Residual profit split. (i) Company A, a Country 1 corporation, provides specialized services pertaining to the processing and storage of Level 1 hazardous waste (for purposes of this example, the most dangerous type of waste). Under long-term contracts with private companies and governmental entities in Country 1, Company A performs multiple services, including transportation of Level 1 waste, development of handling and storage protocols, recordkeeping, and supervision of waste-storage facilities owned and maintained by the contracting parties. Company A’s research and development unit has also developed new and unique processes for transport and storage of Level 1 waste that minimize environmental and occupational effects. In addition to this novel technology, Company A has substantial know-how and a long-term record of safe operations in Country 1. (ii) Company A’s subsidiary, Company B, has been in operation continuously for a number of years in Country 2. Company B has successfully completed several projects in Country 2 involving Level 2 and Level 3 ... Read more

Residual profit split. (i) Company A, a corporation resident in Country X, auctions spare parts by means of an interactive database. Company A maintains a database that lists all spare parts available for auction. Company A developed the software used to run the database. Company A’s database is managed by Company A employees in a data center located in Country X, where storage and manipulation of data also take place. Company A has a wholly-owned subsidiary, Company B, located in Country Y. Company B performs marketing and advertising activities to promote Company A’s interactive database. Company B solicits unrelated companies to auction spare parts on Company A’s database, and solicits customers interested in purchasing spare parts online. Company B owns and maintains a computer server in Country Y, where it receives information on spare parts available for auction. Company B has also designed a specialized communications network that connects its data center to Company A’s data center in Country X ... Read more

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

The profit split method evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm’s length by reference to the relative value of each controlled taxpayer’s contribution to that combined operating profit or loss. The relative value of each controlled taxpayer’s contribution is determined in a manner that reflects the functions performed, risks assumed and resources employed by such controlled taxpayer in the relevant business activity. For application of the profit split method (both the comparable profit split and the residual profit split), see § 1.482-6. The residual profit split method may not be used where only one controlled taxpayer makes significant nonroutine contributions ... Read more

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(1) In general. The provisions of paragraphs (c)(2)(ii)(B)(1) and (D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section are generally applicable for taxable years beginning after July 31, 2009. (2) Election to apply regulation to earlier taxable years. A person may elect to apply the provisions of paragraphs (c)(2)(ii)(B)(1) and (D), (c)(3)(i)(A) and (B), and (c)(3)(ii)(D) of this section to earlier taxable years in accordance with the rules set forth in § 1.482-9(n)(2) ... Read more

Application of Residual Profit Split. (i) XYZ is a U.S. corporation that develops, manufactures and markets a line of products for police use in the United States. XYZ’s research unit developed a bulletproof material for use in protective clothing and headgear (Nulon). XYZ obtains patent protection for the chemical formula for Nulon. Since its introduction in the U.S., Nulon has captured a substantial share of the U.S. market for bulletproof material. (ii) XYZ licensed its European subsidiary, XYZ-Europe, to manufacture and market Nulon in Europe. XYZ-Europe is a well- established company that manufactures and markets XYZ products in Europe. XYZ-Europe has a research unit that adapts XYZ products for the defense market, as well as a well-developed marketing network that employs brand names that it developed. (iii) XYZ-Europe’s research unit alters Nulon to adapt it to military specifications and develops a high-intensity marketing campaign directed at the defense industry in several European countries. Beginning with the 1995 taxable year, XYZ-Europe ... Read more

The provisions of this paragraph (c)(3) are illustrated by the following example ... Read more

Like the methods described in §§ 1.482-3, 1.482-4, 1.482-5, and 1.482-9, the first step of the residual profit split relies exclusively on external market benchmarks. As indicated in § 1.482-1(c)(2)(i), as the degree of comparability between the controlled and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, to the extent the allocation of profits in the second step is not based on external market benchmarks, the reliability of the analysis will be decreased in relation to an analysis under a method that relies on market benchmarks. Finally, the reliability of the analysis under this method may be enhanced by the fact that all parties to the controlled transaction are evaluated under the residual profit split. However, the reliability of the results of an analysis based on information from all parties to a transaction is affected by the reliability of the data and the assumptions pertaining to each party to the controlled transaction. Thus, if the data and ... Read more

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

The first step of the residual profit split relies on market benchmarks of profitability. Thus, the comparability considerations that are relevant for the first step of the residual profit split are those that are relevant for the methods that are used to determine market returns for the routine contributions. The second step of the residual profit split, however, may not rely so directly on market benchmarks. Thus, the reliability of the results under this method is reduced to the extent that the allocation of profits in the second step does not rely on market benchmarks ... Read more

