1. What Is Transfer Pricing and Why Does It Matter?

When companies do business with related entities (like a parent company and its subsidiary), they set prices for goods or services exchanged between them. This is called transfer pricing.

Ethiopia’s law says these prices should be the same as if the companies were unrelated and doing business at arm’s length — meaning fair market prices. This rule helps prevent companies from shifting profits to low-tax countries.

This rule is found in:

  • Income Tax Proclamation No. 979/2016 (Article 79)
  • Transfer Pricing Directive No. 981/2024

2. What Is an “Arm’s Length” Price?

It’s the price independent companies would charge each other for the same transaction under similar conditions. Think of it like this:

Example: If Company A in Ethiopia sells shoes to its foreign branch at 100 birr per pair, but sells the same shoes to local shops at 300 birr, tax authorities will ask: why the difference?

To check if the price is fair, the company must use one of the approved transfer pricing methods.

3. What Methods Can Be Used in Ethiopia?

The law allows five standard methods. Each one helps find the arm’s length price in a different way:

1. Comparable Uncontrolled Price (CUP) Method

  • How it works: Compares the price of a controlled transaction (between related companies) with an uncontrolled one (between unrelated companies).
  • Best for: When there are identical or very similar products sold under similar terms.
  • Example: Comparing the price of sugar sold to a sister company vs. the price sold to a third-party buyer.

2. Resale Price Method (RPM)

  • How it works: Looks at how much the product was resold for, then subtracts a standard profit margin.
  • Best for: Distributors or retailers who don’t add much value (e.g., no manufacturing).
  • Example: A company buys electronics from its parent company and resells them to local customers.

 3. Cost Plus Method (CPM)

  • How it works: Starts with the cost to produce a product and adds a reasonable markup.
  • Best for: Manufacturers or service providers.
  • Example: A local factory making leather bags for its foreign parent adds a 15% markup to its cost.

 4. Transactional Net Margin Method (TNMM)

  • How it works: Compares the net profit margin from a related-party transaction with that of similar businesses dealing with unrelated parties.
  • Best for: Service providers or manufacturers where exact product comparison is difficult.
  • Example: A consulting firm checks if its profit margin from related-company clients matches industry norms.

 5. Profit Split Method (PSM)

  • How it works: Divides total profits between the related companies based on their contributions (people, assets, ideas).
  • Best for: Complex or joint operations with shared risks or unique intellectual property.
  • Example: Two related tech companies jointly develop a new app and share global profits based on their roles.

4. How Do You Choose the Right Method?

There’s no fixed rule for which method to use. Instead, choose the method that:

  • Best fits the type of transaction
  • Has reliable data
  • Reflects economic reality

According to Article 7(2) of the Directive, you should consider:

  • The strengths/limits of each method
  • What the business actually does, owns, and risks
  • Whether good comparisons are available

Note: You only need to apply one method. As long as your documentation explains why it was the best choice, the tax authority usually accepts it — unless they find a better one (Article 7(5)).

5. Why Is Documentation So Important?

Transfer pricing issues are a top concern for tax audits. So, clear documentation is essential. As required by Article 15 of the Directive, your report should:

  • Explain the chosen method
  • Include supporting data and analysis
  • Show why the price is fair

This protects your business from:

  • Fines or penalties
  • Tax reassessments
  • Reputation damage

Final Takeaway

Choosing the right transfer pricing method helps your business stay compliant, avoid disputes, and build trust with tax authorities. Ethiopia’s laws give you the flexibility to choose, but also expect you to be transparent and accurate.

Need help? Our law office provides practical, tailored advice to ensure your transfer pricing strategy meets both legal and commercial needs with confidence.