Best Method Rule
Which methodology should be appled to determine the arm's-length price?
The "best method rule" of transfer pricing requires that the methodology used to determine the transfer price be the one that offers the greatest precising in matching the price of an arm's-length transaction between unrelated parties. Some countries leave the decision as to which method is most appropriate for a given transaction up to the taxpayer, while others require that a particular methodology be employed. IRS regulations specify the best method for a given type of transaction. The official definition of the best method rule as it applies in the United States as well as a number of examples of its application can be found in Section 482-1 (c) of the transfer pricing regulations:
(c) Best method rule--(1) In general. The arm's length result of a
controlled transaction must be determined under the method that, under
the facts and circumstances, provides the most reliable measure of an
arm's length result. Thus, there is no strict priority of methods, and
no method will invariably be considered to be more reliable than others.
An arm's length result may be determined under any method without
establishing the inapplicability of another method, but if another
method subsequently is shown to produce a more reliable measure of an
arm's length result, such other method must be used. Similarly, if two
or more applications of a single method provide inconsistent results,
the arm's length result must be determined under the application that,
under the facts and circumstances, provides the most reliable measure of
an arm's length result. See Sec. 1.482-8 for examples of the application
of the best method rule. See § 1.482–7 for the applicable method in
the case of a qualified cost sharing arrangement.
The definition in the regulations goes on to discuss the method for determining the best method. Here is a pdf of the complete regulations: 26 CFR 1.482, including that section.
Here are some articles that discuss the best method rule: