The Berry Ratio in Transfer Pricing: Complete Guide with Examples
Borys Ulanenko
CEO of ArmsLength AI
TL;DR - Key Takeaways
Berry Ratio = Gross Profit ÷ Operating Expenses. It measures gross profit relative to operating expenses—a cost base that proxies value-adding effort in intermediary models.
Use Berry Ratio only where OECD ¶2.107 conditions hold: value proportional to OPEX, not materially affected by product value, and no other significant functions requiring separate remuneration.
Berry Ratio is explicitly recognized in US regulations (§1.482-5) and OECD Guidelines (¶2.106–2.108), but faces scrutiny in India and is rarely used in some jurisdictions. Document conditions carefully.
A Berry Ratio of 1.0 means break-even (operating profit = zero). There is no universal 'correct' Berry Ratio—the arm's length range must be derived from comparables.
Berry Ratio is highly sensitive to cost classification—inconsistent COGS vs. OPEX treatment between tested party and comparables will undermine reliability.
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Quick Answer: What is the Berry Ratio?
The Berry Ratio is a profit level indicator (PLI) defined as Gross Profit ÷ Operating Expenses. It measures how much gross profit is earned per dollar of operating expense incurred.
Per OECD ¶2.107, Berry Ratio is appropriate only where:
The value of functions performed is proportional to operating expenses
The value of functions is not materially affected by the value of products distributed
The taxpayer does not perform other significant functions (e.g., manufacturing) requiring separate remuneration
Classic use cases include limited-risk distributors, sales agents, commissionaires, and service intermediaries. Berry Ratio is generally not appropriate for manufacturers, full-fledged distributors with inventory risk, or entities with valuable intangibles.
What is the Berry Ratio?
The Berry Ratio is named after Dr. Charles Berry, an economist who introduced this metric in the landmark E.I. DuPont de Nemours & Co. v. United States case in 1979. Dr. Berry used the ratio to analyze the transfer pricing of DuPont's Swiss sales affiliate, demonstrating that comparing gross profit to operating expenses could determine whether an intermediary's profit was arm's length.
Origin Story: The Berry Ratio wasn't included in US transfer pricing regulations as a listed PLI until the 1994 final §482 regulations. Today it's discussed in OECD Guidelines and recognized in US regulations—but with significant conditions on when it's appropriate.
The Economic Logic
Berry Ratio rests on a simple premise: for certain businesses, the effort expended (measured by operating expenses) is what drives profit, not the volume of sales or assets employed.
Consider a sales agent who facilitates transactions between a manufacturer and customers. The agent's revenue might be enormous (reflecting the value of goods passing through), but the agent isn't really "earning" that revenue—it's just flowing through. What the agent actually contributes is sales effort, customer service, and logistics coordination. Those activities are captured in operating expenses (salaries, marketing, admin). Berry Ratio tests whether the gross profit earned is proportionate to that effort.
Berry Ratio Formula and Calculation
The Formula
Berry Ratio = Gross Profit ÷ Operating Expenses
Where:
Gross Profit = Net Sales − Cost of Goods Sold (COGS)
Gross Profit should reflect only the value-added portion of transactions. For a distributor, this is the markup over purchase cost. For an agent, it's typically the commission earned. OECD notes that interest and extraneous income should be excluded from gross profit determination.
Operating Expenses generally means non-COGS operating costs (often SG&A), and treatment of depreciation/amortization must be consistent and justified:
Exclude: Interest expense (financing cost, not operational), extraordinary items, pass-through costs that are reimbursed
Depreciation: Treatment varies—IRS APA training materials include depreciation in SG&A, while OECD says it may or may not be included depending on comparability concerns
Depreciation Treatment: OECD allows flexibility on including depreciation in operating expenses. If one comparable has heavy depreciation and another doesn't, the Berry Ratios won't be comparable. Be consistent and document your treatment.
