Tag: Comparability factors

Factors taken into account in determining the level of comparability of the controlled and comparable transactions. These are attributes of the transactions or parties that could materially affect prices or profits, including the characteristics of the property or services; functional analysis; contractual terms; economic circumstances and business strategies pursued.

§ 1.482-6(c)(2)(ii)(B)(1) In general.

The degree of comparability between the controlled and uncontrolled taxpayers is determined by applying the comparability provisions of § 1.482-1(d). The comparable profit split compares the division of operating profits among the controlled taxpayers to the division of operating profits among uncontrolled taxpayers engaged in similar activities under similar circumstances. Although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on the considerations described under the comparable profits method in § 1.482-5(c)(2) or § 1.482-9(f)(2)(iii) because this method is based on a comparison of the operating profit of the controlled and uncontrolled taxpayers. In addition, because the contractual terms of the relationship among the participants in the relevant business activity will be a principal determinant of the allocation of functions and risks among them, comparability under this method also depends particularly on the degree of similarity of the contractual terms of the controlled and uncontrolled taxpayers. Finally, the comparable profit split may not be used if the combined ... Read more

§ 1.482-5(c)(2)(iv) Adjustments for the differences between the tested party and the uncontrolled taxpayers.

If there are differences between the tested party and an uncontrolled comparable that would materially affect the profits determined under the relevant profit level indicator, adjustments should be made according to the comparability provisions of § 1.482-1(d)(2). In some cases, the assets of an uncontrolled comparable may need to be adjusted to achieve greater comparability between the tested party and the uncontrolled comparable. In such cases, the uncontrolled comparable’s operating income attributable to those assets must also be adjusted before computing a profit level indicator in order to reflect the income and expense attributable to the adjusted assets. In certain cases it may also be appropriate to adjust the operating profit of the tested party and comparable parties. For example, where there are material differences in accounts payable among the comparable parties and the tested party, it will generally be appropriate to adjust the operating profit of each party by increasing it to reflect an imputed interest charge on each party’s ... Read more

§ 1.482-5(c)(2)(iii) Other comparability factors.

Other factors listed in § 1.482-1(d)(3) also may be particularly relevant under the comparable profits method. Because operating profit usually is less sensitive than gross profit to product differences, reliability under the comparable profits method is not as dependent on product similarity as the resale price or cost plus method. However, the reliability of profitability measures based on operating profit may be adversely affected by factors that have less effect on results under the comparable uncontrolled price, resale price, and cost plus methods. For example, operating profit may be affected by varying cost structures (as reflected, for example, in the age of plant and equipment), differences in business experience (such as whether the business is in a start-up phase or is mature), or differences in management efficiency (as indicated, for example, by objective evidence such as expanding or contracting sales or executive compensation over time). Accordingly, if material differences in these factors are identified based on objective evidence, the reliability of the ... Read more

§ 1.482-5(c)(2)(ii) Functional, risk and resource comparability.

An operating profit represents a return for the investment of resources and assumption of risks. Therefore, although all of the factors described in § 1.482-1(d)(3) must be considered, comparability under this method is particularly dependent on resources employed and risks assumed. Moreover, because resources and risks usually are directly related to functions performed, it is also important to consider functions performed in determining the degree of comparability between the tested party and an uncontrolled taxpayer. The degree of functional comparability required to obtain a reliable result under the comparable profits method, however, is generally less than that required under the resale price or cost plus methods. For example, because differences in functions performed often are reflected in operating expenses, taxpayers performing different functions may have very different gross profit margins but earn similar levels of operating profit ... Read more

§ 1.482-3(d)(3)(ii)(C) Adjustments for differences between controlled and uncontrolled transactions.

