Cost Plus vs Transfer Pricing

21 March 2023

Transfer pricing and cost-plus arrangements are both methods used by multinational corporations to determine the prices at which goods, services, and intellectual property are transferred between related entities. While there are similarities between these two concepts, there are also some key differences when operating in the UK.

Transfer pricing refers to the process of determining the prices at which related entities within a multinational corporation transfer goods, services, or intellectual property between each other. The aim of transfer pricing is to ensure that the prices charged for these transfers are fair and reflect market values. In the UK, transfer pricing rules are set out in the Income Tax (Trading and Other Income) Act 2005 and the Transfer Pricing Regulations 2018. These regulations require companies to use arm's length pricing, which means that the price charged for a transfer should be similar to what would be charged between unrelated parties.

A cost-plus arrangement, on the other hand, is a pricing method where a seller adds a markup to the cost of producing a good or service in order to determine its selling price. The cost-plus method is often used in construction contracts or where there is no established market price for the good or service being provided. In the UK, there is no specific legislation governing cost-plus arrangements, but companies are required to ensure that the price charged for goods or services is fair and reasonable.

The key difference between transfer pricing and cost-plus arrangements is that transfer pricing is focused on ensuring that the price charged for a transfer is similar to what would be charged between unrelated parties, while cost-plus arrangements are focused on ensuring that the price charged for a good or service reflects the actual cost of producing it plus a reasonable profit margin.

Transfer pricing is generally used for intangible goods or services where market prices may not be readily available, while cost-plus arrangements are more commonly used for tangible goods or services where the cost of production can be easily calculated.

In summary, while both transfer pricing and cost-plus arrangements are used to determine prices within multinational corporations, they are distinct concepts with different objectives and legal frameworks in the UK.