Skip Page Banner  
Skip Navigation

Section 482 Allocations: Specific Allocation Methods and Rules the Code and Regulations (Portfolio 552)

Product Code: TPOR40
$400.00 Print
Buy Now

Section 482 Allocations: Specific Allocation Methods and Rules in the Code and Regulations, written by Brian D. Lepard of the University of Nebraska College of Law, examines specific rules in the Code and regulations prescribing allocation methods under §482 and addressing other particular issues, such as correlative allocations, the burden of proof, and penalties.

This Portfolio discusses the allocation methods for income from transfers of tangible property, from the use of tangible property, from the performance of services, from loans or advances, and from the transfer of intangibles. 

Section 482 Allocations: Specific Allocation Methods and Rules in the Code and Regulations examines the comparable profits method and transactional profit split methods authorized by the regulations. Having reviewed these detailed allocation rules in the regulations, the Portfolio returns to the problem of how to apply the overarching “best method rule” described in 551 T.M., and, based on the regulations, gives a number of specific examples. 

This Portfolio then explores other important issues addressed in the regulations, including the special rules dealing with  

(1) collateral adjustments

(2) setoffs

(3) the effect of legal restrictions on transfer pricing adjustments

(4) the relationship between §482 and specific nonrecognition provisions of the Code, such as §351, and the very detailed rules for so-called “cost sharing arrangements”  

Drawing upon the coverage of these various rules, the Portfolio examines standards in the Code and regulations regarding the burden of proof in tax cases generally and how these standards affect §482 cases. Finally, the Portfolio takes up the all-important issue of transfer pricing penalties, considers the statutory and regulatory provisions governing these penalties, and provides advice on how taxpayers can minimize the risk of being subject to such penalties. 

This Portfolio is a companion to 551 T.M., Section 482 Allocations: General Principles in the Code and Regulations. It should be consulted in tandem with its companion Portfolios, but especially with 551 T.M., which lays the analytical foundation for the discussion in this Portfolio and also contains an extensive review of the history of §482 and the regulations. Certain portions of this introductory section duplicate the analysis in 551 T.M. to facilitate the reader's ease of use of the Portfolio. 

Section 482 Allocations: Specific Allocation Methods and Rules in the Code and Regulations allows you to benefit from:

  • Hundreds of hours of original research on specific tax planning topics from leading practitioners in this area
  • Invaluable practice documents including tables, charts and lists
  • Plain-English guidance from world-class experts
  • Real-world and in-depth analysis that lets you explore various options
  • Time-saving access to relevant sections of tax laws, regulations, court cases, IRS documents and more
  • Alternative approaches to both common and unique tax scenarios 

This Portfolio is part of the U.S. Income Portfolios Library, a comprehensive series that includes more than 200 Portfolios, which covers every federal tax topic with expert, in-depth analysis, and offer commentary on a wide range of federal taxation topics, including Compensation Planning, Deductions and Credits, Partnerships and Corporations, Special Pass-Through Entities, Corporate Reorganizations, Real Estate, Procedure and Administration, and more. 