If there are material differences between the controlled and uncontrolled transactions that would affect the gross profit markup, adjustments should be made to the gross profit markup earned in the comparable uncontrolled transaction according to the provisions of § 1.482-1(d)(2). For this purpose, consideration of the operating expenses associated with the functions performed and risks assumed may be necessary, because differences in functions performed are often reflected in operating expenses. If there are differences in functions performed, however, the effect on gross profit of such differences is not necessarily equal to the differences in the amount of related operating expenses. Specific examples of the factors that may be particularly relevant to this method include – (1) The complexity of manufacturing or assembly; (2) Manufacturing, production, and process engineering; (3) Procurement, purchasing, and inventory control activities; (4) Testing functions; (5) Selling, general, and administrative expenses; (6) Foreign currency risks; and (7) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms) ... Read more

§ 1.482-3(c)(3)(ii)(C) Adjustments for differences between controlled and uncontrolled transactions.

If there are material differences between the controlled and uncontrolled transactions that would affect the gross profit margin, adjustments should be made to the gross profit margin earned with respect to the uncontrolled transaction according to the comparability provisions of § 1.482-1(d)(2). For this purpose, consideration of operating expenses associated with functions performed and risks assumed may be necessary, because differences in functions performed are often reflected in operating expenses. If there are differences in functions performed, however, the effect on gross profit of such differences is not necessarily equal to the differences in the amount of related operating expenses. Specific examples of the factors that may be particularly relevant to this method include – (1) Inventory levels and turnover rates, and corresponding risks, including any price protection programs offered by the manufacturer; (2) Contractual terms (e.g., scope and terms of warranties provided, sales or purchase volume, credit terms, transport terms); (3) Sales, marketing, advertising programs and services, (including promotional programs, rebates, and ... Read more

§ 1.482-3(c)(3)(ii)(B) Other comparability factors.

Comparability under this method is less dependent on close physical similarity between the products transferred than under the comparable uncontrolled price method. For example, distributors of a wide variety of consumer durables might perform comparable distribution functions without regard to the specific durable goods distributed. Substantial differences in the products may, however, indicate significant functional differences between the controlled and uncontrolled taxpayers. Thus, it ordinarily would be expected that the controlled and uncontrolled transactions would involve the distribution of products of the same general type (e.g., consumer electronics). Furthermore, significant differences in the value of the distributed goods due, for example, to the value of a trademark, may also affect the reliability of the comparison. Finally, the reliability of profit measures based on gross profit may be adversely affected by factors that have less effect on prices. For example, gross profit may be affected by a variety of other factors, including cost structures (as reflected, for example, in the age ... Read more

§ 1.482-1(d)(4)(iii)(B)Example 2.

USP, a United States manufacturer of farm machinery, sells its products to FSub, its wholly-owned distributor in Country Y. USP, operating at nearly full capacity, sells 95% of its inventory to FSub. To make use of its excess capacity, and also to establish a comparable uncontrolled price for its transfer price to FSub, USP increases its production to full capacity. USP sells its excess inventory to Compco, an unrelated foreign distributor in Country X. Country X has approximately the same economic conditions as that of Country Y. Because one of the principal purposes of selling to Compco was to establish an arm’s length price for its controlled transactions with FSub, USP’s sale to Compco cannot be used as an uncontrolled comparable to determine USP’s arm’s length result from its controlled transaction ... Read more

§ 1.482-1(d)(4)(iii)(B)Example 1.

Not in the ordinary course of business. USP, a United States manufacturer of computer software, sells its products to FSub, its foreign distributor in country X. Compco, a United States competitor of USP, also sells its products in X through unrelated distributors. However, in the year under review, Compco is forced into bankruptcy, and Compco liquidates its inventory by selling all of its products to unrelated distributors in X for a liquidation price. Because the sale of its entire inventory was not a sale in the ordinary course of business, Compco’s sale cannot be used as an uncontrolled comparable to determine USP’s arm’s length result from its controlled transaction ... Read more

§ 1.482-1(d)(4)(iii)(A) In general.