Whether results derived from this method are the most reliable measure of the arm’s length result is determined using the factors described under the best method rule in § 1.482-1(c). Thus, comparability and the quality of data and assumptions must be considered in determining whether this method provides the most reliable measure of an arm’s length result. The application of these factors to the residual profit split is discussed in paragraph (c)(3)(ii)(B), (C), and (D) of this section ... Read more

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In many cases, nonroutine contributions of a taxpayer to the relevant business activity may be contributions of intangible property. For purposes of paragraph (c)(3)(i)(B)(1) of this section, the relative value of nonroutine intangible property contributed by taxpayers may be measured by external market benchmarks that reflect the fair market value of such intangible property. Alternatively, the relative value of nonroutine intangible property contributions may be estimated by the capitalized cost of developing the intangible property and all related improvements and updates, less an appropriate amount of amortization based on the useful life of each intangible property. Finally, if the intangible property development expenditures of the parties are relatively constant over time and the useful life of the intangible property contributed by all parties is approximately the same, the amount of actual expenditures in recent years may be used to estimate the relative value of nonroutine intangible property contributions ... Read more

The allocation of income to the controlled taxpayer’s routine contributions will not reflect profits attributable to each controlled taxpayer’s contributions to the relevant business activity that are not routine (nonroutine contributions). A nonroutine contribution is a contribution that is not accounted for as a routine contribution. Thus, in cases where such nonroutine contributions are present, there normally will be an unallocated residual profit after the allocation of income described in paragraph (c)(3)(i)(A) of this section. Under this second step, the residual profit generally should be divided among the controlled taxpayers based upon the relative value of their nonroutine contributions to the relevant business activity. The relative value of the nonroutine contributions of each taxpayer should be measured in a manner that most reliably reflects each nonroutine contribution made to the controlled transaction and each controlled taxpayer’s role in the nonroutine contributions. If the nonroutine contribution by one of the controlled taxpayers is also used in other business activities (such as transactions with ... Read more

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The first step allocates operating income to each party to the controlled transactions to provide a market return for its routine contributions to the relevant business activity. Routine contributions are contributions of the same or a similar kind to those made by uncontrolled taxpayers involved in similar business activities for which it is possible to identify market returns. Routine contributions ordinarily include contributions of tangible property, services and intangible property that are generally owned by uncontrolled taxpayers engaged in similar activities. A functional analysis is required to identify these contributions according to the functions performed, risks assumed, and resources employed by each of the controlled taxpayers. Market returns for the routine contributions should be determined by reference to the returns achieved by uncontrolled taxpayers engaged in similar activities, consistent with the methods described in §§ 1.482-3, 1.482-4, 1.482-5 and 1.482-9 ... Read more

Under this method, the combined operating profit or loss from the relevant business activity is allocated between the controlled taxpayers following the two-step process set forth in paragraphs (c)(3)(i)(A) and (B) of this section ... Read more

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Like the methods described in §§ 1.482-3, 1.482-4, 1.482-5, and 1.482-9, the comparable profit split relies exclusively on external market benchmarks. As indicated in § 1.482-1(c)(2)(i), as the degree of comparability between the controlled and uncontrolled transactions increases, the relative weight accorded the analysis under this method will increase. In addition, the reliability of the analysis under this method may be enhanced by the fact that all parties to the controlled transaction are evaluated under the comparable profit split. However, the reliability of the results of an analysis based on information from all parties to a transaction is affected by the reliability of the data and the assumptions pertaining to each party to the controlled transaction. Thus, if the data and assumptions are significantly more reliable with respect to one of the parties than with respect to the others, a different method, focusing solely on the results of that party, may yield more reliable results ... Read more

The reliability of the results derived from the comparable 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 between the relevant business activity and the participants’ other activities will affect the accuracy of the determination of combined operating profit and its allocation among the participants. If it is not possible to allocate costs, income, and assets directly based on factual relationships, a reasonable allocation formula may be used. To the extent direct allocations are not made, the reliability of the results derived from the application of this method is reduced relative to the results of a method that requires fewer allocations of costs, income, and assets. Similarly, the reliability of the results derived from the application of this method is affected by the extent to which it is possible to apply the method ... Read more

If there are differences between the controlled and uncontrolled taxpayers that would materially affect the division of operating profit, adjustments must be made according to the provisions of § 1.482-1(d)(2) ... Read more