Detailed Analysis

I. Introduction

A. The Purpose of the Portfolio

B. The Function of § 482 and a Brief History

1. The Code

2. Congress's Purposes in Enacting § 482

3. The Regulatory History

C. An Example of Income Shifting and Possible Incentives for Income, Deduction or Credit Shifting

D. An Overview of Alternative Allocation Methods

II. Allocation Methods for Income from Transfers of Tangible Property

A. Overview

B. The Comparable Uncontrolled Price Method

1. General Rule

2. Particularly Relevant Factors of Comparability and Reliability

3. Examples Applying the Comparable Uncontrolled Price Method in the Regulations

a. Comparable Sales of Same Product

b. The Effect of a Trademark

c. Minor Product Differences

d. Effect of Geographic Differences

4. Marginal or Incremental Pricing

5. Use of Quotation Media and Public Exchange Data

a. Permissible Use of Quotation Media

b. Prohibited Use of Quotation Media Because of Extraordinary Market Conditions

6. Critical Analysis of the Regulations on the CUP Method

C. The Resale Price Method

1. Introduction

2. Application of the Resale Price Method

3. Standards of Comparability and Reliability Under the Resale Price Method

4. Adjustments for Differences Between Controlled and Uncontrolled Transactions

5. Functions Similar to a Sales Agent

6. Data, Assumptions and Accounting Consistency

7. Multiple Related Party Transactions

8. Arm's Length Range as Applied to the Resale Price Method

9. Examples of the Resale Price Method in the Regulations

10. Critical Analysis of the Regulations

D. The Cost Plus Method

1. In General

2. Application of the Cost Plus Method

3. Standards of Comparability Under the Cost Plus Method

4. Adjustments for Differences Between Controlled and Uncontrolled Transactions

5. Functions Similar to a Purchasing Agent

6. Data, Assumptions and Accounting Consistency

7. Arm's Length Range as Applied to the Cost Plus Method

8. Examples of the Cost Plus Method in the Regulations

9. Critical Analysis of the Regulations

E. Unspecified (“Fourth”) Methods

F. Coordination with Intangible Property Rules and the “Embedded Intangible” Problem

G. The Application of the Regulations by the Courts in Domestic § 482 Cases

III. Allocation Methods for Income from the Use of Tangible Property

A. The Regulatory Scheme Under the 1994 and 1968 Regulations

B. Safe Haven Rental Charge for Pre-May 1986 Leases

C. Deemed Arm's Length Rental Charge for Subleases

IV. Allocation Methods for Income from the Performance of Services

A. General Principles

B. Relationship Between the General Arm's Length Standard in the Regulations and the True Earner Principle

C. General Principles Applicable to All Allocations of Income from Services

1. The “Benefit” Test

2. Duplicated Services

3. Adequate Books and Records

4. Costs or Deductions to Be Taken into Account Under the Deemed Arm's Length Charge Rule

a. Direct and Indirect Costs or Deductions

b. Costs Not to Be Taken into Account

c. The “Sound Accounting Practice” Rule for Allocation and Apportionment of Costs or Deductions

