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Archive for January, 2013

(From “A Primer on Transfer Pricing” by Robert J. Misey, Jr., updated by Kimberlee S. Phelan)

 

Reminder of the example:  NJCo manufactures and sells widgets in the U.S.  Due to increased widget orders from Canadian customers, NJCo decides to form a Canadian distribution subsidiary (“CanSub”).  Although CanSub does not have any manufacturing functions, CanSub employs its own administrative and sales staff while using NJCo’s unique distribution software to ensure that there are not any distribution problems.  In an effort to make sure that CanSub is financially solvent, CanSub has payment terms to NJCo of six months and, if CanSub’s customers do not pay, CanSub enjoys the use of NJCo’s collection staff, which is comprised of former defensive linemen from Rutgers.

 

Tangible Property

The sale from NJCo to CanSub of widgets constitutes a sale of tangible property, which is the type of intercompany transaction tax professionals traditionally contemplated when reviewing transfer pricing.  The arm’s length amount charged in intercompany transactions involving tangible property should be tested under one of the following methods:  the comparable uncontrolled price method, the resale price method, the cost plus method, the profit split method, and the comparable profits method.[i]

 

The comparable uncontrolled price (“CUP”) method compares amounts charged in intercompany transactions with amounts charged in comparable third party transactions.[ii]  If NJCo can find a comparable sale of its product to a third party, NJCo may try to apply the CUP method.  For example, NJCo may try to compare sales to a major customer with sales to CanSub.  However, the stringent comparability requirements regarding sales volume, geographic markets, currency exchange, and others may make the sales to the major customer uncomparable.

 

The resale price method (“RPM”) evaluates whether the amount charged in an intercompany transaction is at arm’s length by reference to the gross margin a comparable reseller would realize.[iii]  For example, if CanSub can find comparable distributors of widgets in Canada, it may try to apply the RPM.  However, the presence of different functions performed and risks assumed by the comparable distributors (i.e., a marketing function or sales functions), and the difficulty in obtaining the gross margin of these companies may affect the applicability of this method.

 

The cost plus method compares the gross margins on intercompany sales with gross margins on third party sales.[iv]  For example, if NJCo receives a five- percent mark-up on its sales to CanSub and a five percent mark-up on sales to third parties, NJCo’s sales should be at arm’s length.  However, as with the CUP method, the intercompany and third party sales may face a host of comparability problems.

 

The profit split methods allocate operating profits from intercompany transactions in proportion to the relative contributions of each party in creating the combined profits.[v] NJCo should review the functions performed, risks assumed, resources employed, and costs incurred to determine relative contributions.  There are two types of profit split methods – the comparable profit split method and the residual profit split method.  Although many foreign taxing authorities favor profit splits, profit splits are hard for the tax professional to apply because they involve the extremely difficult task of finding two unrelated companies that have functions, risks, and transactions comparable to NJCo and CanSub.

 

The comparable profits method (“CPM”) compares the profitability of the less complex party (“CanSub”) to that of comparable companies.[vi]  As with profit splits, the CPM is based on profits rather than individual transactions.  In applying the CPM, the analyst will choose a financial ratio for CanSub and determine if CanSub’s ratio is in the interquartile range for all comparable distributors.  Two factors make the CPM easy to use:  1) comparability is based on functions performed and risks assumed, as opposed to comparability of product, and 2) financial information is easily derived from information that public companies disclose.  Finally, although other countries have not shown enthusiasm for the CPM, the CPM is arguably similar to Canada’s Transaction Net Margin Method and is clearly the method of choice for the I.R.S.’ International Examiners.


[i] Treas. Reg. section 1.482-3(a).

[ii] Treas. Reg. section 1.482-3(b).

[iii] Treas. Reg. section 1.482-3(c).

[iv] Treas. Reg. section 1.482-3(d).

[v] Treas. Reg. section 1.482-6.

[vi] Treas. Reg. section 1.482-5.

 

 

 

For additional information, please contact Kimberlee Phelan or Robert Misey

 

Robert J. Misey, Jr.

Reinhart Boerner Van Deuren s.c.

Admitted in California, Wisconsin, and the District of Columbia

Milwaukee Office: 414-298-8135 

Cell: 414-550-3270

Chicago Office:  312-207-5456

rmisey@reinhartlaw.com

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From “A Primer on Transfer Pricing” by Robert J. Misey, Jr., updated by Kimberlee S. Phelan

 

A transfer price is the price charged for intercompany transactions.  The principles of I.R.C. section 482 require that intercompany transactions be priced at arm’s length.  Although ostensibly a simple concept, the arm’s length standard has spawned hundreds of pages of regulations.

 

Transfer pricing continues to be a hot issue for multi-national companies.  Mr. Misey has learned informally from his former colleagues at the I.R.S. that companies with sales in excess of $15 million in sales can expect to have an I.R.S. economist review their intercompany transactions.  Because intercompany transactions across international borders continue to expand and because the I.R.S. continues to rigorously review intercompany transactions, transfer pricing is more than just the international tax issue of today, it is the tax issue for this millennium.

 

Political awareness of the amount of taxes paid by foreign-owned companies, may have led many U.S.-based companies to not worry about transfer pricing.  However, the transfer pricing regulations can trap U.S.-owned companies with modest operations abroad just as easily as foreign-owned companies.

 

For example, suppose NJCo manufactures and sells widgets in the U.S.  Due to increased widget orders from Canadian customers, NJCo decides to form a Canadian distribution subsidiary (“CanSub”).  Although CanSub does not have any manufacturing functions, CanSub employs its own administrative and sales staff while using NJCo’s unique distribution software to ensure that there are not any distribution problems.  In an effort to make sure that CanSub is financially solvent, CanSub has payment terms to NJCo of six months and, if CanSub’s customers do not pay, CanSub enjoys the use of NJCo’s collection staff, which is comprised of former defensive linemen from Rutgers.

 

The Best Method Rule

The best method rule in the section 482 regulations states that the arm’s length result of a controlled transaction must be determined under the method that, given the facts and circumstances, provides the most reliable measure of an arm’s length result.  The application of the best method rule establishes an arm’s length range of prices or financial returns with which to test the controlled transactions.  The tested party must fall within the middle fifty percent of that range, known as the interquartile range.

 

In determining the most reliable measure of an arm’s length result, NJCo should consider the degree of comparability between controlled and uncontrolled transactions by analyzing the functions, contractual terms, risks, economic conditions, and the nature of goods and services supplied.  If this analysis requires numerous or sizable adjustments to meet comparability, the comparable may not be reliable.

 

Future blogs will review how the U.S. transfer pricing regulations affect the intercompany transactions between NJCo and CanSub.

 

 

 

For additional information, please contact Kimberlee Phelan or Robert Misey

 

Robert J. Misey, Jr.

Reinhart Boerner Van Deuren s.c.

Admitted in California, Wisconsin, and the District of Columbia

Milwaukee Office: 414-298-8135 

Cell: 414-550-3270

Chicago Office:  312-207-5456

rmisey@reinhartlaw.com

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Experienced travelers’ biggest problem just might be the inexperienced traveler clogging up the TSA security checkpoint.  Patience here is not just a virtue, it is a requirement.  First, pointers for the less experienced:

 

1.         Liquids 3-1-1:  no larger than three ounce containers, held in a single one quart zip-lock bag, one per passenger.

India-airport-security

2.         Take it out/Take it off:  Computer out, shoes off, belt off.  Please — nothing in your pockets.  If your watch is large, take it off.  If you jewelry is large, take it off.  If your cell phone is attached, take it off.

 

3.         If you are travelling with children, make sure their carry-ons are easy to handle.

 

4.         No sharp objects, flammables, matches, weapons (or anything that could possibly be weapon).  Don’t overlook the nail scissors, metal nail files, etc.

 

Yes, baggage check fees are high and add to the cost of travel, but I’m of the opinion that your trip through not just the security line but the whole airport should be as smooth, easy and light as possible.   If you don’t need it and can afford it, anything that can be checked should be checked.

 

On a recent trip, I met John Kleinschmidt, a manager on one of the many TSA lines at Newark Liberty International Airport (I was not allowed to take a picture of his huge smile).  He managed a team doing their best with long lines and impatient travelers (go back and re-read the first paragraph).  His job was behavior analysis, which he took not only to mean watching out for the agitated, irrational and irate, but to keep the attitude of his team (and that long line of passengers) positive.  He kept me smiling during my wait.

 

If you aren’t sure what to do when you reach the security check, ask!  The TSA teams are well trained and all take their job very seriously (as they should).  Better to ask once than require multiple screenings of either your self or your stuff!

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