Transfer Pricing: Perspectives of Economists and Accountants (Part 2) (Portfolio 6909)

Chapter 4 examines the availability of potential U.S. and non-U.S. external comparables that might be used to apply transfer pricing methods that depend on external comparables, including an analysis of the ranges of markups that are observed for generic sets of providers of various types of services. To view this Portfolio, visit Bloomberg Tax for a free trial.

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Description

Chapter 4 examines the availability of potential U.S. and non-U.S. external comparables that might be used to apply transfer pricing methods that depend on external comparables, including an analysis of the ranges of markups that are observed for generic sets of providers of various types of services. As background, the chapter begins with the history of the U.S. regulations under §482 governing the pricing of services between related parties. Final U.S. services regulations were issued in 2009, and the chapter describes in detail the provisions and transfer pricing methods in those final regulations. Non-U.S. guidance on the transfer pricing of services is provided in the form of the OECD's Guidelines, and this chapter provides the historical context as well as a description of the major provisions of the Guidelines as they relate to the pricing of services. After discussing the economic considerations in the application of potential U.S. and non-U.S. external comparables, the chapter concludes with a discussion of major issues affecting transfer pricing for services.

CHAPTER 5: Relationship Between Intangible Valuations Done for Financial Statement Purposes and for Transfer Pricing Purposes

Mergers and acquisitions are one of the key ways in which companies acquire new technology and other intangibles. Companies typically integrate the newly acquired capabilities into existing business after a merger or acquisition. This often involves the transfer of intangibles across legal entities. Under such circumstances, companies often prepare one study that determines the fair value of the intangibles that they have purchased for financial statement purposes, and a separate study to determine the transfer price that should be charged when the intangible is transferred from one legal entity to another.

The definition of “intangibles” for financial reporting is generally consistent with the definition used for transfer pricing, and, in each case, the value should reflect the price paid between a willing buyer and a willing seller. Taxpayers, therefore, often would like to use fair value computed for financial reporting to determine the transfer price for the acquired intangibles when they are transferred across different legal entities, both to save on costs and to minimize the chance of using inconsistent data and assumptions.

The IRS, however, is generally skeptical about the use of intangible valuations developed under a financial reporting framework for transfer pricing purposes and has stated in Reg. §1.482-7(g)(2)(vii)(A) that “allocations or other valuations done for accounting purposes may provide a useful starting point but will not be conclusive for purposes of the best method analysis in evaluating the arm's length charge in a [platform contribution transaction], particularly where the accounting treatment of an asset is inconsistent with its economic value.” The IRS does not provide any discussion of the relationship between financial reporting and tax standards and, therefore, neither identifies what parts of a valuation done for accounting purposes may provide “a useful starting point” or what changes have to be made to such a valuation before it can be used as the basis for a transfer pricing analysis.

This chapter discusses the similarities and differences between financial statement reporting and transfer pricing analyses. As will be seen, while differences exist between the two, once these differences are taken into account the use of an integrated approach to valuing intangibles for financial reporting and transfer pricing analyses may provide taxpayers with a stronger basis for supporting their positions on audit.

This Portfolio may be cited as Amerkhail, Mirga, Blough, Chandler, and Williams, 6909 T.M., Transfer Pricing: Perspectives of Economists and Accountants (Part 2).

Authors

Valerie Amerkhail

Valerie Amerkhail, Swarthmore College, B.A. Director, Transfer Pricing, Economic Consulting Services, LLC. She was previously a Principal, Coopers & Lybrand, LLP; Senior Manager, Deloitte & Touche, LLP; Principal Analyst responsible for corporate tax projections, Congressional Budget Office; Senior Economist responsible for government sector analyses, Chase Econometrics; and Economic Analyst, Congressional Research Service of the Library of Congress. Her work with international tax attorneys and clients has involved transfer pricing dispute resolution at all stages of IRS field examinations, appeals, Advance Pricing Agreements, and Competent Authority negotiations, as well as examinations by Japanese, Korean, European, and other non-U.S. tax authorities.

