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Transfer Pricing Resource
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ABA Seeks Priority Guidance for Transfer Pricing Issues

by | Jun 7, 2016 | , ,

The ABA recently issued comments to the IRS and Treasury regarding the new temporary regulations issued in TD 9738 concerning the aggregation of controlled transactions, under Section 482, which broaden (“clarify”) the scope of intangible value, to include “all the value provided” from a controlled transaction, and such other transactions that may occur before, during or after, that are so interrelated, as to require aggregate consideration. See attached. While the IRS does not explicitly mention goodwill or going concern—except by reference in one example—the regulations are intended to sweep in the consideration of any goodwill, including synergy, value that may relate to such transactions.

Given the inherent difficulty, and the persistent controversy, as exhibited in the past (i.e., the Veritas and Amazon cases) and as certainly more is yet to come (BEPS) in attempting to determine the value of intangibles generally, let alone goodwill, for the sake of good tax administration, the IRS would do well to provide more concrete/ explicit definitions, or at least boundaries, as to what or when this “extra” value may, or may not, be likely to apply.

This broader scope of consideration is now likely to make it easier for the IRS to recast transactions on economic substance or realistic alternatives grounds, leading to more controversy and disputes, not just with taxpayers, but with foreign governments as well.



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Proposed Code Sec. 367 Regulations Attempt to Tax Foreign Goodwill and Going Concern Value

by | Jun 3, 2016 | , ,

The transfer of foreign goodwill and going concern value by a domestic corporation to a foreign subsidiary for use in a trade or business outside the United States has never been subject to taxation under Code Sec. 367. Without any legislative change, the Internal Revenue Service and the Treasury in proposed regulations would seek to tax such transfers.

In his recent article in the International Tax Journal, Lowell Yoder, global head of McDermott’s Tax Practice, discusses the sweeping changes proposed under the new 367 regulations and the problems posed by the IRS’ approach.  He recommends that the IRS withdraw the proposed regulations, which go far beyond (and actually contradict) legislative intent.

Read the full article.



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IRS Releases Practice Unit on Residual Profit Split Method

by and | May 6, 2016 | , ,

On March 7, 2016, the Internal Revenue Service (IRS) released a new International Practice Unit (IPU) on a specific transfer pricing method—the residual profit split method (RPSM).  The IPU explains to IRS examiners how to determine if the RPSM is the “best method” under Section 482, and if so, how to apply such method between a US parent and its controlled foreign corporation in a transaction where intangible property is employed.  As stated in a previous post, IPUs generally identify strategic areas of importance to the IRS but they are not official pronouncements of law or directives and cannot be used, cited or relied upon as such.  However, taxpayers should benefit from reviewing IPUs, as they reflect the current thinking of the IRS on pertinent issues, and therefore allow taxpayers to structure and document their transfer pricing arrangements in a manner that is consistent with such thinking, as noted in a prior post available here.

Section 482 was designed to prevent the improper shifting or distorting of the true taxable income of related enterprises.  Section 482 accomplishes this by requiring that all transactions between related enterprises must satisfy the arm’s length standard.  That is, the terms of intercompany transactions generally must reflect the same pricing that would have occurred if the parties had been uncontrolled taxpayers engaged in the same transaction under the same circumstances.  One of several possible transfer pricing methods for determining whether a transaction meets the arm’s length standard is the profit split method.  One specific application of the profit split method is the RPSM.  This IPU focuses on the application of the RPSM as it applies to outbound transactions involving intangible property.

The IPU outlines four steps for IRS examiners to follow in determining whether the RPSM is the best method to evaluate a controlled transaction and if so, how to apply the RPSM to that particular transaction.

  1. Identify the routine and nonroutine contributions made by the parties. The IPU cautions that if there are no nonroutine contributions, or if only one controlled taxpayer is making nonroutine contributions (most commonly of intangibles), then the RPSM should not be used.  The IPU provides three examples of when the RPSM may be used:  (a) a tangible goods sale if the seller uses nonroutine manufacturing intangibles to make the goods, and another controlled party purchases and resells the goods using its nonroutine marketing intangibles; (b) a licensing transaction where one controlled party licenses nonroutine manufacturing intangibles to a second controlled party, who then manufactures goods using those manufacturing intangibles and sells the goods using its own nonroutine marketing intangibles; and (c) a commercial sale of software product, if two controlled parties each contribute nonroutine software intangibles to manufacture the product, and the controlled parties share the revenue from the sales.
  1. Determine if the RPSM is the best method. The RPSM is the best method only if it provides the most reliable measure of an arm’s length result.  The IPU cautions that the RPSM should [...]

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Tracy Gomes Appointed to Chair of ABA Transfer Pricing Committee

by | May 5, 2016 | , ,

We are proud to congratulate our Dallas colleague, Tracy Gomes, McDermott’s chief economist in transfer pricing, upon his appointment as chair of the American Bar Association Transfer Pricing Committee.  This position provides the opportunity to propose issues and comments, and to have access to US tax officials in the Internal Revenue Service and Treasury Department as part of the ABA’s leadership committee.  It expands upon McDermott’s already substantial knowledge, reputation and experience in the transfer pricing arena—an increasingly important area of IRS attention and focus.

