Italien fashion group, Dolce & Gabbana s.r.l. (hereinafter DG s.r.l.), the licensee of the Dolce&Gabbana trademark, entered into a sub-licensing agreement with its subsidiary Dolce&Gabbana Industria (hereinafter DG Industria or Industria) whereby the former granted to the latter the right to produce, distribute and sell products bearing the well-known trademark throughout the world and undertook to carry out promotion and marketing activities in return for royalties. DG s.r.l., in order to carry out promotion and marketing activities in the U.S.A., made use of the company Dolce&Gabbana Usa Inc. (hereinafter DG Usa) with contracts in force since 2002; in particular, on March 16, 2005, it entered into a service agreement whereby DG Usa undertook to provide the aforesaid services in return for an annual fee payable by DG s.r.l.; this consideration is determined on the basis of the costs analytically attributable to the provision of the agreed services in addition to a mark up, i.e. a mark-up, determined in a variable ... Read more

(i) Company A is a consumer products company located in the United States. Companies B and C are wholly-owned subsidiaries of Company A and are located in Countries B and C, respectively. Company A and its subsidiaries manufacture products for sale in their respective markets. Company A hires a consultant who has expertise regarding a manufacturing process used by Company A and its subsidiary, Company B. Company C, the Country C subsidiary, uses a different manufacturing process, and accordingly will not receive any benefit from the outside consultant hired by Company A. In allocating and apportioning the cost of hiring the outside consultant (100), Company A determines that sales constitute the most appropriate allocation key. (ii) Company A and its subsidiaries have the following sales: Company A B C Total Sales 400 100 200 700 (iii) Because Company C does not obtain any benefit from the consultant, none of the costs are allocated to it. Rather, the costs of 100 ... Read more

Company A pays an annual license fee of 500x to an uncontrolled taxpayer for unlimited use of a database within the corporate group. Under the terms of the license with the uncontrolled taxpayer, Company A is permitted to use the database for its own use and in rendering research services to its subsidiary, Company B. Company B obtains benefits from the database that are similar to those that it would obtain if it had independently licensed the database from the uncontrolled taxpayer. Evaluation of the arm’s length charge (under a method in which costs are relevant) to Company B for the controlled services that incorporate use of the database must take into account the full amount of the license fee of 500x paid by Company A, as reasonably allocated and apportioned to the relevant benefits, although the incremental use of the database for the benefit of Company B did not result in an increase in the license fee paid by ... Read more

The principles of this paragraph (k) are illustrated by the following examples: ... Read more

The practices used by the taxpayer to apportion costs in connection with preparation of statements and analyses for the use of management, creditors, minority shareholders, joint venturers, clients, customers, potential investors, or other parties or agencies in interest will be considered as potential indicators of reliable allocation methods, but need not be accorded conclusive weight by the Commissioner. In determining the extent to which allocations are to be made to or from foreign members of a controlled group, practices employed by the domestic members in apportioning costs among themselves will also be considered if the relationships with the foreign members are comparable to the relationships among the domestic members of the controlled group. For example, if for purposes of reporting to public stockholders or to a governmental agency, a corporation apportions the costs attributable to its executive officers among the domestic members of a controlled group on a reasonable and consistent basis, and such officers exercise comparable control over foreign ... Read more

Any reasonable method may be used to allocate and apportion costs under this section. In establishing the appropriate method of allocation and apportionment, consideration should be given to all bases and factors, including, for example, total services costs, total costs for a relevant activity, assets, sales, compensation, space utilized, and time spent. The costs incurred by supporting departments may be apportioned to other departments on the basis of reasonable overall estimates, or such costs may be reflected in the other departments’ costs by applying reasonable departmental overhead rates. Allocations and apportionments of costs must be made on the basis of the full cost, as opposed to the incremental cost ... Read more