d. General Requirements for Allocation Methods

e. The Full Cost Requirement

f. Financial Statements and Reports

D. The General Arm's Length Standard Applicable to Services That Are an “Integral Part” of the Taxpayer's Business

1. The General Rule

2. Engagement in the Business of Rendering Similar Services to Unrelated Parties

3. The Rendering of Services to Related Parties as a Principal Activity: the 25% Test

4. Where Renderer Peculiarly Capable and Services Are Principal Element in Recipient's Operations

5. Where Recipient Has Received Substantial Amount of Services from Related Parties

E. Services Rendered in Connection with the Transfer of Property

F. Critical Analysis of the Regulations

G. 2006 Temporary and Proposed Regulations

1. Overview of Temporary and Proposed Regulations

2. Definition of Service and Modification of Benefit Test

3. Transfer Pricing Methods for Services

4. Services Transactions Similar to Intangible Transfers

5. Contingent Payment Services Arrangements

V. Allocation Methods for Income from Loans or Advances

A. Introduction

B. Rules Only Apply to Bona Fide Indebtedness

C. The Arm's Length Interest Rate

1. In General

2. Safe Haven Rates

3. Lender in the Business of Making Loans

4. Foreign Currency Loans

5. The “Situs Rule”

6. Period During Which Interest Is to Be Charged

7. Coordination with Other Code Provisions

D. Intercompany Trade Receivables

1. Definition

2. Period During Which Interest Is Not to Be Charged

E. Period During Which a Loan or Intercompany Trade Receivable Is Considered Outstanding

F. The Financially Troubled Debtor

VI. Allocation Methods for Income from the Transfer of Intangibles

A. In General

B. Definition of Intangible

C. Ownership of Intangibles

1. In General

2. Identification of the Owner

3. Allocations with Respect to Assistance Provided to the Owner

4. Examples

D. Comparable Uncontrolled Transaction Method

1. In General

2. Comparability and Reliability Considerations

a. Comparable Intangible Property

b. Comparable Circumstances

E. Examples of the Application of the Comparable Uncontrolled Transaction Method

F. Alternatives to the Comparable Uncontrolled Transaction Method

1. Other Specified Methods

2. Unspecified Methods

a. In General

b. Example

G. The Commensurate with Income Standard

1. The Statutory Amendment of 1986 and its Legislative History

2. Determining Income from Intangible Rights

3. Form of Consideration

4. The Periodic Adjustment Requirement

5. Exceptions to the Periodic Adjustment Requirement

6. Examples of the Periodic Adjustment Requirement

7. Treatment of Lump Sum Payments

VII. The Comparable Profits Method

A. Overview

B. The History of the Comparable Profits Method

1. League of Nations and OECD Studies

2. The 1992 Proposed Regulations

3. The 1993 Temporary Regulations

4. The 1994 Final Regulations

C. General Principles under the 1994 Regulations

D. Selecting and Analyzing the Tested Party

E. Profit Level Indicators

1. Rate of Return on Capital Employed

2. Financial Ratios

3. Other Profit Level Indicators

F. Selecting and Analyzing the Comparable Parties

1. In General

2. Functional and Risk Considerations

3. Adjustments for Differences Between the Tested Party and the Uncontrolled Taxpayers

4. Accounting and Data Considerations

G. Determination of the Arm's Length Range of Comparable Operating Profits

H. Examples of the Application of the Comparable Profits Method

1. Example of a Transfer of Tangible Property Resulting in No Adjustment

2. Example of a Transfer of Tangible Property Resulting in an Adjustment

3. Multiple Year Analysis

4. Transfer of Intangible to Manufacturer Subsidiary

5. Adjusting Operating Assets and Operating Profit for Differences in Accounts Receivable

6. Adjusting Operating Profit for Differences in Accounts Payable

VIII. Profit Split Methods

A. Background

B. Overview of the 1994 Profit Split Regulations

C. Comparable Profit Split Method

D. Residual Profit Split Method

IX. Examples of the Application of the Best Method Rule

A. Introduction

B. General Rule

C. An Example of a Preference for the CUP Method

D. An Example of a Preference for the Resale Price Method over the CUP Method

E. An Example of a Preference for the Resale Price Method over the Comparable Profits Method

F. An Example of a Preference for the Comparable Profits Method over the Resale Price Method

G. An Example of a Preference for the Cost Plus Method over the Comparable Profits Method

H. An Example of a Preference for the Comparable Profits Method over the Cost Plus Method

I. An Example of a Preference for the CUT Method

J. An Example of a Preference for the Residual Profit Split Method over Other Methods

K. An Example of a Preference for the Comparable Profits Method over a Profit Split Method

X. Other Issues Addressed in the Regulations

A. Introduction

B. Collateral Adjustments

1. Correlative Allocations

2. Conforming or Secondary Adjustments

a. Definition and Function of Conforming Adjustments

b. Rev. Proc. 99-32 Relief

(1) Applicability of Rev. Proc. 65-17

(2) Example in the Regulations

3. Other Collateral Effects

C. Setoffs

D. The Effect of Legal Restrictions and Blocked Income

1. Background

2. Limitations on Allocations in the Case of Foreign Legal Restrictions

3. Deferred Income Method of Accounting

4. Treatment of Domestic Legal Restrictions

5. Critical Analysis of the Regulations

E. Section 482 and Nonrecognition Provisions

1. Introduction

2. The 1994 Regulations

3. Critical Analysis of the Regulations

XI. Cost Sharing Arrangements

A. Background: The Use of Cost Sharing Arrangements

B. A Precedent in the Code: § 936(h)(5)(C)(i)

C. The History of the Regulations

D. The 1995 Regulations

1. General Principles

a. Definition of a Cost Sharing Arrangement

b. Requirements for Qualification as a Qualified Cost Sharing Arrangement

2. Definition of “Participant” in a Cost Sharing Arrangement

a. Definition of “Controlled Participant”

b. Treatment of a Controlled Taxpayer That Is Not a “Controlled Participant”

3. Defining “Costs” of Developing Intangibles

4. Principles for Evaluating Cost Allocations

a. Determining a Controlled Participant's Share of Intangible Development Costs

b. Determining a Controlled Participant's Share of Reasonably Anticipated Benefits