Transactions ordinarily will not constitute reliable measures of an arm’s length result for purposes of this section if – (1) They are not made in the ordinary course of business; or (2) One of the principal purposes of the uncontrolled transaction was to establish an arm’s length result with respect to the controlled transaction ... Read more

§ 1.482-1(d)(4)(ii)(D) Example.

Couture, a U.S. apparel design corporation, contracts with Sewco, its wholly owned Country Y subsidiary, to manufacture its clothes. Costs of operating in Country Y are significantly lower than the operating costs in the United States. Although clothes with the Couture label sell for a premium price, the actual production of the clothes does not require significant specialized knowledge that could not be acquired by actual or potential competitors to Sewco at reasonable cost. Thus, Sewco’s functions could be performed by several actual or potential competitors to Sewco in geographic markets that are similar to Country Y. Thus, the fact that production is less costly in Country Y will not, in and of itself, justify additional profits derived from lower operating costs in Country Y inuring to Sewco, because the competitive positions of the other actual or potential producers in similar geographic markets capable of performing the same functions at the same low costs indicate that at arm’s length such ... Read more

§ 1.482-1(d)(4)(ii)(C) Location savings.

If an uncontrolled taxpayer operates in a different geographic market than the controlled taxpayer, adjustments may be necessary to account for significant differences in costs attributable to the geographic markets. These adjustments must be based on the effect such differences would have on the consideration charged or paid in the controlled transaction given the relative competitive positions of buyers and sellers in each market. Thus, for example, the fact that the total costs of operating in a controlled manufacturer’s geographic market are less than the total costs of operating in other markets ordinarily justifies higher profits to the manufacturer only if the cost differences would increase the profits of comparable uncontrolled manufacturers operating at arm’s length, given the competitive positions of buyers and sellers in that market ... Read more

§ 1.482-1(d)(4)(ii)(B) Example.

Manuco, a wholly-owned foreign subsidiary of P, a U.S. corporation, manufactures products in Country Z for sale to P. No uncontrolled transactions are located that would provide a reliable measure of the arm’s length result under the comparable uncontrolled price method. The district director considers applying the cost plus method or the comparable profits method. Information on uncontrolled taxpayers performing comparable functions under comparable circumstances in the same geographic market is not available. Therefore, adjusted data from uncontrolled manufacturers in other markets may be considered in order to apply the cost plus method. In this case, comparable uncontrolled manufacturers are found in the United States. Accordingly, data from the comparable U.S. uncontrolled manufacturers, as adjusted to account for differences between the United States and Country Z’s geographic market, is used to test the arm’s length price paid by P to Manuco. However, the use of such data may affect the reliability of the results for purposes of the best method ... Read more

§ 1.482-1(d)(4)(ii)(A) In general.

Uncontrolled comparables ordinarily should be derived from the geographic market in which the controlled taxpayer operates, because there may be significant differences in economic conditions in different markets. If information from the same market is not available, an uncontrolled comparable derived from a different geographic market may be considered if adjustments are made to account for differences between the two markets. If information permitting adjustments for such differences is not available, then information derived from uncontrolled comparables in the most similar market for which reliable data is available may be used, but the extent of such differences may affect the reliability of the method for purposes of the best method rule. For this purpose, a geographic market is any geographic area in which the economic conditions for the relevant product or service are substantially the same, and may include multiple countries, depending on the economic conditions ... Read more

§ 1.482-1(d)(4)(i) Market share strategy.

In certain circumstances, taxpayers may adopt strategies to enter new markets or to increase a product’s share of an existing market (market share strategy). Such a strategy would be reflected by temporarily increased market development expenses or resale prices that are temporarily lower than the prices charged for comparable products in the same market. Whether or not the strategy is reflected in the transfer price depends on which party to the controlled transaction bears the costs of the pricing strategy. In any case, the effect of a market share strategy on a controlled transaction will be taken into account only if it can be shown that an uncontrolled taxpayer engaged in a comparable strategy under comparable circumstances for a comparable period of time, and the taxpayer provides documentation that substantiates the following – (A) The costs incurred to implement the market share strategy are borne by the controlled taxpayer that would obtain the future profits that result from the strategy, and ... Read more

§ 1.482-1(d)(3)(v) Property or services.