Jerrie Varrone Mirga

Jerrie Varrone Mirga, College of William & Mary, B.A.; George Washington University, MBA and post-MBA Certificate in International Taxation; Candidate Member of the American Society of Appraisers. Vice President, Economic Consulting Services, LLC. Ms. Mirga advises clients on transfer pricing issues involving tangible and intangible property and services for planning, U.S. and non-U.S. documentation, audit, and other purposes.

Dr. Stephen Blough

Dr. Stephen Blough is a principal in the Economic and Valuation Services group within KPMG LLP's Washington National Tax practice. Prior to joining KPMG in 1994, Dr. Blough was an economist at the Federal Reserve Bank of Boston, where he was responsible for the analysis of financial markets in their relationship to monetary and regulatory policy. He also spent six years on the faculty of the Department of Economics at Johns Hopkins University, where he taught graduate courses in econometric methods and macroeconomics. He has published frequently on transfer pricing topics; prior to joining KPMG his publications focused on the development of new statistical methods and their application to financial and economic issues. Dr. Blough has a Ph.D. in economics from the University of California at Berkeley, an M.A. in statistics from Berkeley, and a B.A. in economics from Swarthmore College.

Dr. Clark Chandler

Clark Chandler is a principal in the Economic and Valuation Services group within KPMG LLP's Washington National Tax practice. He focuses primarily on the areas of transfer pricing and the valuation of intangibles for large firms. In his more than 15 years of transfer pricing controversy work, Dr. Chandler has extensive experience with international transfer pricing issues involving tangible and intangible property, as well as services and cost sharing arrangements. He has written numerous articles and thought leadership pieces. Dr. Chandler has a Ph.D. and M.A. in economics from the University of Michigan and a B.A. in economics from Dickinson College.

Will Williams

Will Williams is a principal and East Coast leader in KPMG LLP's Economic and Valuation Services practice. He has more than 11 years of professional consulting experience. He specializes in structuring, pricing, and documenting intercompany transactions to comply with U.S. regulations and OECD Guidelines. In addition, he works with clients in valuing closely held business entities, securities, and intangible assets to meet financial and tax regulatory requirements. Prior to joining KPMG in 1998, Will completed his International M.B.A. at the University of South Carolina, graduating first in his class with a concentration in international finance. He earned his B.A. degree in business administration from Furman University, graduating with honors.

Table of Contents

Detailed Analysis
Chapter 4: Economic Considerations in the Analysis of Controlled Services Transactions
4:I. Introduction
4:II. U.S. Regulations Governing Transfer Pricing for Controlled Services Transactions
Introductory Material
A. History of Guidance Pertaining to Transfer Pricing for Controlled Services Transactions
1. Early Developments
2. The First Regulations
3. 1968 Regulations
a. Costs vs. Costs Plus Markup
b. Determining the Cost Base
4. 1994 Regulations
a. Best Method Rule
b. Arm's-Length Range
5. Interim Rulemaking in 2003 and 2006
B. Final 2009 Regulations for Controlled Services Transactions
1. Services Cost Method (SCM)
a. Covered Services
b. Excluded Activities
c. Business Judgment Rule
d. Adequate Books and Records
e. Shared Services Arrangements (SSAs)
2. Comparable Uncontrolled Services Price Method (CUSP)
3. Gross Services Margin Method (GSM)
4. Cost of Services Plus Method
5. Comparable Profits Method (CPM)
6. Profit Split Method
7. Unspecified Methods
C. Summary of Approach to Analysis of Controlled Services Transactions Under the 2009 Regulations
4:III. Identifying U.S. Comparables for Different Types of Services
Introductory Material
A. The U.S. Database Universe of Potential Service Provider Comparables
B. White List Services
1. Staffing and Recruiting
2. Treasury Activities
3. Insurance Claims Management
4. Payroll, Accounts Receivable and Payable, Budgeting, Statistical Assistance, Benefits, and IT Services
5. Combining Possible SIC Categories for White List Services
C. Excluded Services
1. Research, Development, and Testing Services
2. Engineering, Architectural, and Surveying Services
D. Potential Low Margin Covered Services/Other Services
1. Information Technology and Related Services
2. Advertising
3. Management and Public Relations Services
4. Miscellaneous Business Services
5. Other Services
E. Conclusions from U.S. Data
4:IV. OECD Guidelines Governing Transfer Pricing for Controlled Services Transactions
Introductory Material
A. History
1. 1979 OECD Report
2. 1984 OECD Report
B. 1995 OECD Guidelines
C. Post-1995 Additions to the Guidelines that Are Still Current
1. 1996 Services Chapter
2. 1997 Cost Contribution Arrangements Chapter
D. 2010 OECD Guidelines
4:V. Identifying Non-U.S. Comparables for Different Types of Services
Introductory Material
A. The Non-U.S. Database Universe of Potential Service Provider Comparables
B. White List Services
1. Staffing and Recruiting
2. Treasury Activities
3. Insurance Claims Management
4. Payroll, Accounts Receivable and Payable, Budgeting, Statistical Assistance, Benefits, and IT Services
C. Excluded Services
1. Research, Development, and Testing Services
2. Engineering, Architectural, and Surveying Services
D. Potential Low Margin Covered Services/Other Services
1. Information Technology and Related Services
2. Advertising
3. Management and Public Relations Services
4. Miscellaneous Business Services
5. Other Services
E. Conclusions from Non-U.S. Data
4:VI. Selected Issues
Introductory Material
A. Cost Versus Cost Plus
B. Transfer of Intangibles
C. Pass-Through Costs
D. Geographic Markets
4:VII. Conclusions
Chapter 5: Relationship Between Intangible Valuations Done for Financial Statement Purposes and for Transfer Pricing Purposes
5:I. Objectives and Overview
A. Statement of the Issue
B. Determination of What Has to Be Valued
1. Financial Statement Definition
2. Transfer Pricing Definition
C. Organization
5:II. Conceptual Issues
A. Basic Objectives of Financial Statement Valuations and Transfer Pricing Analyses
B. Fair Value Compared to Taxable Income/Deductions
1. Overview
2. Tax Shield/Section 197 Benefit
3. Application of After-Tax Discount Rate to Royalty Payments
4. Relationship Between Payments and Fair Value in the Context of an Acquisition
5. Commensurate with Income and the Market Participant Assumption
6. “Crown Jewels” and Buyer-Specific Synergies
C. Methods
1. Valuation
2. Transfer Pricing
3. Comparison
D. Intercompany Contracts
E. Customer Relationships
1. Overview
2. Marketing Intangibles
F. Use of Relief from Royalty and CUT Method in Trademark Valuation
G. Issues Related to the Life of Technology (Including In-Process R&D)
H. Cash Flow vs. Accounting Measures of Profits
I. Forecasts and Discount Rates
1. Forecasts and Internal Rate of Return
2. Weighted Average Cost of Capital
3. Weighted Average Return on Assets
4. Implications for Transfer Pricing
J. Contributory Charges and Routine Profits
5:III. Implications of the Transfer Pricing Methods Set Forth in the Cost Sharing Regulations
A. Acquisition Price and Market Capitalization Methods
1. Overview
2. Synergies
3. Other Complications with the Acquisition Price Method
4. Equity Ownership Interests vs. Transfers of Specific Intangible Property
B. Exit Charges and Goodwill and Going Concern Value
1. What Is Goodwill and Going Concern?
2. Routine Goodwill and Going Concern Example
3. Impact of a Favorable Supply Contract that Increases Profit Margins in the Short Term
4. Impact of an Intangible that Increases Growth over a Finite Life
5. Platform Value, Goodwill, and Going Concern Value
5:IV. Conclusions

Working Papers

Table of Worksheets
Worksheet 1 Rev. Proc. 2007-13 (Identification of Specified Covered Services)
Worksheet 2 IRS Examples: Services Cost Method
Worksheet 3 IRS Examples: Shared Services Arrangements
Worksheet 4 IRS Examples: Comparable Uncontrolled Services Price Method
Worksheet 5 IRS Examples: Gross Services Margin Method
Worksheet 6 IRS Examples: Cost of Services Plus Method
Worksheet 7 IRS Examples: Comparable Profits Method
Worksheet 8 IRS Examples: Profit Split Method
Worksheet 11 Key Terms