Tax Notes International · March 27, 2023

My article with coauthor Guy Sanschagrin, Introducing the Profit Split Method: “To Apply or Not to Apply, This is a BEPS Question” debuted on March 27, 2023, in issues of Tax Notes International and Tax Notes Federal. The article examines the complex facets of the Profit Split Method (PSM), exploring its origins and utility in orchestrating the distribution of profits or losses among controlled entities within multinational enterprises (MNEs).

The OECD Transfer Pricing Guidelines (OECD TPG) and U.S. Treasury Regulations (U.S. Regs) expound on various transfer pricing methods. The U.S. Regs specify two profit-based methods: the PSM and the comparable profits method (CPM). While the CPM has traditionally been more prevalent due to its simplistic comparison of operating profit returns of “tested party” entities with those of comparable uncontrolled companies, it is less equipped than the PSM for transactions among controlled entities that jointly contribute nonroutine intangible property, share significant entrepreneurial risk, or whose activities are intricately linked in an integrated value chain.

Under these three scenarios, the PSM stands out as a versatile and reliable tool. For example, the residual PSM first allocates profits for routine activities, like contract manufacturing or limited-risk distribution. Second, it distributes the remaining nonroutine profits, which often stem from unique and valuable intangible property contributed by two or more controlled entities. This PSM process effectively realizes the BEPS objective of aligning transfer pricing outcomes with the economic activities and value contributions of controlled parties in MNC value chains.

Many practitioners who embrace the BEPS initiative view the PSM favorably as it supports the emphasis of BEPS on aligning transfer pricing outcomes with the economic activities and value-add of controlled parties in MNC value chains. By allocating profits based on each entity’s contribution to value creation, such as through manufacturing, marketing, distribution, R&D, or the development and exploitation of intangible assets, the PSM helps achieve the BEPS goal of ensuring that transfer pricing outcomes reflect the actual economic activities and value creation within the MNC.

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