Braxton Consulting

Our client, a mining resale company, had limited internal resources (essentially a one person transfer pricing department) to deal with the number of transfer pricing issues within the company.The mining resale industry has many challenges with respect to transfer pricing, from it is commodity flows from the upstream (exploration and production) operations to the midstream (marketing) activities to downstream (distribution) activities. The entire internal supply chain may be based upon determining the appropriate transfer pricing at each stage. Some of these internal supply chain transactions are international transfer pricing issues and accordingly are under scrutiny by the tax authorities.

One of the problems encountered was the use of different distributors, both related and unrelated. Subsidiaries in Argentina, the US and the UK serve as distributors in their respective markets.

An arm’s length price is determined using the resale price method by deducting an appropriate discount for the activities of the reseller from the actual resale price. The appropriate discount is the gross margin, expressed as a percentage of net sales, earned by a reseller on the sale of property that is both purchased and resold in an uncontrolled transaction in the relevant market. In this case, the discount may be derived from unrelated party purchases and sales for the reseller involved in the inter-company transaction.

Through a search of comparable distributors, it is determined that independent distributors earn gross margins of 8%. There is one major difference between the related party distributors and the independent distributors – the independent distributors also made the marketing, whereas the related party distributors do not. Independent distributors typically charge a 2% (on sales) royalty for the marketing work. Based on this information, the comparable resale price margin is adjusted for the marketing function. Therefore, the gross margin to be earned by the related party distributors is reduced from 8 to 6% to account for the absence of a marketing function.