of the transaction, particularly the activities and
risks undertaken by each party, and that the allocation of profits is
likewise consistent with the contributions of the parties.
• That is, the measure of profits to be split will depend on the accurate
delineation of the transaction. For instance, if the accurate
delineation of the transaction determines that the parties share the
assumption of not only market risk, which affects the volume of sales
and prices charged, but also risks associated with producing or
otherwise acquiring goods and services, which affect the level of gross
profit, it would be most appropriate to use gross profits as the basis of
the split.
• In such a scenario, the parties may have integrated or joint functions
and assets relating to the production or acquisition of goods and
services. If the accurate delineation of the transaction determines
that the parties share the assumption of, in addition to market and
production risks, a further range of risks that affect the level of
operating expenses that may include investment in intangibles, it
would be most appropriate to use operating profits as the basis of the
split. In this scenario, the parties may have integrated or joint
functions relating to the entire value chain.
• For example, two associated enterprises, each with its own
manufacturing specialisation and unique and valuable
intangibles, agree to contribute the intangibles to produce
innovative, complex products. The accurate delineation of
the transaction determines that the enterprises in this
example share the assumption of risks associated with the
success or otherwise of the products in the marketplace.
However, they do not share the assumption of risks
associated with their selling and other expenses, which are
largely unintegrated.
• Using a profit split based on combined operating profits after
all expenses of both parties would have the potential result
of sharing the consequences of risks that are assumed by
only one of the parties. In such cases, a splitting of gross
profits may be more appropriate and reliable since this level
of profits captures the outcomes of market and production
activities that the parties share together with the assumption
of associated risks.
• Similarly, in the case of associated enterprises that engage in
highly integrated worldwide trading operations, if the
accurate delineation of the actual transaction determines
that the shared assumption of risks and level of integration
does not extend to operating costs, it may be appropriate to
split the gross profits from each trading activity, and then
deduct from the resulting share of the overall gross profits
allocated to each enterprise its own operating expenses
incurred.
Splitting the profits
• Profits should be split on an economically valid basis that
reflects the relative contributions of the parties to the
transaction and thus approximates the division of profits that
would have obtained at arm’s length. The relevance of
comparable uncontrolled transactions or internal data and
the criteria used to achieve an arm’s length division of the
profits depend on the facts and circumstances of the case. It
is therefore not desirable to establish a prescriptive list of
criteria or profit splitting factors.
• In addition, the criteria or splitting factors used to split the
profit should:

Be independent of transfer pricing policy formulation, i.e.

they should be based on objective data (e.g. sales to
independent parties), not on data relating to the
remuneration of controlled transactions (e.g. sales to
associated enterprises),
Be verifiable, and
Be supported by comparables data, internal data, or both.
• One possible approach is to split the relevant profits based on
the division of profits that actually is observed in comparable
uncontrolled transactions. Examples of possible sources of
information on uncontrolled transactions that might usefully
assist the determination of criteria to split the profits,
depending on the facts and circumstances of the case, include
joint-venture arrangements between independent parties
under which profits are shared, such as development projects
in the oil and gas industry; pharmaceutical collaborations, co-
marketing or co-promotion agreements; arrangements
between independent music record labels and music artists;
uncontrolled arrangements in the financial services sector, etc.
• However, it can be difficult to find reliable comparables data that
can be used in this manner. Nevertheless, external market data
can be relevant in the profit split analysis to assess the value of
contributions that each associated enterprise makes to the
transactions. In effect, the assumption is that independent
parties would have split relevant profits in proportion to the
value of their respective contributions to the generation of profit
in the transaction. Thus, where there is no more direct evidence
of how independent parties in comparable circumstances would
have split the profit in comparable transactions, the allocation of
profits may be based on the relative contributions of the parties,
as measured by their functions, assets used and risks assumed.
Profit splitting factors
• As noted above, arm’s length parties can be assumed to split profits
on the basis of their relative contributions to the creation of those
profits. The division of the relevant profits under the transactional
profit split method is generally achieved using one or more profit
splitting factors. The functional analysis and an analysis of the context
in which the transactions take place (e.g. the industry and
environment) are essential to the process of determining the relevant
factors to use in splitting profits, including determining the weighting
of applicable profit splitting factors, in cases where more than one
factor is used.
• The determination of appropriate profit splitting factor(s)
should reflect the key contributions to value in relation to
the transaction.
• Depending on the facts and circumstances of the case, the
factor can be a figure (e.g. a 30%-70% split based on
evidence of a similar split achieved between independent
parties in comparable transactions), or a variable (e.g.
relative value of participant’s marketing contributions or
other possible factors as discussed below) which could be
calculated on the basis of a single profit splitting factor or a
weighting of multiple factors.
• Profit splitting factors based on assets or capital (e.g.
operating assets, fixed assets (e.g. production assets, retail
assets, IT assets), intangibles), or costs (e.g. relative spending
and/or investment in key areas such as research and
development, engineering, marketing) may be used where
these capture the relative contributions of the parties to the
profits being split and they can be measured reliably. Note
that while costs may be a poor measure of the value of
intangibles contributed, the relative costs incurred by parties
may provide a reasonable proxy for the relative value of
those contributions where such contributions are similar in
nature.
• Other profit splitting factors that could be appropriate in the
circumstances of a given case include incremental sales, or
employee compensation (relating to the individuals involved
in the key functions that generate value to the transaction,
for example in relation to the global trading of financial
instruments). In other situations it is possible that headcount
or time spent by a certain group of similarly skilled
employees with similar responsibilities could be used if there
is a strong and relatively consistent correlation between this
and the creation of value represented by the relevant profits.
• The guidance in this section should not be considered as an
exhaustive list of potential profit splitting factors. Other
profit splitting factors may be acceptable provided they
result in arm’s length outcomes for all relevant parties.
• In addition to the Local File, which should contain a detailed
functional analysis of the taxpayer and its relevant associated
enterprises, the MNE group’s Master File might be a useful
source of information relevant to the determination of
appropriate profit splitting factors.
• The Master File should include information on the important
drivers of business profit, the principal contributions to value
creation by entities within the group, and key group
intangibles. However, it should be borne in mind that the
Master File is intended only to provide a high-level overview
of an MNE group, and not granular or detailed information as
to all of the group’s transactions.
Reliance on data from the taxpayer’s own
operations (internal data)
• Where comparable uncontrolled transactions of sufficient reliability
are lacking to support the division of the relevant profits,
consideration should be given to internal data, which may provide a
reliable means of establishing or testing the arm’s length nature of
the division of profits. The types of such internal data that are
relevant will depend on the facts and circumstances of the case and
should satisfy the conditions. They will frequently be extracted from
the taxpayers’ cost accounting or financial accounting.
• For instance, where an asset-based profit splitting factor is
used, it may be based on data extracted from the balance
sheets of the parties to the transaction. It will often be the
case that not all the assets of the taxpayers relate to the
transaction at hand and that accordingly some analytical
work is needed for the taxpayer to draw up a “transactional”
balance sheet that will be used for the application of the
transactional profit split method. In addition, certain assets,
such as self-developed intangibles, may not be reflected on
the balance sheet at all, and accordingly must be separately
evaluated.
• In this regard, valuation techniques, such as those based on
the discounted value of projected future income streams or
cash flows derived from the exploitation of the intangible
may be useful.
• Similarly, where cost-based profit splitting factors are used
that are based on data extracted from the taxpayers’ profit
and loss accounts, it may be necessary to draw up
transactional accounts that identify those expenses that are
related to the controlled transaction at hand and those that
should be excluded from the determination of the profit
splitting factor.
• The type of expenditure that is taken into account (e.g.
salaries, depreciation, etc.) as well as the criteria used to
determine whether a given expense is related to the
transaction at hand or is rather related to other transactions
of the taxpayer (e.g. to other lines of products not subject to
this profit split determination) should be applied consistently
to all the parties to the transaction.
• Internal data may also be helpful where the profit splitting
factor is based on a cost accounting system, e.g. employee
costs related to some aspects of the transaction, or time
spent by a certain group of employees on certain tasks, etc.
• Internal data are essential to assess the values of the
respective contributions of the parties to the controlled
transaction. The determination of such values should rely on
a functional analysis that takes into account all the
economically significant functions, assets and risks
contributed by the parties to the controlled transaction. In
those cases where the profit is split on the basis of an
evaluation of the relative importance of the functions, assets
and risks to the value added to the controlled transaction,
such evaluation should be supported by reliable objective
data in order to limit arbitrariness.
