The Profit Split Method: Effective Application for Precision and Administrability
2 October 1996
By Dr. Harlow Higinbotham
This article provides a comprehensive and thorough discussion of the theory and application of profit split method. The profit split method provides an important alternative to other arm's-length valuation methods. Correctly structured, the valuations produced by the profit split method are fully consistent with arm's-length economics and the separate enterprise standard. They are thus distinctly different from the results produced by factor formulas and similar apportionment rules that bear little or no relationship to the underlying economic principles determining an arm's-length division of profits.
The methods developed and outlined in this article reflect the current state of the art, including some of the more innovative approaches that have been taken to such issues as the appropriate definition of the business, how to integrate the Residual Profit Split Method with arm's-length ranges derived for functional contributions, computational approaches to valuing intangibles, foreign currency translations, ex-ante vs. ex-post determinations, and the legitimate role of Comparable Profit Split Method calculations. In each instance, the appropriate guiding principle is an economic rationale based on the arm's-length paradigm of independent taxpayers.
This article was published in Tax Management Transfer Pricing Special Report No. 24.
