TRansfer pricing glossary
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Cost Plus Method (CPM)

Cost Plus Method

20/11/2024
The Cost Plus Method (CPM) is a transfer pricing method that starts with a supplier’s costs and adds a mark-up. This final price should reflect what an independent party would charge in similar circumstances. It ensures that even related-party transactions comply with the arm’s length principle.

What is the Cost Plus Method?

The Cost Plus Method (CPM) is a transfer pricing method that starts with a supplier’s costs and adds a mark-up. This final price should reflect what an independent party would charge in similar circumstances. It ensures that even related-party transactions comply with the arm’s length principle.

How Does the Cost Plus Method Work?

It’s simple:

  • Identify the supplier’s direct and indirect costs related to the transaction.
  • Add an appropriate profit mark-up based on what independent parties would expect.
  • Determine the arm’s length price.

In short: cost plus profit equals price.

When Is the Cost Plus Method Appropriate?

This method is most useful in situations like:

  • Selling semi-finished goods within a group
  • Providing intercompany services such as IT or marketing
  • Routine contract or toll manufacturing
  • Long-term buy-and-supply or joint facility arrangements

It’s a practical option for low-risk, repetitive activities within a multinational group.

What Are Some Real-World Examples?

Internal Comparable Example: A Finnish PR firm offers services to both a third party in Germany and a related company in Austria. The service fee to the third party includes a 5 percent mark-up. This becomes the reference for the fee charged to the Austrian entity.

External Comparable Example: A UK company provides IT services to related subsidiaries, but has no third-party service transactions. A benchmarking study finds that similar IT services are typically priced with a 7 percent margin. This external data sets the transfer price.

What Costs Should Be Included in the “Cost” Base?

The OECD and Aibidia suggest including:

  • Direct costs, like labor and materials
  • Indirect costs tied directly to the service or product
  • Exclude unrelated items like donations, interest, or extraordinary expenses

The cost base should reflect only those costs directly connected to the controlled transaction.

How Is the Mark-Up Determined?

Mark-ups should be benchmarked against comparable transactions. These can be internal—based on prices charged to independent third parties—or external, using industry data or market studies.

Typical ranges:

  • Around 5 to 10 percent for administrative and IT services
  • Up to 15 percent for routine manufacturing or logistics

What Are the Strengths of the Cost Plus Method?

This method is popular for good reasons:

  • It’s straightforward to calculate and explain
  • Internal cost data is usually readily available
  • Tax authorities often accept it for routine operations

What Are the Weaknesses?

However, it does have limitations:

  • It can be hard to find reliable comparables, especially for specialized services
  • Cost allocation across different entities can get complex
  • It’s not ideal when transactions involve intangibles or high-risk functions

What Profit Level Indicator (PLI) Is Used?

The most common PLI for CPM is the Cost Plus Margin. It’s calculated by dividing gross profit by total direct and indirect costs. This margin helps ensure the price includes an appropriate return for the supplier’s role in the transaction.

How Does the Cost Plus Method Compare to Other Methods?

Compared to other methods, the CPM is:

  • Less complex than the Comparable Uncontrolled Price (CUP) Method
  • More focused on costs than the Resale Price Method
  • Not as dependent on net profit outcomes as the Transactional Net Margin Method (TNMM)

The key difference is that CPM is cost-based, making it ideal when you have reliable internal cost data but limited price information from the market.

What Is the Fixed Mark-Up Variation?

There’s also a simplified version called the Fixed Mark-Up Method. It applies a set percentage to costs without benchmarking. While easy to use, this approach may not meet strict OECD standards unless backed by regulatory approval or local simplification rules.

Is the Cost Plus Method Accepted Globally?

Yes, it’s widely accepted—especially in OECD countries. That said, tax authorities expect solid benchmarking and clear documentation to justify the mark-up applied. Always include a functional analysis and keep audit-ready records.

What’s the Best Way to Apply the Cost Plus Method?

To apply CPM effectively:

  • Conduct a functional analysis of the transaction
  • Identify the relevant cost base
  • Use benchmarking to determine a market-based mark-up
  • Keep documentation to support your choices

Can It Be Used for Intra-Group Services?

Yes, CPM is especially useful for services such as:

  • IT support
  • Human resources
  • Legal or finance functions
  • Marketing and administrative support

These are typically routine functions with well-defined costs, making them ideal candidates for this method.

Can This Method Be Used for Manufacturing?

Yes, and it’s particularly common for:

  • Contract manufacturers that produce goods under agreement without taking market risk
  • Toll manufacturers that provide only processing services and don’t own the raw materials or finished products

These roles are typically low-risk and suitable for cost-plus pricing.

Should You Use the Cost Plus Method?

If you’re dealing with routine services, semi-finished goods, or internal support functions, the Cost Plus Method could be your best option. It’s easy to apply, widely accepted, and provides clear, defensible pricing based on actual costs.

Just be sure you:

  • Include only relevant costs
  • Benchmark your mark-up
  • Document every step clearly

Still unsure if the Cost Plus Method fits your case? Ask yourself:

  • Is the transaction low-risk and routine?
  • Are cost records available and reliable?
  • Can you justify the mark-up?

If yes, you’re on solid ground.