Profit Split Method: Definition, Variants and When It Applies
The profit split method defined: the two-sided approach that divides the combined profit between the parties according to their unique contributions — for when one-sided methods break down.
Definition
The profit split method (PSM) is the OECD’s two-sided approach: instead of testing one party’s result against a pool, it determines the combined profit of the controlled transaction (or group of transactions) and divides it between the parties in proportion to their unique contributions — their DEMPE roles, their control of the key risks, their assets. It is the method for the situation one-sided methods cannot capture: both parties are non-routine, or one party’s contribution is a residual that no comparable pool can price.
The two standard variants:
- Conventional profit split — the split follows agreed, contractual proportions of the contributions, verified against the arm’s length standard.
- Residual profit split — each party first receives a routine return for its routine functions (benchmarked, one-sided), and the residual — the profit above the routine returns — is divided according to the unique contributions, typically weighted to the party controlling the key intangibles and risks.
When it applies
| Situation | Why one-sided methods fail | What the split does |
|---|---|---|
| Both parties non-routine | No “least complex” party to test | Splits the combined result by contribution |
| One party owns the residual value | The residual is the point; a pool prices only the routine part | The residual is allocated by DEMPE and risk control |
| Integrated, hard-to-separate transactions | No clean transaction-level price exists | The combined profit is the unit |
The method is data-hungry (the combined profit and both parties’ contributions must be measurable) and assumption-heavy (the allocation key is the argument) — which is why the best method rule reaches it only after the one-sided options are shown to fail, and why the file’s DEMPE and risk-control analysis is its load-bearing exhibit.
Example
A group’s software business: an Indian development entity (performs D, engineering control) and a licensing entity (holds the rights, the E and P). Both are non-routine; no pool prices either. The residual split: each first receives its routine return (the development entity at a routine cost-plus-style return on its services), and the residual software profit is divided by the DEMPE analysis — the developer’s contribution to D and engineering control weighted against the holder’s rights and exploitation — with the royalty between the two set at the resulting split.
See also
FAQ
Is the profit split “more sophisticated” and therefore better? No — it is harder to defend, because its allocation key is an assumption set against the facts, not a pool measurement. The best method rule prefers it only where the one-sided methods genuinely cannot work; a profit split used where TNMM would have been clean is a study that chose its difficulty.
What data does a profit split need that TNMM does not? The combined profit of the transaction (both parties’ results, combined consistently), the measurement of each party’s routine functions (to strip them out in the residual variant), and the DEMPE/risk-control evidence for the allocation. The pool is not the centre of gravity — the contribution analysis is.
Run the screens as a study, not a spreadsheet
Quartyl applies the method, PLI and screening steps above as a pipeline — and keeps a documented reason for every exclusion.
Related docs
DEMPE: Development, Enhancement, Maintenance, Protection, Exploitation
DEMPE defined: the five functions that determine who performs the work on intangibles — and therefore who is entitled to the residual profit they generate.
Read docBest Method Rule: How the OECD Chooses the Right Method
The best method rule defined: the method providing the most reliable measure of the arm's length result, given the comparability, the data and the assumptions available.
Read doc