Interpretation
Berry Ratio
Meaning
< 1.0
Operating loss (gross profit doesn't cover operating expenses)
Berry Ratio = 1 + (Operating Profit ÷ Operating Expenses)
So a Berry Ratio of 1.25 means the operating profit equals 25% of operating expenses—equivalent to a 25% markup on costs.
When to Use Berry Ratio
Berry Ratio is a narrow-application PLI designed for specific circumstances. OECD TPG 2022 discusses Berry ratios at ¶2.106–2.108, and US Treasury Regulations list it as a valid PLI. Both emphasize it should only be used when operating expenses are the primary value driver.
The Three OECD Conditions
OECD Guidelines ¶2.107 establishes three conditions that must all be satisfied:
Proportionality to Expenses: "The value of the functions performed (taking into account assets used and risks assumed) is proportional to the operating expenses." More effort = more profit, with no significant returns from other factors.
Independence from Product Value: "The value of the functions performed is not materially affected by the value of the products distributed." Whether selling cheap or expensive goods, the tested party's functions (and required profit) remain the same.
No Other Significant Functions: "The taxpayer does not perform, in the controlled transaction, any other significant function (e.g., manufacturing) that should be remunerated using another method."
Appropriate Scenarios
Entity Type
Berry Ratio Appropriate?
Rationale
Limited-risk distributor
Yes (often)
Gross profit covers sales efforts; COGS is largely transfer price pass-through
Commissionaire / sales agent
Yes
Revenue is commission or pass-through; OPEX captures all value-add
Service intermediary
Yes
When revenue = cost recovery + service fee
Procurement hub
Possibly
If acting as a routine sourcing agent without inventory risk
Full-fledged distributor
No
Inventory risk and market risk mean returns should tie to sales/assets
Contract manufacturer
No
Value-add is in production (COGS), not SG&A
Any entity with intangibles
No
IP value isn't captured in operating expenses
Decision Rule: Ask yourself: "Could this arrangement have been structured as a cost-plus service fee?" If yes, Berry Ratio may be appropriate. If the entity needs returns tied to sales volume, inventory risk, or valuable IP, Berry Ratio is not the right tool.
When NOT to Use Berry Ratio
Understanding when Berry Ratio fails is as important as knowing when it works. Misapplication is one of the most common transfer pricing errors.
Scenarios Where Berry Ratio Fails
1. Significant Inventory or Product Value Risk
If the tested party owns inventory and bears obsolescence or pricing risk, profit should partly reflect a return on that capital. Berry Ratio ignores inventory—two distributors with identical operating expenses but vastly different inventory levels would show identical Berry Ratios, which doesn't reflect their different risk profiles.
2. Asset-Intensive Operations
Berry Ratio has no place for assets in the formula. If the tested party uses significant tangible assets (warehouses, equipment) or intangibles (brand, technology), the return to those assets isn't captured. Use ROA or operating margin instead.
3. Valuable Intangibles
If the tested party owns or exploits valuable intangibles, its profits shouldn't just be a function of operating expenses. A company with a famous brand might have minimal selling expenses (the brand sells itself) but high profits—an appropriately high Berry Ratio that doesn't need "fixing."
4. Manufacturing Functions
Manufacturers create value through production (reflected in COGS), not just SG&A. OECD ¶2.107 explicitly excludes entities performing "other significant function (e.g., manufacturing)" from Berry Ratio applicability. The ratio would typically yield unreliable results because manufacturing value-add isn't captured in the operating expense denominator.
5. Inconsistent Cost Classification
Berry Ratio is "very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues" (OECD ¶2.106). If comparables treat freight, distribution costs, or certain labor differently (COGS vs. OPEX), the Berry Ratios won't be comparable.
The Comparability Trap: Berry Ratio can produce drastically different results from identical economics if costs are classified differently. If you can't verify consistent COGS/OPEX treatment across comparables, consider a different PLI.