Evaluating the degree of comparability between controlled and uncontrolled transactions requires a comparison of the property or services transferred in the transactions. This comparison may include any intangible property that is embedded in tangible property or services being transferred (embedded intangibles). The comparability of the embedded intangibles will be analyzed using the factors listed in § 1.482-4(c)(2)(iii)(B)(1) (comparable intangible property). The relevance of product comparability in evaluating the relative reliability of the results will depend on the method applied. For guidance concerning the specific comparability considerations applicable to transfers of tangible and intangible property and performance of services, see §§ 1.482-3 through 1.482-6 and § 1.482-9; see also §§ 1.482-3(f), 1.482-4(f)(4), and 1.482-9(m), dealing with the coordination of intangible and tangible property and performance of services rules ... Read more

§ 1.482-1(d)(3)(iv) Economic conditions.

Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the significant economic conditions that could affect the prices that would be charged or paid, or the profit that would be earned in each of the transactions. These factors include – (A) The similarity of geographic markets; (B) The relative size of each market, and the extent of the overall economic development in each market; (C) The level of the market (e.g., wholesale, retail, etc.); (D) The relevant market shares for the products, properties, or services transferred or provided; (E) The location-specific costs of the factors of production and distribution; (F) The extent of competition in each market with regard to the property or services under review; (G) The economic condition of the particular industry, including whether the market is in contraction or expansion; and (H) The alternatives realistically available to the buyer and seller ... Read more

§ 1.482-1(d)(3)(iii)(C) Example 4.

USSub is the wholly-owned U.S. subsidiary of FP, a foreign manufacturer. USSub acts as a distributor of goods manufactured by FP. FP and USSub execute an agreement providing that FP will bear any ordinary product liability costs arising from defects in the goods manufactured by FP. In practice, however, when ordinary product liability claims are sustained against USSub and FP, USSub pays the resulting damages. Therefore, the district director disregards the contractual arrangement regarding product liability costs between FP and USSub, and treats the risk as having been assumed by USSub ... Read more

§ 1.482-1(d)(3)(iii)(C) Example 3.

S, a Country X corporation, manufactures small motors that it sells to P, its U.S. parent. P incorporates the motors into various products and sells those products to uncontrolled customers in the United States. The contract price for the motors is expressed in U.S. dollars, effectively allocating the currency risk for these transactions to S for any currency fluctuations between the time the contract is signed and payment is made. As long as S has adequate financial capacity to bear this currency risk (including by hedging all or part of the risk) and the conduct of S and P is consistent with the terms of the contract (i.e., the contract price is not adjusted to reflect exchange rate movements), the agreement of the parties to allocate the exchange risk to S will be respected ... Read more

§ 1.482-1(d)(3)(iii)(C) Example 2.

The facts are the same as in Example 1, except that in Year 1 FD had only $100,000 in total capital, including loans. In subsequent years USM makes no additional contributions to the capital of FD, and FD is unable to obtain any capital through loans from an unrelated party. Nonetheless, USM continues to sell 20,000 widgets annually to FD under the terms of the contract, and USM extends credit to FD to enable it to finance the purchase. FD does not have the financial capacity in Years 1, 2 and 3 to finance the purchase of the widgets given that it could not sell most of the widgets it purchased during those years. Thus, notwithstanding the terms of the contract, USM and not FD assumed the market risk that a substantial portion of the widgets could not be sold, since in that event FD would not be able to pay USM for all of the widgets it purchased ... Read more

§ 1.482-1(d)(3)(iii)(C) Example 1.

FD, the wholly-owned foreign distributor of USM, a U.S. manufacturer, buys widgets from USM under a written contract. Widgets are a generic electronic appliance. Under the terms of the contract, FD must buy and take title to 20,000 widgets for each of the five years of the contract at a price of $10 per widget. The widgets will be sold under FD’s label, and FD must finance any marketing strategies to promote sales in the foreign market. There are no rebate or buy back provisions. FD has adequate financial capacity to fund its obligations under the contract under any circumstances that could reasonably be expected to arise. In Years 1, 2 and 3, FD sold only 10,000 widgets at a price of $11 per unit. In Year 4, FD sold its entire inventory of widgets at a price of $25 per unit. Since the contractual terms allocating market risk were agreed to before the outcome of such risk was known ... Read more

§ 1.482-1(d)(3)(iii)(B) Identification of taxpayer that bears risk.

In general, the determination of which controlled taxpayer bears a particular risk will be made in accordance with the provisions of § 1.482-1(d)(3)(ii)(B) (Identifying contractual terms). Thus, the allocation of risks specified or implied by the taxpayer’s contractual terms will generally be respected if it is consistent with the economic substance of the transaction. An allocation of risk between controlled taxpayers after the outcome of such risk is known or reasonably knowable lacks economic substance. In considering the economic substance of the transaction, the following facts are relevant – (1) Whether the pattern of the controlled taxpayer’s conduct over time is consistent with the purported allocation of risk between the controlled taxpayers; or where the pattern is changed, whether the relevant contractual arrangements have been modified accordingly; (2) Whether a controlled taxpayer has the financial capacity to fund losses that might be expected to occur as the result of the assumption of a risk, or whether, at arm’s length, another party to ... Read more

§ 1.482-1(d)(3)(iii)(A) Comparability.

Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the significant risks that could affect the prices that would be charged or paid, or the profit that would be earned, in the two transactions. Relevant risks to consider include – (1) Market risks, including fluctuations in cost, demand, pricing, and inventory levels; (2) Risks associated with the success or failure of research and development activities; (3) Financial risks, including fluctuations in foreign currency rates of exchange and interest rates; (4) Credit and collection risks; (5) Product liability risks; and (6) General business risks related to the ownership of property, plant, and equipment ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 6.

Contractual terms imputed from economic substance. (i) Company X is a member of a controlled group that has been in operation in the pharmaceutical sector for many years. In years 1 through 4, Company X undertakes research and development activities. As a result of those activities, Company X developed a compound that may be more effective than existing medications in the treatment of certain conditions. (ii) Company Y is acquired in year 4 by the controlled group that includes Company X. Once Company Y is acquired, Company X makes available to Company Y a large amount of technical data concerning the new compound, which Company Y uses to register patent rights with respect to the compound in several jurisdictions, making Company Y the legal owner of such patents. Company Y then enters into licensing agreements with group members that afford Company Y 100% of the premium return attributable to use of the intangible property by its subsidiaries. (iii) In determining ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 5.

Non-arm’s length compensation. (i) The facts are the same as in paragraph (i) of Example 4. As in Example 4, assume that, after adjustments are made to improve the reliability of the comparison for any material differences relating to marketing activities, manufacturing or marketing intangible property, and other comparability factors, the royalties paid by independent licensees would provide the most reliable measure of the arm’s length royalty owed by USSub to FP, apart from the additional facts described in paragraph (ii) of this Example 5. (ii) In years 1 through 4, USSub performs certain incremental marketing activities with respect to the AA trademark athletic gear, in addition to the activities required under the terms of the basic license agreement, that are also incremental as compared with those activities observed in the comparables. At the start of year 1, FP enters into a separate services agreement with USSub, which states that FP will compensate USSub quarterly, in an amount equal to specified costs plus X%, for ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 4.

Contractual terms imputed from economic substance. (i) FP, a foreign producer of athletic gear, is the registered holder of the AA trademark in the United States and in other countries worldwide. In year 1, FP enters into a licensing agreement that affords its newly organized United States subsidiary, USSub, exclusive rights to certain manufacturing and marketing intangible property (including the AA trademark) for purposes of manufacturing and marketing athletic gear in the United States under the AA trademark. The contractual terms of this agreement obligate USSub to pay FP a royalty based on sales, and also obligate both FP and USSub to undertake without separate compensation specified types and levels of marketing activities. Unrelated foreign businesses license independent United States businesses to manufacture and market athletic gear in the United States, using trademarks owned by the unrelated foreign businesses. The contractual terms of these uncontrolled transactions require the licensees to pay royalties based on sales of the merchandise, and obligate ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 3.

Contractual terms imputed from economic substance. (i) FP, a foreign producer of wristwatches, is the registered holder of the YY trademark in the United States and in other countries worldwide. In year 1, FP enters the United States market by selling YY wristwatches to its newly organized United States subsidiary, USSub, for distribution in the United States market. USSub pays FP a fixed price per wristwatch. USSub and FP undertake, without separate compensation, marketing activities to establish the YY trademark in the United States market. Unrelated foreign producers of trademarked wristwatches and their authorized United States distributors respectively undertake similar marketing activities in independent arrangements involving distribution of trademarked wristwatches in the United States market. In years 1 through 6, USSub markets and sells YY wristwatches in the United States. Further, in years 1 through 6, USSub undertakes incremental marketing activities in addition to the activities similar to those observed in the independent distribution transactions in the United States market ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 2.

Reliability of adjustment for differences in volume. (i) FS manufactures product XX and sells that product to its parent corporation, P. FS also sells product XX to uncontrolled taxpayers at a price of $100 per unit. Except for the volume of each transaction, the sales to P and to uncontrolled taxpayers take place under substantially the same economic conditions and contractual terms. In uncontrolled transactions, FS offers a 2% discount for quantities of 20 per order, and a 5% discount for quantities of 100 per order. If P purchases product XX in quantities of 60 per order, in the absence of other reliable information, it may reasonably be concluded that the arm’s length price to P would be $100, less a discount of 3.5%. (ii) If P purchases product XX in quantities of 1,000 per order, a reliable estimate of the appropriate volume discount must be based on proper economic or statistical analysis, not necessarily a linear extrapolation from the ... Read more

§ 1.482-1(d)(3)(ii)(C) Example 1.

Differences in volume. USP, a United States agricultural exporter, regularly buys transportation services from FSub, its foreign subsidiary, to ship its products from the United States to overseas markets. Although FSub occasionally provides transportation services to URA, an unrelated domestic corporation, URA accounts for only 10% of the gross revenues of FSub, and the remaining 90% of FSub’s gross revenues are attributable to FSub’s transactions with USP. In determining the degree of comparability between FSub’s uncontrolled transaction with URA and its controlled transaction with USP, the difference in volumes involved in the two transactions and the regularity with which these services are provided must be taken into account if such difference would have a material effect on the price charged. Inability to make reliable adjustments for these differences would affect the reliability of the results derived from the uncontrolled transaction as a measure of the arm’s length result ... Read more

§ 1.482-1(d)(3)(ii)(B)(2) No written agreement.

In the absence of a written agreement, the district director may impute a contractual agreement between the controlled taxpayers consistent with the economic substance of the transaction. In determining the economic substance of the transaction, greatest weight will be given to the actual conduct of the parties and their respective legal rights (see, for example, § 1.482-4(f)(3) (Ownership of intangible property)). For example, if, without a written agreement, a controlled taxpayer operates at full capacity and regularly sells all of its output to another member of its controlled group, the district director may impute a purchasing contract from the course of conduct of the controlled taxpayers, and determine that the producer bears little risk that the buyer will fail to purchase its full output. Further, if an established industry convention or usage of trade assigns a risk or resolves an issue, that convention or usage will be followed if the conduct of the taxpayers is consistent with it. See UCC 1-205. For ... Read more

§ 1.482-1(d)(3)(ii)(B)(1) Written agreement.

The contractual terms, including the consequent allocation of risks, that are agreed to in writing before the transactions are entered into will be respected if such terms are consistent with the economic substance of the underlying transactions. In evaluating economic substance, greatest weight will be given to the actual conduct of the parties, and the respective legal rights of the parties (see, for example, § 1.482-4(f)(3) (Ownership of intangible property)). If the contractual terms are inconsistent with the economic substance of the underlying transaction, the district director may disregard such terms and impute terms that are consistent with the economic substance of the transaction ... Read more

§ 1.482-1(d)(3)(ii)(A) In general.

Determining the degree of comparability between the controlled and uncontrolled transactions requires a comparison of the significant contractual terms that could affect the results of the two transactions. These terms include – (1) The form of consideration charged or paid; (2) Sales or purchase volume; (3) The scope and terms of warranties provided; (4) Rights to updates, revisions or modifications; (5) The duration of relevant license, contract or other agreements, and termination or renegotiation rights; (6) Collateral transactions or ongoing business relationships between the buyer and the seller, including arrangements for the provision of ancillary or subsidiary services; and (7) Extension of credit and payment terms. Thus, for example, if the time for payment of the amount charged in a controlled transaction differs from the time for payment of the amount charged in an uncontrolled transaction, an adjustment to reflect the difference in payment terms should be made if such difference would have a material effect on price. Such comparability adjustment is required even if no interest ... Read more

§ 1.482-1(d)(3)(i) Functional analysis.

Determining the degree of comparability between controlled and uncontrolled transactions requires a comparison of the functions performed, and associated resources employed, by the taxpayers in each transaction. This comparison is based on a functional analysis that identifies and compares the economically significant activities undertaken, or to be undertaken, by the taxpayers in both controlled and uncontrolled transactions. A functional analysis should also include consideration of the resources that are employed, or to be employed, in conjunction with the activities undertaken, including consideration of the type of assets used, such as plant and equipment, or the use of valuable intangibles. A functional analysis is not a pricing method and does not itself determine the arm’s length result for the controlled transaction under review. Functions that may need to be accounted for in determining the comparability of two transactions include – (A) Research and development; (B) Product design and engineering; (C) Manufacturing, production and process engineering; (D) Product fabrication, extraction, and assembly; (E) Purchasing and materials management; ... Read more

§ 1.482-1(d)(3) Factors for determining comparability.

The comparability factors listed in § 1.482-1(d)(1) are discussed in this section. Each of these factors must be considered in determining the degree of comparability between transactions or taxpayers and the extent to which comparability adjustments may be necessary. In addition, in certain cases involving special circumstances, the rules under paragraph (d)(4) of this section must be considered ... Read more

§ 1.482-1(d)(1) In general.

Whether a controlled transaction produces an arm’s length result is generally evaluated by comparing the results of that transaction to results realized by uncontrolled taxpayers engaged in comparable transactions under comparable circumstances. For this purpose, the comparability of transactions and circumstances must be evaluated considering all factors that could affect prices or profits in arm’s length dealings (comparability factors). While a specific comparability factor may be of particular importance in applying a method, each method requires analysis of all of the factors that affect comparability under that method. Such factors include the following – (i) Functions; (ii) Contractual terms; (iii) Risks; (iv) Economic conditions; and (v) Property or services ... Read more
UK vs BlackRock, July 2022, Upper Tribunal, Case No [2022] UKUT 00199 (TCC)

UK vs BlackRock, July 2022, Upper Tribunal, Case No [2022] UKUT 00199 (TCC)

