Every cross-border transaction between related companies raises a fundamental question: is the price right? Transfer pricing, the set of rules governing how multinational groups price their intercompany transactions, is consistently ranked as the most important tax issue facing international businesses. It determines how profits are allocated across jurisdictions, how much tax is paid and where, and whether a business is exposed to adjustments, penalties, or double taxation.

Yet transfer pricing is widely misunderstood. Many entrepreneurs and business owners associate it exclusively with large multinationals or aggressive tax planning. In reality, transfer pricing applies to any business that conducts transactions with a related party in another country, regardless of size. A Dutch BV paying a management fee to a foreign holding company, a subsidiary purchasing inventory from its parent, or a group company licensing a trademark to an affiliate: all of these are transfer pricing transactions that must comply with the arm’s length principle.

This article explains what transfer pricing is, how it works, and why it matters. We cover the arm’s length principle, the main pricing methods, documentation requirements, the role of intangibles, and what happens when things go wrong. While the rules are international in nature, we pay particular attention to how they apply in the Netherlands and highlight developments that business owners should be aware of.

Table of contents

1. What is transfer pricing?

2. The arm’s length principle

3. Transfer pricing methods: how prices are tested

4. The functional analysis: functions, assets and risks

5. Intangibles and the DEMPE framework

6. Documentation requirements: master file, local file and country-by-country report

7. Transfer pricing in the Netherlands

8. Business restructurings and transfer pricing

9. Enforcement, penalties and dispute resolution

10. Getting transfer pricing right

1. What is transfer pricing?

Transfer pricing refers to the prices charged in transactions between related parties, typically companies that belong to the same multinational group. These transactions can involve goods, services, the use of intangible assets such as trademarks or technology, financial arrangements such as intercompany loans, or any other commercial or financial dealing between entities under common control.

When two independent companies transact with each other, the price is determined by market forces: supply, demand, negotiation, and competition. When two related companies transact, those market forces may be absent or weakened. The parent company and its subsidiary do not negotiate at arm’s length in the same way that unrelated parties would. This creates the risk that the prices set on intercompany transactions do not reflect what the market would produce, which in turn affects how profits are distributed across the countries where the group operates.

Transfer pricing rules exist to prevent this profit shifting. They require that intercompany transactions be priced as if the parties were independent, ensuring that each country collects its fair share of tax on the economic activity taking place within its borders. The international consensus on transfer pricing is set out in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, most recently revised in January 2022, and implemented through domestic legislation in over 140 countries.

2. The arm’s length principle

At the heart of all transfer pricing rules lies the arm’s length principle. This principle, codified in Article 9 of the OECD Model Tax Convention and incorporated into virtually every bilateral tax treaty, provides that conditions in commercial and financial relations between associated enterprises should be consistent with those that would have been agreed between independent enterprises in comparable transactions under comparable circumstances.

In practice, this means that a multinational group must price its intercompany transactions as if each entity were dealing with an unrelated party. If a Dutch subsidiary purchases goods from its German parent, the price must reflect what the subsidiary would have paid if it had bought the same goods from an unrelated supplier under similar conditions. If a holding company charges a management fee to its operating subsidiaries, that fee must correspond to what an independent service provider would charge for equivalent services.

The arm’s length principle treats each entity within a group as a separate enterprise. This separate entity approach ensures broad parity of tax treatment between multinational groups and independent businesses operating in the same markets. It also prevents the artificial shifting of profits from higher-tax to lower-tax jurisdictions by requiring that the allocation of profits follows the allocation of economic functions, assets and risks.

Why not just use a formula?

An alternative to the arm’s length principle that is sometimes proposed is global formulary apportionment: dividing a group’s total worldwide profit among countries based on a predetermined formula, such as the proportion of sales, employees, or assets in each country. The OECD and its member countries have consistently rejected this approach. A formula would be inevitably arbitrary, difficult to agree upon internationally, and would fail to account for the specific facts and circumstances of individual transactions. It would also create significant risks of double taxation where countries disagree on the formula or its inputs.

3. Transfer pricing methods: how prices are tested

The OECD Guidelines describe five transfer pricing methods, divided into two categories. The goal is always to select the method that is most appropriate to the circumstances of the case, taking into account the nature of the transaction, the availability of reliable comparable data, and the degree of comparability between the controlled and uncontrolled transactions.