Berry Ratio vs. Operating Margin
Berry Ratio and Operating Margin measure profitability against different bases. Understanding when each is appropriate is essential.
Side-by-Side Comparison
Factor
Berry Ratio (GP/OPEX)
Operating Margin (OP/Sales)
Formula
Gross Profit ÷ Operating Expenses
Operating Profit ÷ Sales
Value Driver Focus
Operating expenses (effort)
Revenue (sales volume)
Best For
Pass-through activities, agents
Distributors, service providers
Sensitivity
Cost classification; OPEX changes
Revenue fluctuations; pricing
When Revenue is Pass-Through
More reliable
May distort results
Acceptance
Limited (specific conditions)
Universal
Numerical Example
Same Distributor, Different PLI Results:
Item
Amount
Sales
€1,000,000
COGS (purchases from parent)
€950,000
Gross Profit
€50,000
Operating Expenses
€40,000
Operating Profit
€10,000
PLI Calculations:
PLI
Calculation
Result
Operating Margin
€10,000 ÷ €1,000,000
1.0%
Berry Ratio
€50,000 ÷ €40,000
1.25
Interpretation: The 1% operating margin looks thin, but this is a pass-through distributor. Berry Ratio of 1.25 (25% markup on operating costs) is reasonable for a routine intermediary. Berry Ratio strips out the pass-through COGS and evaluates profit against the value-adding activities.
Jurisdictional Acceptance
Berry Ratio acceptance varies by jurisdiction. Understanding local preferences helps anticipate audit challenges.
United States (IRS)
Status: Explicitly recognized in Treas. Reg. §1.482-5(b)(4)(ii)(B) as "ratio of gross profit to operating expenses"
Usage: Used in some APAs and TNMM-style CPM analyses, alongside operating margin and other PLIs
Caution: Reliability depends on "the extent to which the composition of the tested party's operating expenses is similar to that of the uncontrolled comparables"
OECD Guidelines
Status: Discussed at ¶2.106–2.108 with detailed conditions in ¶2.107
Key Warning: "Berry ratios are very sensitive to classification of costs as operating expenses or not, and therefore can pose comparability issues"
Use Case: OECD gives an example at ¶2.108 where Berry ratios can be useful: "intermediary activities where a taxpayer purchases goods from an associated enterprise and on-sells them to other associated enterprises"
Germany
Status: Germany generally follows OECD concepts
Practice: If Berry Ratio is used, it should be justified under OECD ¶2.107 and documented carefully; operating margin or cost-based indicators are more commonly used in practice
Expectation: Strong documentation required to demonstrate ¶2.107 conditions are met
India
Status: Berry Ratio analyses face scrutiny at assessment stage
Challenge: Indian tax authorities have disputed Berry Ratio in numerous cases, arguing the TNMM base should be broader
Judicial Acceptance: Indian tribunals and courts have accepted Berry ratio-type PLIs in appropriate "indenting/intermediary" fact patterns (e.g., Mitsui & Co. India, Mitsubishi-type rulings)
Risk: Defensibility hinges on facts, documentation, and clear fit with TNMM principles under Rule 10B
OECD-Aligned Jurisdictions (UK, Australia, etc.)
Status: In jurisdictions following OECD guidance, acceptance generally tracks OECD conditions
Practice: Berry Ratio is less common than operating margin in documentation, but may be appropriate for intermediary functions meeting ¶2.107 conditions
Caution: Always verify local administrative guidance and confirm the OECD conditions are demonstrably satisfied
Finding Berry Ratio Comparables
Berry Ratio benchmarking requires comparables with similar functional profiles and consistent cost classification.
