Transfer Pricing overvie · © 2014 KPMG LLP, a Delaware limited liability partnership and the U.S....

Transfer Pricing

Essentials

Steven C. Wrappe

KPMG LLP

Washington, D.C.

© 2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent

member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.2

Notice

The following information is not intended to be “written advice concerning one or more

Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury

Department Circular 230.

You (and your employees, representatives, or agents) may disclose to any and all

persons, without limitation, the tax treatment or tax structure, or both, of any

transaction described in the associated materials we provide to you, including, but not

limited to, any tax opinions, memoranda, or other tax analyses contained in those

materials.

The information contained herein is of a general nature and based on authorities that

are subject to change. Applicability of the information to specific situations should be

determined through consultation with your tax adviser.



Outline

• What is Transfer Pricing?

• Why is it Different/Important?

• Conceptual Framework

• Transfer Pricing Methods

• Intangibles

• Services

• Penalty Rules

• Transfer Pricing Controversy

What Is Transfer

Pricing?



What is Transfer Pricing?

•Transfer pricing refers to pricing of transactions between related parties for:

— Tangible property

— Intangible property

— Services

— Rents

— Loans



What is Transfer Pricing?

• Related party aspect of the transactions suspends the normal laws of supply and demand

• Without governmental restraint, related parties could use transfer pricing to artificially shift income to achieve tax benefits

• IRC § 482 and similar statutes in other countries prevent related parties from artificially shifting income to achieve tax benefits



What is Transfer Pricing?—Opportunity

Transfer Pricing Planning Opportunity

Parent

(Country A)

Sub

(Country B) Consolidated

Total profit reported on tax return 700 300 1,000

Tax rate 40% 10%

Tax liability before change to transfer price 280 30 310

Global Effective Tax Rate (“ETR”) 31%

Effect of Transfer Pricing Change on ETR

Total profit after using transfer pricing to shift 400 of income 300 700 1,000

Tax rate 40% 10%

Tax liability after change to transfer price 120 70 190

Global ETR 19%



What is Transfer Pricing?—Exposure

Exposure to Double Taxation

Parent

(Country A)

Sub

(Country B) Consolidated

Total profit reported on tax return 300 700 1,000

Tax rate 40% 10%

Tax liability before Country B transfer pricing adjustment 120 70 190

Global Effective Tax Rate (“ETR”) 19%

Double taxation effect on ETR

Total profit after adjustment (increase in profits) by Country A of 400

(assumes no correlative relief in B)

700 700 1,400

Tax rate 40% 10%

Tax liability after Country A transfer pricing adjustment (penalties and

interest not included)

280 70 350

Global ETR 35%



What is Transfer Pricing?The Accounting Perspective

Manufacturer Distributor Total

Sales Transfer Price 15,000 15,000

COGS < 10,000 > < Transfer Price > < 10,000 >

Gross Profit (____%) _________ (____%) _________ 5,000

S, G & A < 1,750 > < 1,250 > < 3,000 >

Net Operating Income (____%) _________ (____%) _________ 2,000



What is Transfer Pricing?The Tax Perspective

Section 482– In any case of two or more organizations, trades, or businesses

(whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades, or businesses, if he determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. In the case of any transfer (or license) of intangible property (within the meaning of Code Sec. 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.

Why Is Transfer

Pricing Different/

Important?



Why is Transfer Pricing Different/Important?

• Subjective application of the rules

• Potentially large adjustments and penalties

• Procedural options

• Double taxation exposure

• Figures prominently in financial statement disclosure (FIN 48)



Why is Transfer Pricing Different/Important?

• Transfer Pricing In the News

― Glaxo litigation

― FIN 48/UTP Form implications

― OECD Base Erosion and Profit Shifting Project

― “Inversions” produce transfer pricing issues



The Public Debate

“Starbucks paid just

£8.6M in U.K. tax over

14 years.” BBC News,

October 16, 2012

“From now on I’ll be putting away my Kindle

and feeding my caffeine addiction

somewhere other than Starbucks. We know

that Amazon, Google and Starbucks are

raking in profits from their economic activity

in Britain but using a range of devices to

avoid paying their fair share of corporation

tax.” U.K. Observer, November 18, 2012

“[Google’s] highly contrived tax

arrangement has no purpose other than

to enable the company to avoid U.K.

corporation tax.“ Margaret Hodge, Chair

of U.K. PAC, June 12, 2013

“Apple pays just 2% U.K. tax as

Amazon and Google face

questioning.” International Business

Times, November 5, 2012.

