RoyaltyStat Blog

The Profit Markup Model in Transfer Pricing

Posted by Ednaldo Silva

We have well-specified “return on assets” showing that we must estimate reduced-forms (instead of structural) equations and ran away from using this scrappy financial ratio to determine arm’s length profits subject to corporate income taxes. However, criticism is valid if we can provide a better substitute that can satisfy two conditions: First, the new alternative theory (markup pricing) resolves certain knotty issues of the old theory (such as avoid the cloudy base of “return on assets”); and second, the new theory provides more reliable measures of arm’s length profits. We hold that markup pricing-based profits are superior to “return on assets” respecting these two conditions.