Search Strategy
Screen for functional profile: Look for independent distributors, agents, or intermediaries in similar industries (NACE/SIC codes)
Verify limited-risk nature: Low inventory relative to sales, low fixed assets—indicators of pass-through activity
Confirm data availability: Both gross profit and operating expenses must be clearly reported
Check cost classification: Review financial statement notes for COGS vs. OPEX treatment
Common Challenges
Challenge
Mitigation
Comparables classify costs differently
Review notes; adjust if possible; exclude if unreliable
Some comparables include depreciation in COGS
Standardize treatment; document adjustments
Mixed business models
Screen out companies with manufacturing or IP segments
Wide Berry Ratio variance
Check functional comparability; outliers may not be comparable
Establishing the Arm's Length Range
There is no universal "correct" Berry Ratio—the arm's length range must be derived from your own comparable company analysis. In some routine intermediary benchmark sets, observed Berry Ratios may cluster modestly above 1.0 (reflecting that profitable entities exceed break-even), but the specific range depends entirely on industry, function, and comparable data.
Do Not Use Rules of Thumb: Berry Ratio ranges like "1.1–1.3 for distributors" are sometimes cited in practitioner discussions, but these are illustrative heuristics, not defensible benchmarks. Your analysis must be based on actual comparable company data, not industry generalizations.
Worked Examples
Example 1: Limited-Risk Distributor (Berry Ratio Appropriate)
Facts:
European subsidiary distributes products from US parent
No significant inventory risk (consignment-like arrangement)
Comparable Range (illustrative): Assume a benchmarking study identified independent limited-risk distributors with Berry Ratios ranging from 1.15–1.30.
Result: Berry Ratio of 1.25 falls within the illustrative arm's length range. The subsidiary earns a 25% markup on its operating expenses, consistent with its routine functions. (In practice, you must derive the range from your own comparable search.)
Example 2: Full-Fledged Distributor (Berry Ratio NOT Appropriate)
Facts:
Same revenue and expense structure as Example 1
BUT: this distributor owns €2M of inventory, sets local pricing, bears market risk, and has built a local brand
Why Berry Ratio Fails:
Using Berry Ratio = 1.25 would suggest this entity should earn only €100,000 profit. But this distributor:
Bears inventory obsolescence risk
Invested in building customer relationships and brand
Takes pricing risk in a competitive market
An operating margin analysis with comparables bearing similar risks might show arm's length margins of 5%–8%, yielding appropriate profits of €250,000–€400,000. Berry Ratio dramatically undercompensates the entrepreneurial functions.
Correct Approach: Use Operating Margin or potentially ROA given the inventory and working capital investment.
Example 3: Impact of Cost Classification
Same Economics, Different Classification:
Firm A
Firm B (€40 reclassified from OPEX to COGS)
Revenue
1,000
1,000
COGS
850
890
Gross Profit
150
110
OPEX
120
80
Operating Profit
30
30
Berry Ratio
1.25
1.375
Lesson: Same operating profit, same economics—but Berry Ratio differs by 12.5 percentage points solely due to accounting classification. This illustrates why consistent COGS/OPEX treatment is critical for Berry Ratio reliability.
Common Pitfalls and How to Avoid Them
1. Misclassification of Expenses
Problem: Inconsistent COGS vs. OPEX treatment between tested party and comparables.
Solution: Review financial statement notes; make adjustments for consistency; if adjustment is impossible, consider excluding the comparable or using a different PLI.
2. Including Pass-Through Costs
Problem: Operating expenses include reimbursed costs that don't represent value-adding activities.
Solution: Exclude pass-through costs from both tested party and comparables. The denominator should reflect only the entity's own value-adding expenses.
3. Using Berry for the Wrong Entity
Problem: Applying Berry Ratio to entities with inventory risk, valuable intangibles, or manufacturing functions.
Solution: Validate that OECD ¶2.107 conditions are met before selecting Berry Ratio. If in doubt, use Operating Margin.
4. Ignoring Comparables' Functional Profiles
Problem: Including full-fledged distributors in a comparable set for a limited-risk distributor.
Solution: Strict functional screening—comparables must match the tested party's limited functions, not just industry codes.
5. Inadequate Documentation
Problem: Selecting Berry Ratio because it produces a favorable result without documenting why it's appropriate.