“Google caught in

crossfire over French tax

planning.” Le Figaro,

October 19, 2012

“International retailers that have lowered

U.K. tax by holding trademarks in the

Netherlands include not only Starbucks and

IKEA but also SABMiller, Nike, Bacardi-

Martini, Zara, Speedo and Volkswagen.

Het Financieele Dagblad, 15 November

2012

“Google insists its Irish

headquarters are more than

just a ‘post box.’” Le Figaro,

November 6, 2012.

“Dolce and Gabanna to face trial over tax

evasion Milan prosecutors allege the

fashion had sold their D&G and Dolce &

Gabbana brands to a holding company

they set up in Luxembourg in 2004 in

order to avoid paying high taxes in Italy.”

The Telegraph, June 11, 2012

“There is a technical term economists like to use for

behavior like this. Unbelievable chutzpah.” Edward

Kleinbard, former Chief of Staff of the Congressional

Joint Committee on Taxation, on Apple’s efforts to

avoid paying taxes.” New York Times, May 21, 2013.

“Rampant corporate tax

avoidance may not be

illegal, but that doesn’t make

it right or fair.” NY Times

Editorial, May 25, 2013



Global Introduction of Transfer Pricing Rules

Korea (Republic

Slovak Republic

United Kingdom

Korea (Republic

Slovak Republic

United Kingdom

of China)

2007200620052004200320022001200019991998199719961995<1994 2008-2010

China (People

FinlandFranceGermanyGreeceHong KongHungaryIndiaIndonesia

IsraelItalyJapan

of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingapore

SloveniaSouth AfricaSpainSri LankaSwedenSwitzerlandTaiwan (Republic

ThailandTurkeyUkraine

United StatesVenezuelaVietnam

ArgentinaAustraliaAustriaBelgiumBrazilCanadaChile

ColombiaCzech RepublicDenmarkEcuadorEgyptEstoniaFranceGermanyHungaryIndiaIndonesiaIsraelItalyJapanKorea (Republic of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSloveniaSouth AfricaSpainSri LankaSwedenTaiwan (Republic

ThailandUkraineUnited KingdomUnited StatesVenezuelaVietnam

ArgentinaAustraliaAustriaBelgiumBrazilCanadaChileChina (People

Colombia

DenmarkEcuadorEgyptEstoniaFranceGermanyHungaryIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSloveniaSouth AfricaSwedenTaiwan (Republic of China)ThailandUkraineUnited KingdomUnited StatesVenezuela


Colombia

DenmarkEstoniaFranceGermanyHungaryIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenTaiwan (Republic

ThailandUkraineUnited KingdomUnited StatesVenezuela

ArgentinaAustraliaAustriaBrazilCanadaChileChina (People

Czech RepublicDenmarkEstoniaFranceGermanyHungaryIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenThailandUkraineUnited KingdomUnited StatesVenezuela


Czech RepublicDenmarkEstoniaFranceGermanyIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLuxembourgMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenThailandUkraineUnited KingdomUnited StatesVenezuela


Czech RepublicDenmarkEstoniaFranceGermanyIndiaIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPeruPhilippinesPolandRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited KingdomUnited StatesVenezuela


Czech RepublicDenmarkEstoniaFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandRussiaSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited KingdomUnited StatesVenezuela


Czech RepublicDenmarkFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandRussiaSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited KingdomUnited States

ArgentinaAustraliaAustriaBrazilCanadaChileChina (PeopleRepublic of)Czech RepublicDenmarkFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited States

AustraliaAustriaBrazilChileCzech RepublicFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited States

AustraliaAustriaCzech RepublicFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUnited States

AustraliaCzech RepublicFranceGermanyIndonesiaItalyJapanLatviaOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUnited States

AustraliaCzech RepublicFranceGermanyIndonesiaItalyJapanPolandSingaporeSlovak RepublicSwedenUnited States


Colombia

DenmarkEcuadorEgyptEstonia

ArgentinaAustraliaAustriaBelgiumBrazilCanadaChileChina (PeopleRepublic of)Colombia

DenmarkEcuadorEgyptEstoniaFinlandFranceGermanyGreeceHong KongHungaryIndiaIndonesia

IsraelItalyJapan

of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingapore

SloveniaSouth AfricaSpainSri LankaSwedenSwitzerlandTaiwan (Republicof China)ThailandTurkeyUkraine

United StatesVenezuelaVietnam


Republic of)ColombiaCzech RepublicDenmarkEcuadorEgyptEstoniaFranceGermanyHungaryIndia