(1) In General

(2) How to Measure Benefits

(3) Indirect Bases for Measuring Anticipated Benefits

(a) Units Used, Produced or Sold

(b) Sales

(c) Operating Profit

(d) Other Bases

(4) Examples of Indirect Bases for Measuring Anticipated Benefits

(5) Reliability of Projections Used to Determine Anticipated Benefits

c. Timing of Allocations

5. Treatment of “Buy-Ins”

a. In General

b. Rules Regarding Buy-In Payments for Preexisting Intangibles

c. Other Rules Regarding Buy-In Payments

d. Failure to Assign Interests Under a Qualified Cost Sharing Arrangement

e. Form of Consideration

f. Examples of the Treatment of Buy-Ins

6. The Character of Payments Made Pursuant to a Qualified Cost Sharing Arrangement

a. In General

b. Examples

7. Accounting Requirements

8. Administrative Requirements

a. In General

b. Documentation Requirements

c. Reporting Requirements

E. The 2009 Temporary Regulations

1. General Principles

2. Nature of the Requirements

3. Range of Available Methods to Determine Arm's Length Price

4. IRS Authority

XII. The Burden of Proof in § 482 Cases

A. The General Rule Under Pre-1998 Law

B. The Effect on § 482 Cases of the Shift in the Burden of Proof Rule Under the 1998 IRS Restructuring and Reform Act

XIII. Penalties

A. The Statutory Provisions and Their History

1. The 1989 Act and its Penalty Provisions

2. The 1990 Act Revisions

3. The 1993 Act Revisions

B. The Regulations

1. Regulations Defining a Substantial Valuation Misstatement and a Gross Valuation Misstatement

2. Regulations on the Transactional and Net Adjustment Penalties

3. The Transactional Penalty

4. The Net Adjustment Penalty

a. In General

b. Application of Setoffs

c. Gross Receipts

d. Coordination with § 6664(c) Reasonable Cause Exception

e. The Application of the Net Adjustment Penalty

f. Amounts Excluded from Net § 482 Adjustments

(1) In General

(2) The Specified Method Safe Harbor

(a) In General

(b) The Specified Method Requirement

(c) The Documentation Requirement

(i) Principal Documents

(ii) Background Documents

(3) The Unspecified Method Safe Harbor

(a) In General

(b) The Unspecified Method Requirement

(c) The Documentation Requirement

(4) The Foreign-to-Foreign Transaction Safe Harbor

g. Special Rule

h. Examples of Application of the Net Adjustment Penalty Safe Harbors

5. Carrybacks and Carryovers

6. Coordination Between the Transactional and the Net Adjustment Penalties

a. Coordination of Net § 482 Adjustment Subject to the Net Adjustment Penalty and a Gross Valuation Misstatement Subject to the Transactional Penalty

b. Coordination of Net § 482 Adjustment Subject to the Net Adjustment Penalty and a Substantial Valuation Misstatement Subject to the Transactional Penalty

c. Examples

C. Critical Analysis of the Code and Regulations

Working Papers

Table of Worksheets

Worksheet 1 Preamble to 1995 § 482 Cost Sharing Regulations

Worksheet 2 Preamble to 1996 § 6662 Penalty Regulations

Bibliography

OFFICIAL

Statutes:

Legislative History:

Treasury Regulations:

IRS Revenue Procedures and Rulings:

Cases:

UNOFFICIAL

Tax Management Portfolios:

Books and Treatises:

Articles:

Brian D. Lepard
Brian D. Lepard is Associate Professor of Law at the University of Nebraska College of Law, where he has taught the basic course on taxation and courses on the international aspects of U.S. income taxation, the corporate tax, tax policy and business planning. He has published an article on the arm's length standard and is the principal co-author of BNA's Health Law & Business Portfolio No. 2000, Unrelated Business Income Tax Issues in Health Care (1996). Before becoming a professor of law he worked for six years as an associate at the Philadelphia law firm of Dechert Price & Rhoads, where he practiced tax law with an emphasis on the international aspects of U.S. income taxation and the taxation of exempt organizations.