IRS on Pricing Intangibles:It's the Economics, Stupid

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Dolores W. Gregory

June 8 — An IRS official says there is little in new OECD transfer pricing guidelines that conflicts with long-standing U.S. regulations under tax code Section 482.

The bottom line is that the economics of a transaction must make sense economically. That is the very definition of an arm's-length price, said Christopher Bello, chief of Branch 6 in the Internal Revenue Service Office of Associate Chief Counsel (International).

“This is about economics. People are making contributions to value. And when they do that, they need to receive an arm’s-length price in return. Some people do things that require a big price and some people do things that require a small price. Because some people are creating more value and some people are creating less,” Bello said June 8 at an international tax conference co-sponsored by Bloomberg BNA and Baker & McKenzie LLP.

And yet that message is consistently lost on taxpayers, he said.

Modifications Ahead?

Moderator John M. Peterson Jr., a partner with Baker & McKenzie in Palo Alto, Calif., asked Bello if there was any plan to modify U.S. transfer pricing regulations to incorporate some of the provisions of the Organization for Economic Cooperation and Development 's final report on Actions 8 to 10 of its plan on base erosion and profit shifting (BEPS).

Peterson noted that under the BEPS report, a party is entitled to returns on intangibles only if it is involved in the development, enhancement, maintenance, protection and exploitation of the intangible (DEMPE functions).

U.S. cost-sharing regulations set out tough valuation rules relating to originating cost-sharing arrangements and starting with platform contributions, he said. But for arrangements that have been around for many years, Peterson said, “there seems to be no particular requirement that a cost-sharing participant must have any DEMPE functions or do anything other than what it’s doing now.”

Bello responded that work on U.S. regulations—particularly under Section 482—goes on for many years.

“There are a lot of people who worked very, very hard to try to make the regs clear and convey the point we really wanted to convey. And after you’ve worked on regs a few times, what you learn is that no matter how hard you try to make the reg convey the point you are trying to make, the rest of the world misses the point every time. And it looks like that is what’s happening again in the work we did in Chapters 1 and 6” of the OECD guidelines.

“People miss the point,” he said.

Creating Value

Bello said U.S. regulators frequently see a situation in which a U.S. taxpayer with valuable intellectual property seeks to transfer the intangibles to a controlled foreign corporation (CFC) and declare the CFC to be an entrepreneur who should get all the income from the IP.

“But that fails to take into account who created the value,” he said. “ What our regs have been trying to say and the work we’ve done in BEPS is trying to say is that you’ve got to identify the transactions that occur. You have to identify who's making the contributions to the value, and then you have to give everyone an arm’s-length return to that.”

In practice, that might be complicated, Bello said. But the theory isn't.

“It’s pretty straightforward what we’ve been trying to say. And if people have been reading what we said in Chapters 1 and 6 as suggesting something else—we think we’re saying identify the actual transactions between the parties, figure out the economics and that will lead you to the arm’s-length price. That will lead you to getting the right amount of income in the U.S. and the right amount of income anywhere else,” he said.

No Inconsistency

Bello said he sees no inconsistency between U.S. transfer pricing regulations and the work done on the OECD report related to transfer pricing.

“One thing I will note that is particularly relevant to cost sharing is that if you read the output closely, it says the right thing about ex ante returns, but it doesn’t actually say anything about ex post” returns.

“The way that we understand our own regs is that people need to be getting the pricing right on an ex ante basis, and if they do that, then they can contractually allocate the ex post returns that may resolve to whoever they want.”

However, he said, many countries in the OECD's Working Party 6 don’t like that idea. “They don’t accept that would be arm's length, even though economically it clearly is.”

Dispute in Working Party

Bello said the other countries wanted the rule to provide that ex post returns will always go “to the guy who does the most stuff. It feels right to us that it should go to that guy. And we said that doesn’t make sense economically. It would be inconsistent with arm’s length. And so what we ended up with was guidance that actually punts and doesn’t say what happens to the ex post” return.

That issue may be resolved under future work to be done on financial transactions, he said. “But we understand why other countries are so concerned about ex post returns.”

“Because people lowballed the ex ante and then said, ‘I’m so fortunate that all these ex post returns are now off shore.' We think that people are systematically treating ex ante returns as ex post.”

Anti-Abuse Rule

The U.S. response was to propose an anti-abuse rule that wouldn't allow the shifting of ex-post returns offshore.

“The only catch is you can't put that rule into the transfer pricing guidelines because that rule is outside of arm’s-length” policy, Bello said.

“It’s just saying, policywise, we know what people are doing and we want it to stop, but we are not going to pretend that rule would be consistent with arm’s length. And most other countries said, ‘we like that rule but we want to say it falls within the arm’s-length principle.' So therefore we couldn’t agree,” he said. “The fact that we didn’t go along with this approach to treat ex post returns doesn’t mean we don’t know what people are doing, and we still think it is something we can prevent in applying our own regs.”

To contact the reporter on this story: Dolores W. Gregory in Washington at

To contact the editor responsible for this story: Molly Moses at

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