IsraelItalyJapanKorea (Republic of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSloveniaSouth AfricaSpainSri LankaSwedenTaiwan (Republicof China)ThailandUkraineUnited KingdomUnited StatesVenezuelaVietnam


Republic of)Colombia

DenmarkEcuadorEgyptEstoniaFranceGermanyHungaryIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSloveniaSouth AfricaSwedenTaiwan (Republic



Colombia

DenmarkEstoniaFranceGermanyHungaryIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLithuaniaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenTaiwan (Republic


ArgentinaAustraliaAustriaBrazilCanadaChile

Republic of)Czech RepublicDenmarkEstoniaFranceGermanyHungaryIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLuxembourgMalaysiaMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenThailandUkraineUnited KingdomUnited StatesVenezuela


Republic of)Czech RepublicDenmarkEstoniaFranceGermanyIndiaIndonesiaItalyJapanKorea (Republic of)LatviaLuxembourgMexicoMontenegroNetherlandsNew ZealandOECDPeruPhilippinesPolandPortugalRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenThailandUkraineUnited KingdomUnited StatesVenezuela


Republic of)Czech RepublicDenmarkEstoniaFranceGermanyIndiaIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPeruPhilippinesPolandRussiaSerbiaSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited KingdomUnited StatesVenezuela


Republic of)Czech RepublicDenmarkEstoniaFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandRussiaSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited KingdomUnited StatesVenezuela


Republic of)Czech RepublicDenmarkFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandRussiaSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited KingdomUnited States


Czech RepublicDenmarkFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited States

AustraliaAustriaBrazilChileCzech RepublicFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaMexicoNew ZealandOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUkraineUnited States

AustraliaAustriaCzech RepublicFranceGermanyIndonesiaItalyJapanKorea (Republic of)LatviaOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUnited States

AustraliaCzech RepublicFranceGermanyIndonesiaItalyJapanLatviaOECDPhilippinesPolandSingaporeSlovak RepublicSouth AfricaSwedenUnited States

AustraliaCzech Republic

GermanyIndonesiaItalyJapanPolandSingaporeSlovak RepublicSwedenUnited States

OECDPeruPhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSloveniaSouth AfricaSpainSri LankaSwedenSwitzerlandTaiwan (Republicof China)ThailandTurkeyUkraineUnited KingdomUnited StatesVenezuelaVietnam

OECD

PhilippinesPolandPortugalRomaniaRussiaSerbiaSingaporeSlovak RepublicSloveniaSouth AfricaSpainSri LankaSwedenSwitzerlandTaiwan (Republic

ThailandTurkeyUkraineUnited KingdomUnited StatesVenezuela

MexicoMontenegroNetherlandsNew Zealand

MexicoMontenegroNetherlandsNew Zealand

Kenya

Malawi

Korea (Republic of)LatviaLithuaniaLuxembourg

Korea (Republic

LatviaLithuaniaLuxembourg

Malaysia

Kazakhstan

Czech RepublicDenmarkEcuadorEgyptEstoniaFinlandFranceGermanyGreeceHong KongHungaryIndiaIndonesiaIreland (Republic of)IsraelItalyJapan

China (PeopleRepublic of)Colombia

Czech RepublicDenmarkEcuadorEgyptEstoniaFinlandFranceGermanyGreeceHong KongHungaryIndiaIndonesiaIreland (Republic of)Israel

Japan

Croatia

AustraliaAustriaBelgiumBrazilCanadaChile

Argentina

AustraliaAustriaBelgiumBrazilCanadaChile

Aruba

Norway

Zambia

’

Czech Republic

Republic of)

Czech Republic

Czech RepublicCzech Republic

Czech RepublicCzech Republic

Conceptual

Framework



Conceptual Framework

• Control

• Arm’s length standard

• Best method rule

• Comparability

• Arm’s length range

• Transfer pricing methods




• Control“Controlled”- Reg. §1.482-1(i)(4) – includes any kind of control, direct or indirect, whether legally enforceable or not, and however exercisable or exercised, including control resulting from the actions of two or more taxpayers acting in concert or with a common goal or purpose. It is the reality of control that is decisive, not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.




