Legal Basis for Method Selection
Article 6 of the Saudi TP Bylaws: the arm’s length remuneration of a controlled transaction must be determined using the method that, under the facts and circumstances, provides the most reliable measure of an arm’s length result. Article 7(B) explicitly states that the five approved methods are not listed in any order of preference.
The selection criteria are: (1) respective strengths and weaknesses of each method; (2) appropriateness for the nature of the transaction, based on the functional analysis; (3) availability of reliable information needed to apply the method; and (4) degree of comparability achievable, including the reliability of any adjustments required.
Article 8: where a taxpayer has applied an approved method consistently with the Bylaws, ZATCA’s review will be based on that method. A well-reasoned, consistently applied method is the strongest starting point for any ZATCA examination.
Method 1: Comparable Uncontrolled Price (CUP)
The CUP method compares the price charged in a controlled transaction with the price charged in a comparable uncontrolled transaction. It is the most direct expression of the arm’s length standard — a like-for-like price comparison.
CUP is most appropriate when: the transaction involves a commodity with a quoted market price; the taxpayer has its own transactions with independent parties on comparable terms (internal CUP); the property or services are highly standardised; or for intercompany loans where market interest rate data is available.
Hajar Commodities Co. — Aluminium Purchase
Hajar Commodities Co. (Riyadh, 100% UK-owned) purchases refined aluminium from an independent UK smelter at SAR 4,800/tonne and from the UK parent at SAR 5,200/tonne — identical delivery, volume, and payment terms.
The independent price of SAR 4,800/tonne is the internal CUP. The SAR 400/tonne excess in the parent’s price represents a TP adjustment risk. The analysis works cleanly because the product is identical and terms are the same. Any functional or product difference would require comparability adjustments.
Method 2: Resale Price Method (RPM)
The RPM examines the gross margin earned by a purchaser in a controlled transaction when reselling to independent parties. Most suitable for distribution entities that purchase from related parties and resell without significant processing — where the reseller performs routine distribution functions without contributing unique intangibles.
Al-Jubail Consumer Products Co.
Al-Jubail is a Saudi-based distributor (65% owned by a French FMCG group), purchasing finished goods from the French parent and reselling to Saudi retailers, performing local warehousing, marketing, and sales. It holds inventory risk and manages accounts receivable.
A benchmarking study of independent Saudi/regional FMCG distributors produces an arm’s length gross margin IQR of 18%–27%. Al-Jubail’s actual gross margin: 22%. Within the range — no adjustment required.
If the French parent had priced the goods to leave Al-Jubail only 14% gross margin, Al-Jubail is paying too much for the goods. ZATCA could adjust the purchase price downward.
Method 3: Cost Plus Method (C+)
The Cost Plus method examines the mark-up on costs applied to a controlled transaction versus comparable uncontrolled transactions. Most suitable for contract manufacturers, routine service providers, R&D service providers, and intragroup services where cost is the most reliable starting point.
Dammam Contract Manufacturing Co.
Dammam Contract Manufacturing Co. (100% Japanese-owned) manufactures industrial components under specification. The parent owns the design IP and retains market risk. Dammam’s annual manufacturing costs: SAR 60 million.
A benchmarking study of comparable contract manufacturers produces an arm’s length mark-up range on total costs of 5%–12% (IQR), median 8%. At the median: arm’s length charge ≈ SAR 64.8 million.
If the parent pays only SAR 62 million (3.3% mark-up), Dammam is underpaid. ZATCA may adjust Dammam’s income upward and increase its CIT base accordingly.
Method 4: Transactional Net Margin Method (TNMM)
The TNMM compares the net profit margin of the tested party relative to an appropriate base (costs, sales, or assets) with the net profit margin of comparable independent enterprises. By far the most widely used method in practice — comparable net margins are more readily available from commercial databases, and net margins are less sensitive to functional differences than gross margins.
Common profit level indicators (PLIs):
| PLI | Formula | Typical Use |
|---|---|---|
| Operating Profit Margin (OPM) | EBIT ÷ Revenue | Distributors, service providers |
| Full Cost Mark-up (FCM) | EBIT ÷ Total operating costs | Manufacturers, service providers |
| Return on Assets (ROA) | EBIT ÷ Operating assets | Asset-intensive manufacturers |
| Net Cost Plus (NCP) | Operating profit ÷ Operating costs | Routine service providers |
Al-Madinah Services Co.
Al-Madinah Services Co. (60% UAE-owned) provides administrative services to third parties and group entities under identical conditions. Total revenues: SAR 40M. Operating profit: SAR 4.2M. OPM: 10.5%.
TNMM benchmark of comparable Saudi/regional business services companies: IQR 7%–14%, median 9.5%. Al-Madinah’s 10.5% is within the range — no adjustment required. The documentation requirement: a benchmarking study with search methodology, comparables’ financial data, and a clear explanation of why the selected comparables are appropriate.
Method 5: Transactional Profit Split Method (PSM)
The PSM allocates the combined profit from a controlled transaction between related parties in proportion to the profit allocation that independent parties would have agreed. Applied when: both parties make unique, valuable contributions; the transactions are highly integrated; each party bears significant non-routine risks; or no reliable one-sided comparables exist.
Riyadh Biotech Co. — Joint Development
Riyadh Biotech Co. (50% German pharma group, 50% Saudi investors) holds and develops a unique clinical database critical to the group’s drug development process. The German parent contributes proprietary research methodologies and regulatory expertise. Both contributions are unique and non-routine.
Because both parties make unique intangible contributions and profits depend entirely on their combination, no CUP, RPM, Cost Plus, or TNMM can reliably test either party in isolation. The PSM allocates combined profits based on each party’s relative contribution — measured by development costs, expected IP value, or comparable joint development data.
Method Selection Framework
When selecting a TP method, follow this decision logic:
- Can you identify a reliable CUP? If yes, and comparability is strong, CUP is likely most appropriate.
- Does the transaction involve purchase and resale of goods by a routine distributor? Is the gross margin benchmarkable? RPM may apply.
- Does the transaction involve provision of services or manufacturing with a well-defined cost base? Cost Plus may apply.
- If direct comparables for price or gross margin are not reliably available, is the net margin of the tested party benchmarkable? TNMM is the practical default for routine entities.
- Do both parties make unique, non-routine contributions that cannot be tested independently? Profit Split Method.
The Local File must document the selection reasoning — including why alternative methods are less appropriate. A bare assertion that “TNMM was applied” without analysis of the alternatives does not meet the documentation standard.
Frequently Asked Questions
- Method selection is not mechanical. Each method has specific conditions under which it is most reliable, and the selection must be documented with reasoning.
- The five approved methods carry no fixed hierarchy in Saudi Arabia — the most appropriate method for the specific facts governs.
- The Local File must contain a clear, reasoned explanation of why the selected method was chosen and why the alternatives are less appropriate for the specific transaction.
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This article reflects the Saudi Transfer Pricing Bylaws (March 2023 version) and the ZATCA Transfer Pricing Guidelines (June 2024 edition). It is for informational purposes only and does not constitute legal or tax advice. Readers should confirm the current position with ZATCA guidance or a qualified Saudi TP advisor. dariba.co is an independent platform with no consulting relationships.
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