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Transfer Pricing Alert

Understanding profit split method

15 Oct 2025 5 min read

Another transfer pricing method provided in the OECD Transfer Pricing Guidelines for evaluating the arm’s length price of related party transactions is the Profit Split Method (PSM). This is applied by identifying the profits to be split from the controlled transactions, known as the relevant profits, and subsequently “splits” the same between the related parties based on the economic value that each party brings to the transaction.

Situations where the PSM is most suitable

The PSM works best in situations where:

  • Both parties contribute unique and valuable contributions which cannot be easily replicated by third parties such as unique skills, technology, or brand.
  • The transaction is complex and connected, making it hard to separate each part and cannot be reliably evaluated in isolation.
  • The companies work closely together, such as in joint projects or global operations.
  • There are no good external comparisons, so other methods may not give reliable results.

Key comparability factors in the PSM

To apply the PSM properly, one should look at how each party contributes to the transaction. Here are the key things to consider:

  1. What each party does: Look at the roles and responsibilities of each entity (e.g., who handles production, marketing, R&D).
  2. Risks taken: Consider which party takes on more risks, like financial, market, or product risks.
  3. Assets used: Check what assets are used, including physical tools and valuable intangibles like patents or trademarks.
  4. Type of transaction: This method works best for complex, connected transactions where both parties work closely together.
  5. Quality of information: Reliable financial and operational data is needed to support how profits are split.
  6. Fairness and compliance: The profit split should reflect what independent companies would agree to in similar situations.

Why use the PSM

The PSM has several benefits, especially for complex business setups:

  • Fairly reflects how profits are earned when both parties work closely together and share responsibilities.
  • Works well without needing external comparisons, which can be hard to find for unique or specialised transactions.
  • Gives credit to both parties based on what they actually contribute, including risks and valuable assets.
  • Follows international tax guidelines, making it easier to defend during audits or reviews.
  • Helps show transparency, especially for multinational companies with shared operations.

Challenges and key considerations in applying the PSM

While the PSM can be very useful, it also comes with some challenges:

  • Estimating each party’s contribution can be tricky, especially when dealing with unique assets like intellectual property or specialised services.
  • Getting accurate and complete data is important but can be difficult, especially across different countries or business units.
  • Detailed documentation is needed to explain how profits are split and why the method was chosen. Tax authorities may ask for clear justification.
  • Different tax rules in different countries can lead to disagreements or even double taxation if the method isn’t applied consistently.
  • Applying the method can take time and resources, as it often involves input from various teams like finance, legal, and operations.

(Chapter II: Transfer Pricing Methods, OECD Transfer Pricing Guidelines, January 2022 and BIR RR No. 2-2013)

PSM is a valuable tool in transfer pricing, especially for businesses with complex and closely connected operations. It helps ensure that profits are shared fairly based on each party’s actual contribution, even when reliable comparables are hard to find. While it requires careful analysis and strong documentation, it supports compliance with international tax standards and provides a practical solution for handling transactions involving shared risks, assets, and intangibles.

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