• The Arm’s-Length Standard– An intercompany transaction is arm’s length if results

are same as results realized by uncontrolled taxpayers engaged in same transaction under same circumstances

– Identical uncontrolled transactions generally not available; appropriate to consider comparable uncontrolled transactions

– Analysis of independent, uncontrolled comparable transactions is at center of all transfer pricing analysis

– The arm’s-length standard is fundamental basis of worldwide transfer pricing regulations




• “Best Method” Rule

– No hierarchy of methods specified

– Best method provides most reliable measure of arm’s-length result

– Best method varies depending on facts and circumstances

– If no clear best method, convergence of results



Conceptual FrameworkTransfer Pricing Methods

Tangible property Intangible property Services (Temporary)

CUP

(Comparable Uncontrolled Price Method)

CUT

(Comparable Uncontrolled Transaction

Method)

CUSP

(Comparable Uncontrolled Services

Price Method)

RPM

(Resale Price Method)–

GSM

(Gross Services Margin Method)

Cost Plus

(Cost Plus Method)–

CSPM

(Cost of Services Plus Method)

CPM

(Comparable Profits Method)

(cf. to TNMM in OECD Guidelines)

(Transactional Net Margin Method)

CPM / TNMM

(Commensurate with income rules)CPM

PSM

(Profit Split Method)PSM PSM

CPS (Comparable

Profit Split Method)

RPS (Residual

Profit Split

Method)

CPS RPS CPS RPS

– –SCM

(Services Cost Method)

Unspecified Methods Unspecified Methods/ Cost Sharing –



Conceptual FrameworkComparability

• Purpose- uncontrolled transactions must be sufficiently similar to controlled transactions to provide a reliable measure of the arm’s-length result (i.e., allow taxpayer to characterize tested party in order to find comparables)

• Five Factors:– Functions performed– Contractual terms– Risks assumed– Economic and financial conditions– Nature of property or services transferred

• Each transfer pricing method places priority on different factors




• The Arm’s-Length Range

– In most cases it is not possible to identify a single price that would occur between unrelated parties

– Arm’s-length range results from use of two or more uncontrolled transactions of similar reliability and comparability

– No adjustment if results of controlled transaction are within arm’s-length range

Transfer Pricing

Methods



Transfer Pricing MethodsOverview

Tangible property Intangible property Services (Temporary)

CUP

(Comparable Uncontrolled Price Method)

CUT

(Comparable Uncontrolled Transaction

Method)

CUSP

(Comparable Uncontrolled Services

Price Method)

RPM

(Resale Price Method)–

GSM

(Gross Services Margin Method)

Cost Plus

(Cost Plus Method)–

CSPM

(Cost of Services Plus Method)

CPM

(Comparable Profits Method)

(cf. to TNMM in OECD Guidelines)

(Transactional Net Margin Method)

CPM / TNMM

(Commensurate with income rules)CPM

PSM

(Profit Split Method)PSM PSM

CPS (Comparable

Profit Split Method)

RPS (Residual

Profit Split

Method)

CPS RPS CPS RPS

– –SCM

(Services Cost Method)

Unspecified Methods Unspecified Methods/ Cost Sharing –



Transfer Pricing MethodsComparable Uncontrolled Price (“CUP”)

• General Observations– Based on direct observation of market price– Internal comparables most common– Always the best method if comparable transactions are

available• Concerns:

– Degree of comparability– Information is limited regarding intermediate products– Differences in design, intangibles, volumes, timing, terms,

functions, and geographic markets affect price– Reliable and complete data



Transfer Pricing MethodsCUP (cont.)

• Internal CUPs

– Related party buys from or sells to 3rd party

– Generally good comparability and data

• External CUPs

– 3rd party-to-3rd party transactions

– Generally found by searching publicly available data

– Comparability and data concerns

– Seldom used due to data needs



Transfer Pricing MethodsResale Price Method

• General Observations

– Typically used for distributors

– Functional comparables with similar risks and routine intangibles

• Application of Resale Price Method

– Gross profit margin (“GPM”) derived from uncontrolled transaction as a percentage of sale

– Subtract appropriate GPM from end user resale price to arrive at transfer price



Transfer Pricing MethodsCost Plus Method

• General Observations– Routine manufacturing and service operations– Generally not used for distributors– Assures constant return to manufacturer; shifts general risk to the

distributor

• Application of Cost Plus Method– Prices based on gross profit markup (“GPM”) earned by functional

comparables, over fully absorbed costs– Note: General industry GPM may be used absent transactional data

• Concerns:– Comparables need similar

• Functions, risks & routine intangibles• Production process• Cost structure

– Accounting consistency is essential– Gross profit data typically difficult to obtain for non-U.S. based

companies



Transfer Pricing MethodsComparable Profits Method (“CPM”)

• Operating margin most often used• Typically applied to test routine distribution or manufacturing

functions• Relies on functional comparability; product comparability is

less important• Common use:

– Product comparables not found, or accounting comparability is not assured

– One affiliate performs routine functions– Comparables identified with general similarity of products

and functions• OECD has Transaction Net Margin Method (TNMM)



Transfer Pricing MethodsCPM (cont.)

