(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.
The transfer pricing regulations broadly define intangible property as including:[i]
- patents, inventions, formulae, processes, designs, patterns, or know-how;
- copyrights and literary, musical, or artistic compositions;
- trademarks, trade names, or brand names;
- franchises, licenses, or contracts;
- methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data; and
- other similar items.
CanSub’s use of NJCo’s unique distribution software, regardless of whether the software is patented, constitutes a method, program, or system and is the transfer of an intangible. Transfers of unique intangibles gave the I.R.S. fits in the 1980s and led to the new transfer pricing regulations.[ii] In determining the arm’s length price for the transfer of an intangible, NJCo has a choice of three methods: the comparable uncontrolled transaction method, the profit split methods, and the comparable profits method.[iii]
The comparable uncontrolled transaction method (“CUT”) method is the intangible analog to the CUP method.[iv] As a result, it is subject to the same stringent comparability requirements as the CUP method. Although companies do not usually license the use of unique intangibles, NJCo may apply this method if NJCo licenses the distribution software in transactions that meet those stringent comparability requirements.
The profit split methods and the comparable profits method (“CPM”) are applied in the same manner as they are for tangible property. As a result, the profit split methods are similarly difficult to apply while the CPM should be more practical.
[i] Treas. Reg. section 1.482-4(b).
[ii] A Study of Intercompany Pricing under Section 482 of the Code, Notice 88-123, 1988-2 C.B. 458.
[iii] Treas. Reg. section 1.482-4(a).
[iv] Treas. Reg. section 1.482-4(c).
For additional information, please contact Kimberlee Phelan or Robert Misey
Robert J. Misey, Jr.
Reinhart Boerner Van Deuren s.c.
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