This appointment reflects recognition of McDermott’s professionals as thought leaders in transfer pricing, as well as our commitment to furthering the collective knowledge-base, understanding and application of reasoned and cogent tax administration, and role in the shaping of tax policies, particularly in light of the changing international tax rules brought about by the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) action items.



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3M Company, IRS File Opening Briefs in “Blocked Income” Case

by | Apr 18, 2016 | , , ,

As noted in an earlier post, 3M Co. v. Commissioner, T.C. Dkt. No. 5816-13, involves 3M’s challenge to the Internal Revenue Service’s (IRS’s) determination that Brazilian legal restrictions on the payment of royalties from a subsidiary in that country to its US parent should not be taken into account in determining the arm’s-length royalty between 3M and its subsidiary under Treas. Reg. § 1.482-1(h)(2). The case has been submitted fully stipulated under Tax Court Rule 122, and the parties’ simultaneous opening briefs were filed on March 21, 2016.

Citing First Sec. Bank of Utah and cases following it, 3M first argues that “[c]ase law consistently holds that the Commissioner cannot employ section 482 to allocate income that the taxpayer has not received and cannot receive because a law prevents its payment or receipt.” Under this line of authority the IRS’s proposed allocation of royalty income to 3M is precluded by Brazilian law. This result is not changed by Treas. Reg. § 1.482-1(h)(2) because that regulation is invalid.

The regulation is “procedurally invalid,” 3M argues, because Treasury and the IRS failed to satisfy the requirements of § 553 of the Administrative Procedure Act (APA) when they promulgated the regulation. They did not respond to significant comments criticizing the proposed regulation; nor did they articulate a satisfactory justification or explanation for the regulation. They thus did not engage in the “reasoned decisionmaking” required by the APA and case law such as State Farm and Altera when an agency issues regulations. (more…)



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Subpart F: When Does a CFC Receive Substantial Assistance in Performing Services?

by | Apr 14, 2016 | ,

Income derived by a controlled foreign corporation (CFC) from performing services for an unrelated customer generally is not Subpart F income. However, if U.S. related persons furnish substantial assistance contributing to the performance of the services, under regulations, the CFC will be deemed to perform the services for a related person. In such case, the services income would be Subpart F income to the extent attributable to services performed outside the CFC’s country of organization.

Read the full article.



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Tax Court Rules Whether IRS’s Transfer Pricing Adjustments Are Arbitrary, Capricious Depends on Facts and Circumstances

by | Apr 13, 2016 | , , ,

In Guidant LLC f.k.a. Guidant Corporation, and Subsidiaries, et al. v. Commissioner, 146 T.C. No. 5 (Feb. 29, 2016), the taxpayer filed a motion seeking partial summary judgment on the ground that the Internal Revenue Service’s (IRS’s) transfer pricing adjustments were “arbitrary, capricious and unreasonable” as a matter of law. Judge David Laro denied the motion, ruling that “whether the Commissioner abused his discretion … depends on the facts and circumstances of a given case.” The taxpayer’s motion thus presented “a question of fact that should be resolved on the basis of the trial record.”

The case involves transfer pricing adjustments under Section 482 that increased the income of Guidant Corporation and its U.S. subsidiaries by nearly $3.5 billion. Section 482 grants the IRS broad discretion to “distribute, apportion, or allocate gross income, deductions, credits, or allowances” between or among controlled enterprises if it determines that such a re-allocation is “necessary in order to prevent evasion of taxes or clearly to reflect the income” of any of the enterprises. A taxpayer that challenges a Section 482 adjustment has a “dual burden.” First, it must show that the IRS’s adjustments are “arbitrary, capricious, and unreasonable.” The taxpayer must then show that its intercompany transactions reflect arm’s-length dealing. (more…)



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IRS Release IPU Materials on Transfer Pricing

by | Apr 11, 2016 | , , ,

As we noted in our initial post, the Internal Revenue Service (IRS) began publishing job aids and training materials developed by its International Practice Units (IPUs).  On April 6, 2016, the IRS released another IPU on section 482, available here.  The most recent IPU covers the three requirements under section 482: (1) two or more organizations, trades or business; (2) common ownership or control (direct or indirect) of the entities; and (3) the determination that an allocation is necessary either to prevent evasion of taxes, or to clearly reflect the income of any of the entities.

The most recent IPU takes a broad view of the application of section 482 and looks at the substance of transactions.  Regarding the first requirement, the IPU instructs examiners that organizations can include almost any type of entity and that a trade or business means a trade or business activity of any kind, regardless of place of organization, formal organization, type of ownership (individual or otherwise) and place of operation.  On the common control requirement, the IPU emphasizes that the form of control is not decisive and that the reality of control governs.  It also notes the presumption of control if income or deductions are arbitrarily shifted.  Finally, the reallocation to clearly reflect income requirement notes that an IRS allocation will be upheld unless the taxpayer can provide that the IRS determination was arbitrary and capricious.  Moreover, the IPU provides examples of circumstances that indicate the presence of arbitrary shifting of income, including when the net income of the foreign affiliate is high compared to the net income reported by the US company.  Of course, it may be appropriate for the foreign affiliate to have higher net income.