• Profit Level Indicators– Operating margin = operating profit / sales

– Return on assets = operating profit / assets actively employed in the business (usually tangible assets)

– Berry ratio = gross profit / operating expenses



Transfer Pricing MethodsCPM (Operating Margin)

Manufacturer Distributor Total

Sales 15,000 15,000

< COGS > < 10,000 > < > < 10,000 >

Gross Profit (____%) _________ (____%) _________ 5,000

S, G & A < 1,750 > < 1,250 > < 3,000 >

Net Operating Income (____%) _________ ( 3 %) 450 2,000



Transfer Pricing MethodsProfit Split

• Profit Split Methods– Residual profit split– Comparable profit split

• General Conditions for Use– Each party must have valuable, non-routine contributions

that contribute significantly to profits– Significant transactions to establish comparability– Administrative requirements

Intangibles



IntangiblesDefinition

• Asset with substantial value independent of services of any individual and derives its value not from its physical attributes but from its intellectual content or other intangible properties

• Common examples:– Patents, inventions, formulae, processes, designs, patterns, or know-

how– Copyrights and literary, musical, or artistic compositions– Trademarks, trade names, or brand names– Franchises, licenses, or contracts– Methods, programs, systems, procedures, campaigns, studies,

forecasts, estimates, customer lists, or technical data– Other similar items



IntangiblesOwnership/Consequences

• Ownership of intangible is important because owner is entitled to compensation for transfer or license of intangible

• Legally protected intangible: legal owner or holder of rights treated as owner

• Not legally protected intangible: controlled taxpayer who has control of intangible treated as owner

• Multiple ownership of intangible property: no longer subdivided

• Controlled taxpayers who assist owner in development or enhancement of intangible are entitled to arm’s length compensation



IntangiblesMethodologies

• Comparable Uncontrolled Transaction (“CUT”) Method: generally most direct and reliable measure of arm’s length result if same intangible is transferred in controlled and uncontrolled transaction– CUT method may also provide most reliable measure of arm’s length result in

situations with an “inexact CUT”

• Comparable Profits Method (“CPM”): evaluates whether amount charged in a controlled transaction is arm’s length based on objective measures of profitability

• Profit Split Method (“PSM”): compares allocation of combined operating profit or loss attributable to controlled transactions to relative value of each controlled taxpayer’s contribution – Comparable Profit Split Method– Residual Profit Split Method



Intangibles“Commensurate with Income”

• 482 amended in 1986 to require related party payments re: intangibles to be “commensurate with income”

• Periodic adjustments: consideration charged is subject to an annual adjustment

• Exceptions



IntangiblesCost Sharing Alternative

• Primary tax benefit of cost sharing is all participants considered owner of an interest in the intangible, precluding the transfer pricing rules for intangibles

• Cost sharing is a practical alternative to cross-border licensing

• New cost sharing regulations significantly limit the use of a cost sharing

Intercompany

Services



ServicesDefinition

• Any activity by one member of a group of controlled

taxpayers that results in a benefit to one or more other

members of controlled group

• Activity is defined broadly to include:

― Performance of functions

― Assumption of risks

― Use by a renderer of tangible or intangible property or other

resources, capabilities, or knowledge

― Making available any property or other resources of the renderer



Services—Specified Methods

• Services cost method (SCM)

• Comparable uncontrolled services price

• Gross services margin—similar to Resale Price

• Cost of services plus—similar to Cost Plus

• Comparable profits

• Profit split

Penalty Rules



Section 6662 Penalty

Substantial Valuation

(20% penalty)

Transactional Net Adjustment

Price or value is 200% or

more (50% or less) than the

correct amount

Net adjustment exceeds the

lesser of $5 million or 10% of

gross receipts

Gross Valuation

(40% penalty)

Net adjustment exceeds the

lesser of $20 million or 20% of

gross receipts

Price or value is 400% or

more (25% or less) than the

correct amount



Section 6662 PenaltyContemporaneous Documentation Requirements

• Ten principle documents required to fulfill contemporaneous documentation requirements:1. Overview of taxpayer’s business

2. Description of organizational structure

3. Documentation explicitly required under Section 482 (such as license agreements)

4. Description of method selected and reason for selection

5. Description of alternative methods not used and reason for not using them

6. Description of controlled transactions and internal data

7. Description of comparables and adjustments (if any)

8. Explanation of economic analysis and projections used

9. Description of data obtained after tax year and before filing return

10.General index of documents



Section 6662 Penalty

• Good Faith Exclusion– Valuation misstatement penalties may be waived if

taxpayer can show good reason to believe the company was following the arm’s-length standard in application of the transfer prices.

– Net adjustment penalty- may only be satisfied by documentation

– Two elements are required for the “Good Faith Exclusion”:• Reasonable effort (to establish the arm’s-length nature of prices)• Reasonable belief (that the transfer pricing methodology produced

an arm’s-length result)

– A taxpayer may gain reasonable belief through reliance on a professional tax advisor.



Transfer Pricing Documentation

• Factual analysis– Taxpayer’s Group– Industry– Transactions– Functions– Risks– Intangibles

• Economic analysis– Transfer Pricing Methodology– Comparable Search– Adjustments

Transfer Pricing

Controversy

TP Dispute Procedural Flowchart

Pre-opening or Opening

conference: Start

of Examination

File Return

T/P return selected for

Examination

IRS issues either initial

contact letter or initial

telephone contact

Consider obtaining an Advance Pricing

Agreement (APA) pursuant to Rev.

Proc. 2006-9.

1. Consider extending Statute of

Limitation;

2. T/P considers information to be

provided to IRS and IRS tools for

obtaining the information.

IRS starts detailed

Transfer Pricing

Examination

IRS issues Form 5701 “Notice

of Proposed Adjustments.”

Does T/P agree?

IRS issues Form 4564

“Informal Document

Request” (IDR)

No

Yes

Yes

No

If CIC* Audit, are there any issues

which should be sent to Appeals. “Early

Referral to Appeals” (Pursuant to Rev.

Proc. 99-28)

•IRS and/or T/P should consider if any issue

requires Field Service Advice or Technical

Advice;

•Consider CA**/SAP***, pursuant to Rev.

Proc. 2006-54;

•Consider whether IRS Examination may

resolve open issues, pursuant to Del. Ord.

236 (Rev. 3).

•Consider “Fast-Track” Guidance under Rev.

Proc. 2003-40.

IRS issues 30-day letter

“Preliminary Notice of

Deficiency.” Form 4665,

Publication 5. Pub. 586A

Sign Form 5701 as agreed

and proceed to close

Examination

•Consider correlative and

corresponding adjustments;

•Consider refund request in

foreign jurisdiction.

Does T/P want to

settle issue in

Appeals?

After 30 days expires, IRS

Issues 90 day letter “Notice of

Deficiency” or Statutory Notice

Consider CA**/SAP***,

pursuant to Rev. Proc.

2006-54

Does T/P

petition Tax Court?

T/P pays tax

deficiency; does T/P

agree?

NoYes

Docketed Tax Court

•Consider Docketed Mediation;

•Consider Tax Court Rule 124

(Voluntary Binding Arbitration).

Proceed to close case

and consider CA**

Yes

T/P files for refund;

Refund granted?

No

Previous Appeals review?

T/P accepts;

proceed to close case,

consider CA**

Go to Appeals for

review, consider SAP***

YesNo

Refund Appeals:

Agreement reached?

T/P files with

District Court or Federal

Claims Court

Proceed to close case,

consider CA**

No

Yes

Yes

Proceed with

Tax Court Case

Decision may be

Appealed to Circuit Court

of Appeals

Decision may be appealed via

grant of cert. to Supreme Court

Docketed Appeals: May have case

reviewed by Appeals Officer

Agreement at

Appeals?


consider CA**

Yes

No

No

Does T/P require

Additional time to prepare

and file protest with IRS?

Yes

Non-Docketed Appeals: (a) file written

protest within 30 day period; (b) do not

pay tax – consider cash bond; (c)

consider SAP***.

No

May request additional time to file

protest in writing – generally IRS

will grant an additional 30 days.

T/P and IRS agree to a

resolution In Appeals?

Appeals issue 90 day letter;

Agreement reached?


Consider CA**

Yes

No

No


consider CA**

Yes

KEY

*CIC – Coordinated

Industry and Industry

Case Program

** Competent Authority

*** Simultaneous

Appeals/Competent

Authority Procedure

T/P consider mediation, pursuant

to Rev. Proc. 2002-44 or arbitration

under Rev. Proc. 2006-44;

Agreement reached?

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