Plain English
In a transfer pricing analysis, you usually pick one side of the deal to check — the one with the simpler functions, fewer intangibles and more reliable data. That side is the tested party.
Technical definition
The tested party is the participant in a controlled transaction whose operating profit is used to test the arm's length nature of the transaction. It is typically the least complex party that does not contribute unique or valuable intangibles and does not assume or control economically significant risks.
Why it matters
Choosing the wrong tested party can distort the result and attract adjustments. The tested party should be the one for which reliable comparables are most readily available.
How it works in practice
- 01Analyse the functions, assets and risks of each party.
- 02Identify the party with the less complex profile and no unique intangibles.
- 03Select comparables that reflect that profile.
- 04Apply the chosen method to derive an arm's length range for the tested party.
- 05Compare the controlled result to the range.
Worked example
Limited-risk distributor
In a buy-sell distribution arrangement, the distributor has limited inventory risk, no product development and no valuable local intangibles. The principal owns the brand and bears market risk. The distributor is selected as the tested party and its operating margin is benchmarked against comparable limited-risk distributors.
Common mistakes
- Testing the party that owns the valuable intangibles.
- Switching the tested party between years without justification.
- Ignoring that the tested party must be the one with reliable comparables.
- Testing both parties independently when a profit split is more appropriate.
Audit red flags
- Tested party bears risks it cannot finance.
- Tested party's results are volatile without explanation.
- Selection of tested party changes after the result is known.
Documentation & data
Documents to hold
- Functional analysis of both parties.
- Rationale for tested party selection.
- Comparable set supporting the tested party profile.
- Financial data for the tested party.
Data you need
- Segmented financials for the tested party.
- Comparable profit indicators.
- Functional and risk allocation.
- Intercompany agreement.
Who owns this internally: Transfer pricing team; external advisors validate selection.
Jurisdiction notes
- OECD
- The selection of the tested party is discussed in the context of the TNMM and other one-sided methods.
- United States
- Reg. §1.482-5(b) addresses tested party selection for the comparable profits method.
Notes by role
CFOs & finance leaders
The tested party is usually the entity whose margin you can explain to auditors in one slide.
Frequently asked
- Can both parties be tested parties?
- Not under a one-sided method. If both parties contribute unique value, a profit split method is usually more appropriate.
Sources & status
- Primary source
OECD Transfer Pricing Guidelines, Chapter II
OECD, 2022
Reference material only, not advice on a specific fact pattern. Reviewed 2026-06-30.
Careers
How this shows up in the job
A common interview trap: asking why you would not test the principal. The answer is that the principal owns the intangibles and there are no reliable comparables for its unique returns.
Careers in transfer pricing