The IPU contains instructions on initial factual development of the requirements and provides references to resources that an agent should consult, including internal IRS resources, IRS guidance and case law.  It also identifies the types of documents that should be requested and reviewed during the examination.

As demonstrated by the large number of high-profile transfer pricing disputes currently pending in the courts, the IRS is taking a strong stance on the application of section 482.  Moreover, as demonstrated by this IPU, the IRS wants examining agents to be aggressive in identifying circumstances where there may be noncompliance with section 482.  Taxpayers with transfer pricing issues may benefit from reviewing all IPUs on section 482, both in documenting their transfer pricing activities and upon commencement of an examination to ensure that they have the documentation that the IRS will request.



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Preparing for Country-by-Country Reporting in 2016

by | Mar 30, 2016 | , ,

Country-by Country (CbC) reporting is on the horizon for large US multi-national enterprises (MNE).  As part of the broader Base Erosion Profit Shifting (BEPS) project undertaken by the Group of 20 (G20) and the Organisation for Economic Co-operation and Development (OECD), the United States will soon require the parent entity of large US MNE groups to file with the Internal Revenue Service (IRS) a new annual report that requires information regarding income earned and taxes paid by the group on a country-by-country basis.  The new reporting requirements would generally apply to US MNE groups with annual revenues of $850 million or more.

Late last December, Treasury published proposed regulations detailing the future reporting process.  Recently, Robert Stack, Treasury deputy assistant secretary (international tax affairs) indicated that Treasury anticipates issuing final regulations by June 30, 2016, which would be effective for US MNEs with tax years beginning after that date. (Stack’s comments are available at Tax Notes, here and here.)  Because the US reporting requirements will go into effect in the middle of 2016, some US MNE groups have expressed concern that other tax jurisdictions may require subsidiaries to file CbC reports.

Both Treasury and the IRS believe that CbC reporting will assist in better enforcement of the US tax laws, though there is some concern that information collected may be too readily shared with other tax jurisdictions that may not safeguard such information as carefully as the United States.  Indeed, the Preamble to the new CbC reporting regulations states that CbC reports filed with the IRS may be exchanged with other reciprocating tax jurisdictions in which the US MNE group has operations, and Treasury expects that the competent authority will enter into competent authority agreements for the automatic exchange of CbC reports under the authority of information agreements to which the US is a party.  The Preamble also provides that information exchanged may not be disclosed or used for non-tax purposes.

Mr. Stack recently affirmed the priority of the confidentiality of information gathered through CbC reporting, stating that the United States would have the right to stop sharing information if the other tax jurisdiction were to disclose it.  The issue of confidentiality of CbC reporting was recently highlighted by efforts in the European Union to provide for the public disclosure of CbC reporting.



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IRS and Taxpayers Continue Fight over Regulations Intended to Overrule Judicial Precedent

by | Mar 15, 2016 | , , ,

In March 2013, 3M filed a petition with the US Tax Court challenging the Internal Revenue Service’s (IRS) determination that additional royalty income should be allocated to 3M’s US headquarters from its Brazilian subsidiary.  See 3M Co. v. Commissioner, T.C. Dkt. No. 5186-13.  Specifically, the IRS determined that Brazilian legal restrictions on the payment of royalties to the US parent should not be taken into account in determining the arm’s-length price between 3M and the subsidiary under Treas. Reg. § 1.482-1(h)(2).  3M’s position will require the Tax Court to revisit its earlier, pre-regulations holdings on the subject and to decide whether the Supreme Court of the United States has already resolved the issue.

The parties recently submitted the case fully stipulated under Tax Court Rule 122, with simultaneous opening briefs due on March 21, 2016.  The parties will then have the opportunity to submit reply briefs responding to each other’s arguments.

More than 40 years ago, the Supreme Court in Commissioner v. First Sec. Bank of Utah, 405 U.S. 394 (1972), rejected the IRS’s attempt to apply section 482 where federal law prohibited the taxpayer from receiving the income the IRS was seeking to allocate to it.  Subsequent Tax Court and appellate court decisions applied the Supreme Court’s holding to restrictions under foreign and state law.  In 1994, the IRS promulgated current Treas. Reg. § 1.482-1(h)(2), which provides, in part, that “a foreign legal restriction will be taken into account only to the extent that it is shown that the restriction affected an uncontrolled taxpayer under comparable circumstances for a comparable period of time.”  Although the regulation also contains a deferred income election that permits the deferred recognition of restricted income, subject to a matching deferral of deductions, it may be difficult in most situations to meet these requirements.

Whether 3M succeeds may depend on how the Tax Court applies the recent Supreme Court decision in U.S. v. Home Concrete & Supply LLC, 132 S.Ct. 1836 (2012).  There, the Supreme Court held that its prior interpretation of a statute meant that “there is no longer any different construction that is consistent with [the prior opinion] and available for adoption by the agency.”  This is an important case for all taxpayers, not just those dealing with the blocked income issue, and the Tax Court’s determination may have a broad impact on future challenges to tax regulations.



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