The transactional profit split method (TPSM) is the fifth of the five methods in Chapter II of the OECD Guidelines, and one of the least used. The 1995 Guidelines still called it a method of "last resort". The EU Joint Transfer Pricing Forum found in March 2019 "that the PSM is not used very often at present and that when it is used, this mostly happens in the context of APA procedures". Since the 2010 revision of the Guidelines, it has been one method among equals, and the OECD's revised guidance of June 2018 clarified when it fits. This article explains when that is. The German rules are covered in our separate German-law article.
What is the transactional profit split method?
The transactional profit split method divides the combined profit from a controlled transaction between the associated enterprises, in the way independent parties would have agreed. Paragraph 2.114 of the OECD Guidelines describes it as identifying the relevant profits and splitting them "on an economically valid basis". It looks at both sides of the transaction at once.
The TNMM works the other way round. Under paragraph 2.64, it tests the net profit of one party "relative to an appropriate base (e.g. costs, sales, assets)" against the net margin earned in comparable uncontrolled transactions. That party, the tested party, is usually the one with the less complex functions (paragraph 3.18). The other party keeps whatever remains.
When is a profit split the most appropriate method?
A profit split is most appropriate when a one-sided test would leave out part of the value. The OECD Guidelines name three indicators:
- Unique and valuable contributions on both sides. Paragraph 2.119 calls this the method's main strength: it "can offer a solution for cases where both parties to a transaction make unique and valuable contributions". Under paragraph 2.130, a contribution is unique and valuable when it is not comparable to what independent parties contribute and is a key source of economic benefit. Paragraph 2.126 calls this perhaps the clearest indicator.
- Highly integrated operations. Under paragraph 2.133, integration counts when the functions, assets and risks of one party are so interlinked with the other's that neither can be evaluated reliably in isolation. Paragraph 2.134 names the global trading of financial instruments as an example.
- Shared economically significant risks. Paragraph 2.139 covers parties that assume the same significant risks. Paragraph 2.140 covers risks that are assumed separately but are so closely related that they cannot be isolated.
Paragraph 2.145 adds that each case must be analysed on its own facts. No indicator applies mechanically.
Why is the TNMM still the default for most groups?
The TNMM remains the default because most intragroup transactions have one simple side. A contract manufacturer, a limited-risk distributor or a routine service provider can be benchmarked against independent companies doing the same work. Paragraph 2.127 says a profit split typically would not be appropriate where one party performs only simple functions, assumes no economically significant risks and makes no unique and valuable contribution. Annex II to Chapter II shows the contrast in two examples. In Example 3, manufacturer and distributor both make unique and valuable contributions, and a profit split is likely most appropriate. In Example 4, the distributor's contributions are not unique or valuable, and a one-sided method is likely to fit.
Paragraph 2.143 closes the most common shortcut:
"However, a lack of comparables alone is insufficient to warrant the use of a transactional profit split."
A thin benchmark is therefore a reason to improve the search, not to switch methods. Our article on choosing a transfer pricing method explains why the TNMM usually wins on the availability of reliable data. smartZebra's Benchmarking Pro screens 50,000+ listed companies and 700,000+ European private companies for that test, with operating margins, net cost plus and Berry ratios.
Profit split vs TNMM: how do the two methods compare?
The two methods differ in which side they test, what data they need and where the documentation risk lies.
| Criterion | Transactional profit split method | Transactional net margin method (TNMM) |
|---|---|---|
| Sides tested | Both parties at once (two-sided) | One tested party (one-sided) |
| Typical fact pattern | Both sides make unique and valuable contributions; high integration; shared risks | One side performs simple, benchmarkable functions |
| What is compared | Combined profits, split by contribution | Net profit of the tested party against comparables |
| Main data source | Group's own segmented accounts, plus comparables for routine returns | External comparable companies |
| Main risk | Choice and weighting of the splitting factors | Comparability of the selected companies |
| OECD TPG 2022 | 2.114–2.183 | 2.64–2.113 |
How does a residual profit split use the TNMM?
A residual profit split uses the TNMM in its first step. Paragraph 2.152 describes two categories of contributions. The first are contributions "which can be reliably benchmarked", remunerated through a traditional method or "a transactional net margin method to identify the remuneration of comparable transactions". The second are contributions that cannot be benchmarked, typically unique and valuable ones. The residual profit, after the first category is paid, is split by the relative value of the second.
The profit to be split is normally the operating profit. Paragraph 2.162 states: "Most commonly, the relevant profits to be split under the transactional profit split method are operating profits." Under paragraph 2.166, the splitting factors must be "verifiable" and "supported by comparables data, internal data, or both". Common factors are R&D or marketing spend, capital employed or key headcount (paragraphs 2.171, 2.172 and 2.181). Under paragraphs 2.159 and 2.160, actual profits are split where the parties share the same significant risks; anticipated profits are split where one party does not share those risks.
The routine step is a normal benchmarking study. Benchmarking Pro delivers it with automatic interquartile range and median, links to the original annual reports and a one-click export of the benchmarking appendix. The remuneration for routine functions in a residual split then rests on the same evidence as a stand-alone TNMM. The contribution analysis, the alternative under paragraph 2.150, splits the total profit without that step and depends more heavily on internal data.
What must the documentation show?
The documentation must show why the chosen method is the most appropriate one. The local file template in Annex II to Chapter V already asks for "the reasons for selecting that method". For a profit split, that means three things. First, a functional analysis that identifies which contributions are unique and valuable and why. Second, a segmentation of the profits to the transaction (paragraph 2.157). Third, splitting factors fixed in advance and applied consistently across years, including loss years (paragraph 2.148).
For a TNMM, the same file shows why the tested party performs only routine functions and why its comparables are reliable. Both belong in the master file and local file.
Conclusion: split only what cannot be benchmarked
The profit split method is not a fallback for missing data. It fits where both sides create value that no independent company would contribute in the same way. Everything else, including the routine leg of a residual split, is a benchmarking question. smartZebra covers that leg with Benchmarking Pro; our article on the five OECD methods places the profit split next to the CUP, resale price, cost plus and TNMM methods. Data provenance and methodology are listed on our facts page.
References
- OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022 (20 January 2022), Chapter II, Part III, Section C "Transactional profit split method": paragraphs 2.114, 2.119, 2.126–2.127, 2.130, 2.133–2.134, 2.139–2.140, 2.143, 2.145, 2.148, 2.150, 2.152, 2.157, 2.159–2.160, 2.162, 2.166, 2.171–2.172, 2.181; Annex II to Chapter II, Examples 3 and 4.
- OECD, Transfer Pricing Guidelines 2022: paragraph 2.64 (TNMM), paragraph 3.18 (tested party), Annex II to Chapter V (local file).
- OECD/G20 Inclusive Framework on BEPS, Revised Guidance on the Application of the Transactional Profit Split Method, BEPS Action 10, June 2018.
- EU Joint Transfer Pricing Forum, The Application of the Profit Split Method within the EU, JTPF/002/2019/EN, March 2019, sections 1.1 and 5.
Related pages
- Choosing a transfer pricing method: why TNMM usually wins — the method hierarchy and the data argument
- How to prove an arm's length price — all five OECD methods side by side
- Functional analysis in transfer pricing — how to tell routine from unique and valuable contributions
- Cost plus method — the traditional method for routine manufacturing and services
- Transfer Pricing Benchmarking & TNMM Analysis — Benchmarking Pro and the comparables database
- Grounding / Facts — entity definition, data provenance and methodology