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In any case where the renderer’s activity that results in a benefit (within the meaning of paragraph (l)(3) of this section) for one recipient in a controlled services transaction also generates a benefit for one or more other members of a controlled group (including the benefit, if any, to the renderer), and the amount charged under this section in the controlled services transaction is determined under a method that makes reference to costs, costs must be allocated among the portions of the activity performed for the benefit of the first mentioned recipient and such other members of the controlled group under this paragraph (k). The principles of this paragraph (k) must also be used whenever it is appropriate to allocate and apportion any class of costs (for example, overhead costs) in order to determine the total services costs of rendering the services. In no event will an allocation of costs based on a generalized or non-specific benefit be appropriate ... Read more

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The reliability of the results derived from the residual profit split is affected by the quality of the data and assumptions used to apply this method. In particular, the following factors must be considered – (1) The reliability of the allocation of costs, income, and assets as described in paragraph (c)(2)(ii)(C)(1) of this section; (2) Accounting consistency as described in paragraph (c)(2)(ii)(C)(2) of this section; (3) The reliability of the data used and the assumptions made in valuing the intangible property contributed by the participants. In particular, if capitalized costs of development are used to estimate the value of intangible property, the reliability of the results is reduced relative to the reliability of other methods that do not require such an estimate, for the following reasons. First, in any given case, the costs of developing the intangible may not be related to its market value. Second, the calculation of the capitalized costs of development may require the allocation of indirect costs between the relevant business activity and ... Read more

Allocation of operating or exceptional costs would follow risk assumption and how third parties would treat such costs. Thus in order to determine which associated enterprise should bear exceptional costs, it would be first necessary to accurately delineate the controlled transaction, which would indicate who has the responsibility for performing activities related to the relevant costs and who assumes risks related to these activities. For example, if a cost directly relates to a particular risk, then the party assuming that risk would typically bear the costs associated with that risk. Furthermore, the party initially incurring an exceptional cost may not be the party assuming risks associated to that cost at arm’s length, and consequently such costs may need to be passed on to parties that do assume such risks. Thus a thorough analysis should be performed before concluding whether all or part of the operating or exceptional costs should be allocated between related parties ... Read more

As a result of the COVID-19 pandemic, many enterprises have incurred exceptional, non-recurring operating costs relevant to differing operating conditions for the pandemic period. These include expenditure on Personal Protective Equipment (PPE), reconfiguration of workspaces to enable physical distancing, IT infrastructure expenses relating to test, track and trace obligations and to implement teleworking arrangements. In determining how these costs should be allocated between related parties, it will be important to consider how these costs would be allocated between independent parties operating in comparable circumstances ... Read more

Acer Computer Ibérica S.A. (ACI) is part of the multinational ACER group, which manufactures and distributes personal computers and other electronic devices. Acer Europe AG (AEAG), a group entity in Switzerland, centralises the procurement of the subsidiaries established in Europe, the Middle East and Africa, and acts as the regional management centre for that geographical area. ACI is responsible for the wholesale marketing of electronic equipment and material, as well as in the provision of technical service related to these products in Spain and Portugal. ACI is characterized as a limited risk distributor by the group. At issue was deductibility of payments resulting from factoring agreements undertaken ACI with unrelated banks, adopted to manage liquidity risks arising from timing mismatches between its accounts payable and accounts receivable. Based on an interpretation of the limited risk agreement signed between ACI and its principal AEAG, the tax authorities disregarded the allocation of the risk – and hence allocation of the relevant costs ... Read more

The costs that may be considered in applying the cost plus method are limited to those of the supplier of goods or services. This limitation may raise a problem of how to allocate some costs between suppliers and purchasers. There is a possibility that some costs will be borne by the purchaser in order to diminish the supplier’s cost base on which the mark up will be calculated. In practice, this may be achieved by not allocating to the supplier an appropriate share of overheads and other costs borne by the purchaser (often the parent company) for the benefit of the supplier (often a subsidiary). The allocation should be undertaken based on an analysis of functions performed (taking into account assets used and risks assumed) by the respective parties as provided in Chapter I. A related problem is how overhead costs should be apportioned, whether by reference to turnover, number or cost of employees, or some other criterion. The issue ... Read more