Resale Price Method
Method uses comparable profits in unrelated-party sale of tangible goods to determine profit ratios
The resale price method compares the gross profit relized when an entity re-sells goods to a related party to the gross profits relized by comparable entities in uncontrolled transactions. Comparable profitability is determined by calculating the ratio of the initial purchase price of comparable tangible goods to their resale price to an unrelated party. This ratio (expressed as a percentage) is then used to calculate the value of the goods in a related-party transaction. The official definition of this method can be found in 26CFR 1.482-3(c) of the transfer pricing regulations:
(c) Resale price method—(1) In general
The resale price method evaluates whether the amount charged in a controlled transaction is arm’s length by reference to the gross profit margin realized in comparable uncontrolled transactions. The resale price method measures the value of functions performed, and is ordinarily used in cases involving the purchase and resale of tangible property in which the reseller has not added substantial value to the tangible goods by physically altering the goods before resale. For this purpose, packaging, repackaging, labelling, or minor assembly do not ordinarily constitute physical alteration
Further the resale price method is not ordinarily used in cases where the controlled taxpayer uses its intangible property to add substantial value to the tangible goods
(2) Determination of arm’s length price—(i) In general. The resale price method measures an arm’s length price by subtracting the appropriate gross profit from the applicable resale price for the property involved in the controlled transaction under review
(ii) Applicable resale price. The applicable resale price is equal to either the resale price of the particular item of property involved or the price at which contemporaneous resales of the same property are made. If the property purchased in the controlled sale is resold to one or more related parties in a series of controlled sales before being resold in an uncontrolled sale, the applicable resale price is the price at which the property is resold to an uncontrolled party, or the price at which contemporaneous resales of the same property are made. In such case, the determination of the appropriate gross profit will take into account the functions of all members of the group participating in the series of controlled sales and final uncontrolled resales, as well as any other relevant factors described in § 1.482–1(d)(3)
(iii) Appropriate gross profit. The appropriate gross profit is computed by multiplying the applicable resale price by the gross profit margin (expressed as a percentage of total revenue derived from sales) earned in comparable uncontrolled transactions.
Here is a pdf of the complete regulations: 26 CFR 1.482.
The resale price method is further discussed in the following articles: