§ 1.482-5(e) Example 1.

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Transfer of tangible property resulting in no adjustment.

(i) FP is a publicly traded foreign corporation with a U.S. subsidiary, USSub, that is under audit for its 1996 taxable year. FP manufactures a consumer product for worldwide distribution. USSub imports the assembled product and distributes it within the United States at the wholesale level under the FP name.

(ii) FP does not allow uncontrolled taxpayers to distribute the product. Similar products are produced by other companies but none of them is sold to uncontrolled taxpayers or to uncontrolled distributors.

(iii) Based on all the facts and circumstances, the district director determines that the comparable profits method will provide the most reliable measure of an arm’s length result. USSub is selected as the tested party because it engages in activities that are less complex than those undertaken by FP.

There is data from a number of independent operators of wholesale distribution businesses. These potential comparables are further narrowed to select companies in the same industry segment that perform similar functions and bear similar risks to USSub. An analysis of the information available on these taxpayers shows that the ratio of operating profit to sales is the most appropriate profit level indicator, and this ratio is relatively stable where at least three years are included in the average. For the taxable years 1994 through 1996, USSub shows the following results:

1994 1995 1996 Average
Sales $500,000 $560,000 $500,000 $520,000
Cost of Goods Sold 393,000 412,400 400,000 401,800
Operating Expenses 80,000 110,000 104,600 98,200
Operating Profit 27,000 37,600 (4,600) 20,000

(iv) After adjustments have been made to account for identified material differences between USSub and the uncontrolled distributors, the average ratio of operating profit to sales is calculated for each of the uncontrolled distributors. Applying each ratio to USSub would lead to the following comparable operating profit (COP) for USSub:

Uncontrolled distributor OP/S (percent) USSub COP
A 1.7 $8,840
B 3.1 16,120
C 3.8 19,760
D 4.5 23,400
E 4.7 24,440
F 4.8 24,960
G 4.9 25,480
H 6.7 34,840
I 9.9 51,480
J 10.5 54,600

(v) The data is not sufficiently complete to conclude that it is likely that all material differences between USSub and the uncontrolled distributors have been identified. Therefore, an arm’s length range can be established only pursuant to § 1.482– 1(e)(2)(iii)(B). The district director measures the arm’s length range by the interquartile range of results, which consists of the results ranging from $19,760 to $34,840. Although USSub’s operating income for 1996 shows a loss of $4,600, the district director determines that no allocation should be made, because USSub’s average reported operating profit of $20,000 is within this range.

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