Recommended Transfer Pricing Method:

The most suitable method for this transaction is the Transactional Net Margin Method (TNMM).

Justification:

1. Net Profit Margin Comparison: The TNMM examines the net profit margin relative to an appropriate base such as sales, costs, or assets that a person realizes from a controlled transaction or transactions that it is appropriate to aggregate. This is compared with the result achieved by independent persons on similar transactions.
2. One-Sided Method: Unlike the profit split method, which considers all relevant parties, the TNMM is a one-sided method that focuses only on the net margin of the tested party, in this case, Pyrotechnics Ghana Limited.
3. Comparable Companies: A search will be performed to identify a set of independent companies in the same or similar industry that provide similar marketing support services. These companies will be used as a benchmark to determine an appropriate arm’s length range of return.
4. Application of TNMM: The net margin earned by Pyrotechnics Ghana Limited from providing marketing support services (i.e., the 5% mark-up) will be compared against the net margins of the identified comparable companies. If the margin falls within the arm’s length range, the transaction will be considered compliant with transfer pricing regulations.

Application:

• A database search will identify comparable companies.
• The selected companies’ net margins will be analyzed to establish an arm’s length range.
• The 5% mark-up applied by Pyrotechnics Ghana Limited will be tested against this range to ensure compliance.

(8 marks)