In 2009 the BlackRock Group acquired Barclays Global Investors for a total sum of $13,5bn. The price was paid in part by shares ($6.9bn) and in part by cash ($6.6bn). The cash payment was paid by BlackRock Holdco 5 LLC – a US Delaware Company tax resident in the UK – but funded by the parent company by issuing $4bn loan notes to the LLC. In the years following the acquisition Blackrock Holdco 5 LLC claimed tax deductions in the UK for interest payments on the intra-group loans. Following an audit in the UK the tax authorities disallowed the interest deductions. The tax authorities held that the transaction would not have happened between independent parties. They also found that the loans were entered into for an unallowable tax avoidance purpose. A UK taxpayer can be denied a deduction for interest where a loan has an unallowable purpose i.e, where a tax advantage is the company’s main purpose for entering into ... Read more
France vs Ferragamo France, June 2022, Administrative Court of Appeal (CAA), Case No 20PA03601

France vs Ferragamo France, June 2022, Administrative Court of Appeal (CAA), Case No 20PA03601

Ferragamo France, which was set up in 1992 and is wholly owned by the Dutch company Ferragamo International BV, which in turn is owned by the Italian company Salvatore Ferragamo Spa, carries on the business of retailing shoes, leather goods and luxury accessories and distributes, in shops in France, products under the ‘Salvatore Ferragamo’ brand, which is owned by the Italian parent company. An assessment had been issued to Ferragamo France in which the French tax authorities asserted that the French subsidiary had not been sufficiently remunerated for additional expenses and contributions to the value of the Ferragamo trademark. The French subsidiary had been remunerated on a gross margin basis, but had incurred losses in previous years and had indirect cost exceeding those of the selected comparable companies. In 2017 the Administrative Court decided in favour of Ferragamo and dismissed the assessment issued by the tax authorities. According to the Court the tax administration had not demonstrated the existence of ... Read more
Poland vs "Shopping Centre Developer sp.k.", June 2022, Supreme Administrative Court, Case No II FSK 3050/19

Poland vs “Shopping Centre Developer sp.k.”, June 2022, Supreme Administrative Court, Case No II FSK 3050/19

A Polish company, “Shopping Centre Lender sp.k.”, had been granted three intra group loans in FY 2013 for a maximum amount of EUR 2 million, EUR 115 million and EUR 43.5 million. The interest rate on the loans had been set at 9%. The tax authorities found that the 9% interest rate was higher than the arm’s length rate, and issued an assessment where the interest rate had been lowered to 3.667%, resulting in lower interest expenses and thus additional taxable income. “Shopping Centre Lender sp.k.” filed an appeal with the Administrative Court claiming that the procedure for estimating income – determining the arm’s length interest rate – had not been conducted correctly by the tax authority. In a judgement issued in May 2019 (no. III SA/Wa 1777/18) the Administrative Court issued a judgement in favour of the company. An appeal was then filed by the tax authorities with the Supreme Administrative Court. Judgement of the Supreme Administrative Court The ... Read more
Ukrain vs PrJSC "Poltava GZK", June 2022, Supreme Court, Case No 440/1053/19

Ukrain vs PrJSC “Poltava GZK”, June 2022, Supreme Court, Case No 440/1053/19

Poltova GZK is a Ukrainian subsidiary of the Ferrexpo group – the world’s third largest exporter of iron ore pellets. In FY 2015 the iron ore mined in Ukraine by Poltava GZK was sold to other companies in the group – Ferrexpo Middle East FZE, and the transfer prices for the ore was determined by application of the CUP method using Platts quotations. However, according to the tax authorities Poltava GZK used Platts quotations for pellets with a lower iron content when pricing the higher quality pellets, resulting in non arm’s length prices for the controlled transactions and lower profits in the Ukraine subsidiary. The tax authorities also found that Poltava GZK had overestimated the cost of freight – in the case of actual transportation of pellets by ships of different classes (“Panamax”, “Capesize”), the adjustment of the delivery conditions was carried out only at the maximum rate. On that basis an assessment was issued. Not satisfied with the assessment ... Read more