• Particular attention should be given to the identification of
the relevant contributions of unique and valuable intangibles
and the assumption of economically significant risks and the
importance, relevance and measurement of the factors
which gave rise to these.
Examples of profit splitting factors
• Asset-based profit splitting factors
Asset-based or capital-based profit splitting factors can be
used where there is a strong correlation between tangible
assets or intangibles, or capital employed and creation of
value in the context of the controlled transaction. In order
for a profit splitting factor to be meaningful, it should be
applied consistently to all the parties to the transaction.
Where one or more of the parties to a transaction for which
the transactional profit split method is found to be the most
appropriate makes a contribution in the form of intangibles,
difficult issues can arise in relation both to their identification
and to their valuation.
• Cost-based profit splitting factors
A profit splitting factor based on expenses may be appropriate
where it is possible to identify a strong correlation between
relative expenses incurred and relative value contributed. For
example, marketing expenses may be an appropriate factor for
distributors-marketers if advertising generates unique and valuable
marketing intangibles, e.g. in consumer goods where the value of
marketing intangibles is affected by advertising. Research and
development expenses may be suitable for manufacturers if they
relate to the development of unique and valuable intangibles such
as patents.
However, if, for instance, each party contributes different
valuable intangibles, then it is not appropriate to use a
cost-based factor unless cost is a reliable measure of the
relative value of those intangibles or costs can be risk-
weighted to achieve a reliable measure of relative value.
Even where each party contributes the same kind of
intangibles, risk-weighting will be an appropriate
consideration.
For example, where the risk of failure at an early stage of
development is several times higher than the risk of
failure at a later stage or in the development of
incremental improvements to an already proven concept,
then the costs incurred in that early stage will have a
higher risk weighting than the costs incurred at a later
stage or on functions relating to the skills and experience
of staff are the primary factor in generating the relevant
profits.
• In identifying and applying appropriate cost-based profit
splitting factors a number of issues may need to be
considered. One is that there may be differences between the
parties in the timing of expenditure. For example, research
and development costs that are relevant to the value of a
party's contributions may have been incurred several years in
the past, whereas the expenditure for another party may be
current. As a result, it may be necessary to bring historic costs
to current values (as discussed further below) in addition to
the risk weighting The relevant costs may be part of a larger
cost pool that needs to be analysed and allocated to the
contributions made to the profit split transaction.
• For example, marketing costs may be incurred and recorded
across several product lines, whereas only one product line is
the subject of the profit split transaction. Where location
savings retained by member(s) of the MNE group are a
significant contributor to profits, and such costs are included
in the profits to be split, then the manner in which
independent parties would allocate retained location savings
would need to be reflected in the profit split. Cost-based
profit splitting factors can be very sensitive to differences
and changes in accounting classification of costs.
• It is therefore necessary to clearly identify in advance what
costs will be taken into account in the determination of the
profit splitting factor and to determine the factor consistently
among the parties.
• In some cases, a significant issue for the reliability of cost-
based splitting factors is the determination of the relevant
period of time from which the elements of determination of
the profit splitting factor(s) (e.g. assets, costs, or others)
should be taken into account. A difficulty arises because there
can be a lag between the time when expenses are incurred
and the time when value is created, and it is sometimes
difficult to decide which period’s expenses should be used.
• For example, in the case of a cost-based factor, using the
expenditure on a single-year basis may be suitable for some
cases, while in some other cases it may be more suitable to use
accumulated expenditure (net of depreciation or amortisation,
where appropriate in the circumstances) incurred in the
previous as well as the current years. Depending on the facts
and circumstances of the case, this determination may have a
significant effect on the allocation of profits amongst the
parties. The selection of the profit splitting factor should be
appropriate to the particular circumstances of the case and
provide a reliable approximation of the division of profits that
would have been agreed between independent parties.
• For example, in the case of a cost-based factor, using the
expenditure on a single-year basis may be suitable for some
cases, while in some other cases it may be more suitable to use
accumulated expenditure (net of depreciation or amortisation,
where appropriate in the circumstances) incurred in the
previous as well as the current years. Depending on the facts
and circumstances of the case, this determination may have a
significant effect on the allocation of profits amongst the
parties. The selection of the profit splitting factor should be
appropriate to the particular circumstances of the case and
provide a reliable approximation of the division of profits that
would have been agreed between independent parties.