What is the arm's-length principle in simple terms?

It means related companies should charge each other the same price two unrelated companies would agree to for the same deal. If an outside supplier would charge $100 for a product, your foreign affiliate should pay roughly $100 too. It is the benchmark the IRS uses to test whether intercompany pricing is honest.

What are the main transfer pricing methods?

The five most common are: Comparable Uncontrolled Price (CUP), which compares your price to a real third-party price for the same item; Resale Price, which starts from the resale price and works back; Cost Plus, which adds a market markup to cost; the Transactional Net Margin Method (TNMM), which compares net profit margins; and Profit Split, which divides combined profit between the related parties.

Which transfer pricing method should I use?

The U.S. rules use a 'best method' rule — there is no fixed hierarchy. You use whichever method most reliably produces an arm's-length result given the data you have. CUP is preferred when a truly comparable third-party price exists; TNMM is common when it doesn't, because comparable company profit margins are easier to find than identical transactions.

What are comparables and why do they matter?

Comparables are third-party transactions or companies similar enough to yours to serve as a benchmark. Every transfer-pricing method depends on them — the whole point is to show what an unrelated party would have charged. The quality of your comparables largely determines whether your pricing survives an IRS review.

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Transfer Pricing

The Arm's-Length Principle: Transfer Pricing Methods in Plain English

The arm's-length principle is the core test behind every transfer-pricing rule. Here are the five main methods — CUP, resale-price, cost-plus, TNMM, and profit-split — explained without the jargon.

SMAART Tax Team

February 24, 2026

6 min read

|Reviewed by Ray Dominguez, EA, USTCP