Traditional transaction methods

• Comparable Uncontrolled Price (CUP) method compares the price charged in a controlled transaction directly to the price in a comparable transaction between independent parties. This is the most direct method and is preferred whenever reliable comparables exist. It is particularly effective for commodity transactions where quoted market prices are available.
• Resale Price Method (RPM) starts from the price at which a product purchased from a related party is resold to an independent customer, then subtracts an appropriate gross margin for the reseller. It is most useful for distribution activities where the reseller does not add substantial value to the product.
• Cost Plus Method (CPM) begins with the costs incurred by the supplier in a controlled transaction, then adds an appropriate markup. It is commonly applied to contract manufacturing arrangements and intercompany services where the supplier performs routine functions.

Transactional profit methods

• Transactional Net Margin Method (TNMM) examines the net profit that a taxpayer earns from a controlled transaction relative to an appropriate base, such as costs, sales or assets, and compares it to the net profit earned by comparable independent enterprises. TNMM is a one-sided method: it tests only the less complex party (the “tested party”). It is the most commonly applied method in practice because net profit indicators are generally less sensitive to transactional differences than prices or gross margins.
• Transactional Profit Split Method identifies the combined profits from a controlled transaction and divides them between the parties based on their relative contributions. It is most appropriate when both parties make unique and valuable contributions, such as when each contributes significant intangible assets, or when the operations are so highly integrated that a one-sided method cannot reliably isolate the contribution of either party.

There is no strict hierarchy among these methods, but the OECD Guidelines indicate that traditional methods are generally preferred over transactional profit methods when both can be applied with equal reliability, and that the CUP method is preferred over all others when a comparable uncontrolled transaction can be identified.

4. The functional analysis: functions, assets and risks

The foundation of any transfer pricing analysis is the functional analysis. Before selecting a method or identifying comparables, it is essential to understand what each entity within the group actually does: what functions it performs, what assets it uses, and what risks it assumes. This analysis determines the characterisation of each entity and, consequently, the level of profit it is entitled to earn.

An entity that performs routine distribution functions, uses limited assets, and bears minimal risk is characterised as a limited-risk distributor and is entitled to earn only a routine margin. An entity that develops products, owns valuable intellectual property, makes strategic decisions, and bears the entrepreneurial risk is entitled to the residual profit, the return above the routine compensation paid to limited-function entities.

The five comparability factors

The OECD Guidelines identify five factors that must be examined when comparing a controlled transaction to an uncontrolled transaction:

• Contractual terms of the transaction, recognising that the actual conduct of the parties prevails over written agreements where the two are inconsistent
• Functions performed, assets used, and risks assumed by each party, which is the core of the functional analysis
• Characteristics of property or services transferred, including physical features, quality, availability, and volume
• Economic circumstances of the parties and the market in which they operate, including market size, competition, consumer purchasing power, and regulatory environment
• Business strategies pursued by the parties, such as market penetration, product diversification, or risk aversion

Risk analysis

Risk is a central element of the functional analysis. The party that controls a risk and has the financial capacity to assume that risk is entitled to the return (or loss) associated with that risk. A party that neither controls nor assumes a risk is not entitled to any share of the upside or downside returns from that risk. Under the OECD framework, risk is analysed through a six-step process that examines who identifies economically significant risks, who contractually assumes them, who actually controls the risk through decision-making, and who has the financial capacity to bear the consequences. If a party lacks control over a risk that it contractually assumes, the risk is reallocated to the party with both control and financial capacity.

5. Intangibles and the DEMPE framework

Intangible assets, including patents, trademarks, know-how, trade secrets, customer relationships, and proprietary technology, are often the most significant drivers of value in a multinational group. How the returns from intangibles are allocated among group entities is one of the most contested areas of transfer pricing.

The OECD defines an intangible for transfer pricing purposes as something that is not a physical asset or a financial asset, that is capable of being owned or controlled for use in commercial activities, and that would be compensated if transferred between independent parties. Importantly, this definition is broader than accounting or legal definitions: internally developed intangibles that do not appear on a balance sheet, such as the cumulative value of years of marketing expenditure, may still be relevant for transfer pricing purposes.

The DEMPE framework

The OECD introduced the DEMPE framework to determine which entity within a group is entitled to the returns from intangible assets. DEMPE stands for the five key functions related to intangibles:

• Development of the intangible, such as product R&D or brand creation
• Enhancement of the intangible, including improvements and updates over time
• Maintenance of the intangible’s value through quality control and ongoing investment
• Protection of the intangible through legal measures such as trademark registration, patent filings, and enforcement of IP rights
• Exploitation of the intangible to generate revenue, such as commercialising a product or licensing a brand

The critical insight of the DEMPE framework is that legal ownership of an intangible, by itself, does not entitle the owner to the income generated by that intangible. An entity that merely registers a trademark or holds legal title to a patent but performs none of the DEMPE functions is not entitled to the residual profits. Instead, it is entitled to no more than a risk-adjusted return on its funding contribution, if it provides any funding at all. The entity that actually performs the important DEMPE functions, controls the associated risks, and has the financial capacity to bear those risks is entitled to the intangible-related returns.

This principle has far-reaching implications for structures in which intellectual property is held by a shell company in a low-tax jurisdiction while all development, marketing and strategic decision-making occurs elsewhere. Under the DEMPE framework, such arrangements may not withstand scrutiny.

6. Documentation requirements: master file, local file and country-by-country report

The OECD recommends a standardised three-tier approach to transfer pricing documentation, adopted by the majority of jurisdictions worldwide:

Master file

The master file provides a high-level overview of the multinational group’s global business operations, organisational structure, intangible assets, intercompany financial activities, and overall transfer pricing policies. It is designed to give tax authorities a comprehensive picture of the group’s global operations and how transfer pricing policies fit within that context. The master file covers five categories: organisational structure, business description, intangibles strategy, intercompany financial activities, and the group’s financial and tax positions.

Local file

The local file supplements the master file with detailed information on material intercompany transactions involving the local entity. It includes a description of the local entity, its management structure and business strategy, a detailed functional analysis for each material intercompany transaction, the transfer pricing method selected and the rationale for that selection, the comparability analysis including benchmarking data, and the financial information used to apply the selected method. The local file is where the substance of the transfer pricing analysis resides.

Country-by-country report

The country-by-country report (CbCR) provides aggregate, jurisdiction-by-jurisdiction information on the global allocation of income, taxes paid, employees, and tangible assets. It is intended for high-level risk assessment by tax authorities and is explicitly not to be used as a basis for transfer pricing adjustments or formulary apportionment. The CbCR is required for multinational groups with consolidated group revenue of at least EUR 750 million.

7. Transfer pricing in the Netherlands

The Netherlands has been an early adopter of the arm’s length principle and maintains a transfer pricing framework that closely follows the OECD Guidelines. The Dutch framework is built on several legal foundations.

Article 8b of the Corporate Income Tax Act

The arm’s length principle was codified in Dutch law through Article 8b of the Wet op de vennootschapsbelasting 1969 (Corporate Income Tax Act), effective 1 January 2002. This article provides that where conditions agreed between related entities differ from those that would have been agreed between independent parties, taxable profit is determined as if arm’s length conditions had applied. Article 8b also introduces a documentation requirement: taxpayers must include information in their records demonstrating how transfer prices were established and that they are consistent with what independent parties would have agreed.

The 2022 anti-mismatch rules

Since 1 January 2022, the Netherlands has introduced Articles 8ba through 8bd of the Corporate Income Tax Act, which significantly changed the Dutch transfer pricing landscape. These provisions were designed to prevent situations of double non-taxation that could arise from unilateral downward transfer pricing adjustments.

Under the new rules, a downward adjustment of the Dutch tax base is only permitted to the extent that the corresponding upward adjustment is included in the taxable base of the related party in the other jurisdiction. The burden of proof lies with the Dutch taxpayer, which must demonstrate that the counterparty is indeed taxed on the higher amount.

Documentation obligations

Article 29g of the Corporate Income Tax Act implements the OECD’s three-tier documentation framework for the Netherlands. Multinational groups with consolidated group revenue of at least EUR 50 million are required to maintain both a master file and a local file. These documents must be prepared in Dutch or English and completed by the filing deadline of the corporate income tax return. The country-by-country reporting obligation applies to groups exceeding the EUR 750 million threshold.

8. Business restructurings and transfer pricing

Business restructurings, the cross-border reorganisation of functions, assets, and risks within a multinational group, are one of the most complex areas of transfer pricing. Common examples include converting a full-fledged distributor into a limited-risk distributor, transforming a manufacturer into a contract manufacturer, centralising intellectual property in a single group entity, or consolidating procurement, logistics, or back-office functions in a shared service centre.

The OECD Guidelines require that the arm’s length principle be applied not only to the post-restructuring transactions but also to the restructuring itself. If value is transferred from one entity to another, for example through the surrender of a profitable distribution right or the transfer of customer relationships, the transferring entity must receive arm’s length compensation for the value it gives up.

Profit potential and compensation

The concept of “profit potential” plays an important role. When a full-fledged distributor with a history of high and variable returns is converted into a limited-risk entity earning a fixed routine margin, the question arises whether the distributor is being adequately compensated for the profit potential it surrenders. The analysis depends on the options realistically available to the restructured entity: would an independent enterprise in the same position have accepted the same terms, or would it have negotiated indemnification or other compensation?

9. Enforcement, penalties and dispute resolution

Tax authorities worldwide have significantly increased their focus on transfer pricing in recent years. Audit activity has expanded, specialised transfer pricing units have been established, and information exchange between jurisdictions has intensified, particularly through the automatic exchange of country-by-country reports.

Audit triggers

Common audit triggers include persistent losses in a local entity despite group-level profitability, significant intercompany transactions relative to total turnover, payments to related parties in low-tax jurisdictions, recent business restructurings, and inconsistencies between the local file and other publicly available information. Country-by-country reports give tax authorities a high-level view of the group’s global profit allocation, which they use to identify potential mismatches between where profits are reported and where value is created.

Penalties

Most jurisdictions impose penalties on transfer pricing adjustments, particularly where the taxpayer has failed to maintain adequate documentation. In the Netherlands, the general penalty framework for corporate income tax applies. Where a taxpayer has maintained proper contemporaneous documentation and can demonstrate reasonable efforts to comply with the arm’s length principle, penalties are generally avoidable. However, the absence of documentation can shift the burden of proof to the taxpayer and expose it to both adjustments and penalties.

Double taxation and dispute resolution

One of the most significant consequences of a transfer pricing adjustment is the risk of double taxation. If one country increases the taxable profits of a group entity by adjusting a transfer price upward, and the corresponding country does not make a matching downward adjustment, the same income is taxed in both countries. To address this, most tax treaties include a mutual agreement procedure (MAP) under which the competent authorities of the two countries negotiate to eliminate double taxation. More recently, the EU Arbitration Convention and the Multilateral Instrument (MLI) have introduced binding arbitration mechanisms to ensure that disputes are resolved within defined timescales.

10. Getting transfer pricing right

Transfer pricing is not merely a compliance exercise. It is a core element of how a multinational business structures its operations, allocates its resources, and manages its tax risk. The businesses that approach transfer pricing proactively, rather than reactively, are consistently better positioned to withstand audit scrutiny, avoid double taxation, and maintain commercial flexibility.

The key principles to keep in mind are:

• Every intercompany transaction must be priced at arm’s length, supported by a functional analysis that accurately reflects the functions performed, assets used, and risks assumed by each party
• The entity that performs the important value-creating functions, controls the associated risks, and has the financial capacity to bear those risks is entitled to the residual profit
• Documentation must be contemporaneous, meaning it should be prepared at the time the transaction is entered into or, at the latest, by the time the tax return is filed
• Transfer pricing policies must be consistent with the actual conduct of the parties, not merely with what is written in intercompany agreements
• Business restructurings that transfer value between group entities require arm’s length compensation for the value transferred
• Advance pricing agreements (APAs) can provide certainty for material or complex intercompany arrangements

Every situation is different. The right transfer pricing approach depends on the specific facts of the business, the jurisdictions involved, the nature of the intercompany transactions, and the commercial objectives of the group. Transfer pricing arrangements must reflect genuine economic substance and be supported by robust, contemporaneous documentation.

At Taxboutiq, we specialise in transfer pricing, international tax structuring, and cross-border advisory for entrepreneurs and businesses. Whether you are setting up your first intercompany arrangement or reviewing an existing transfer pricing policy, we work as part of your team to implement solutions that are both compliant and commercially effective.