Solution: Document explicitly how OECD conditions are satisfied. Tax authorities are skeptical of Berry Ratio—expect to defend the choice.
The Berry Ratio equals Gross Profit ÷ Operating Expenses. It's appropriate only for low-risk entities where operating expenses are the primary value driver—typically limited-risk distributors, sales agents, or service intermediaries. Use it when COGS is pass-through and the tested party doesn't bear significant inventory risk or own valuable intangibles. If profit is influenced by factors beyond operating expenses, Berry Ratio will not produce reliable results.
What's the difference between Berry Ratio and Operating Margin?
Berry Ratio (GP/OPEX) measures profit relative to operating expenses—appropriate when operating effort drives value. Operating Margin (OP/Sales) measures profit relative to revenue—appropriate when sales volume drives value. For a pass-through distributor where revenue is largely transfer price markup, Berry Ratio may be more reliable because it focuses on the value-adding expenses. For entities where sales execution creates value (full distributors, service providers), Operating Margin is typically preferred.
Is Berry Ratio accepted by all tax authorities?
Berry Ratio is discussed in OECD Guidelines (¶2.106–2.108) and explicitly listed as a valid PLI in US regulations (§1.482-5). In OECD-aligned jurisdictions, acceptance generally tracks the OECD conditions—but Berry Ratio is less commonly used than operating margin in practice. In India, Berry Ratio analyses face scrutiny at assessment stage, though tribunals and courts have accepted it in appropriate intermediary fact patterns. Always check local guidance and document why Berry Ratio is appropriate for your specific facts.
What Berry Ratio is considered arm's length?
There's no universal "correct" Berry Ratio—it depends entirely on your comparable company analysis. Since Berry Ratio = 1 + (Operating Profit ÷ Operating Expenses), a Berry Ratio above 1.0 indicates profitability (the higher the ratio, the higher the markup on expenses). In some routine intermediary benchmark sets, observed Berry Ratios may cluster modestly above 1.0, but the specific arm's length range must be derived from your own comparables. Do not rely on industry generalizations or rules of thumb.
Why is Berry Ratio sensitive to cost classification?
Berry Ratio uses gross profit in the numerator and operating expenses in the denominator. If costs are classified differently (COGS vs. OPEX), the ratio changes dramatically even when operating profit stays the same. For example, shifting €40 from OPEX to COGS changes Berry Ratio from 1.25 to 1.375—a 12.5 percentage point swing with identical economics. This sensitivity means Berry Ratio analysis requires rigorous verification that tested party and comparables classify costs consistently.
Can I use Berry Ratio for a contract manufacturer?
Generally no. Contract manufacturers create value through production activities, which are reflected in COGS, not operating expenses. OECD ¶2.107 explicitly includes "no other significant function (e.g., manufacturing)" as a condition for Berry Ratio applicability. Using Berry Ratio for a manufacturer would typically produce an unreliable result because the value-adding functions aren't captured in operating expenses. Use Net Cost Plus or Return on Assets for manufacturing operations.
How do I handle pass-through costs in Berry Ratio analysis?
Pass-through costs—expenses that are reimbursed or don't represent value-adding activities—should be excluded from the operating expense denominator for both tested party and comparables. Including them inflates the denominator and artificially depresses the Berry Ratio. Document which costs you've excluded and why.
What case law supports Berry Ratio?
The Berry Ratio originates from E.I. DuPont de Nemours & Co. v. United States (1979), where Dr. Charles Berry introduced the concept as an expert witness. Sundstrand Corp. v. Commissioner (1991) further established its use for limited-risk entities in the US context. In India, tribunals and courts have accepted Berry ratio-type PLIs in appropriate indenting/intermediary fact patterns (e.g., Mitsui & Co. India, Mitsubishi-type rulings). The DHL Corp. case (1998) cautioned that cost-based methods fail when valuable intangibles (like trademarks) drive profits.