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

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Whether results derived from application of this method are the most reliable measure of the arm’s length result is determined using the factors described under the best method rule in § 1.482-1(c) ... Read more

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A comparable profit split is derived from the combined operating profit of uncontrolled taxpayers whose transactions and activities are similar to those of the controlled taxpayers in the relevant business activity. Under this method, each uncontrolled taxpayer’s percentage of the combined operating profit or loss is used to allocate the combined operating profit or loss of the relevant business activity ... Read more

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The allocation of profit or loss under the profit split method must be made in accordance with one of the following allocation methods – (i) The comparable profit split, described in paragraph (c)(2) of this section; or (ii) The residual profit split, described in paragraph (c)(3) of this section ... Read more

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The relative value of each controlled taxpayer’s contribution to the success of the relevant business activity must be determined in a manner that reflects the functions performed, risks assumed, and resources employed by each participant in the relevant business activity, consistent with the comparability provisions of § 1.482-1(d)(3). Such an allocation is intended to correspond to the division of profit or loss that would result from an arrangement between uncontrolled taxpayers, each performing functions similar to those of the various controlled taxpayers engaged in the relevant business activity. The profit allocated to any particular member of a controlled group is not necessarily limited to the total operating profit of the group from the relevant business activity. For example, in a given year, one member of the group may earn a profit while another member incurs a loss. In addition, it may not be assumed that the combined operating profit or loss from the relevant business activity should be shared equally, or ... Read more

The profit split method evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm’s length by reference to the relative value of each controlled taxpayer’s contribution to that combined operating profit or loss. The combined operating profit or loss must be derived from the most narrowly identifiable business activity of the controlled taxpayers for which data is available that includes the controlled transactions (relevant business activity) ... Read more

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Olympus Medical Systems India is a subsidiary of Olympus Corp and engaged in the import, sale and maintenance of medical equipment in India. For FY 2012 and 2013 the company reported losses. An transfer pricing audit was initiated by the tax authorities and later an assessment was issued. Since Olympus India had failed to provide audited financials of its associated enterprises to determine the overall profits of the group, it adopted the Resale Price Method using the Bright Line Test approach. An appeal was then filed by Olympus with the Tax Appellate Tribunal. Olympus India argued that the tax authorities was erroneous in adopting the Residual Profit Split Method in determining the arm’s length price of the AMP expenses and furthermore that the tax authorities could not make an adjustment without having information on the total profits of the group. Judgement of the Tax Appellate Tribunal The tribunal held that Olympus India should not benefit for non-cooperation in providing audited ... Read more

85. Company A, Company B and Company C, members of the same MNE group, jointly agree to share the “greenfield” development of a new product. In this regard, none of the entities brings existing contributions of value such as pre-existing intangibles to the project. Each associated enterprise will be responsible for developing and manufacturing one of the three key components of the product. 86. In this case, assume that the transactional profit split is found to be the most appropriate method for determining the profits of the three companies from the sale of the new product. The functional analysis concludes that the relative contributions of the parties may be measured by reference to the relative expenses incurred by each company in the development of the components as there is a direct correlation between these relative expenses and the relative value contributed by each company. Accordingly, the relevant profits (losses) in relation to the sales of the new product can be ... Read more

80. Company A, resident in Country A, and Company B, resident in Country B, are members of an MNE group. Both companies undertake the design and manufacturing of products and their activities in this regard are highly integrated. Additionally, Company A and Company B are responsible for the marketing and distribution of the products to unrelated customers in Country A and in Country B, respectively. 81. Company A and Company B enter into an agreement to buy and sell pieces, moulds and different components to manufacture various different models of products. These transactions may also relate to semi-finished products to effectively meet customers’ demands in a timely fashion. As a result of their broad experience in the sector, Company A and Company B have each developed unique and valuable know-how and other intangibles in their respective design and manufacturing processes. 82. The functional analysis shows the economically significant risks are the strategic and operational risks in relation to the design ... Read more

74. Below are some illustrations of the effect of choosing a measure of profits to determine the relevant profits to be split when applying a transactional profit split Scenario 1 74. Assume A and B are two associated enterprises situated in two different tax jurisdictions. Both manufacture the same widgets and incur expenditure that results in the creation of a unique and valuable intangible which they can mutually use. For the purpose of this example, it is assumed that the nature of this particular unique and valuable intangible is such that the value of A and B’s respective unique and valuable contributions in the year in question is proportional to A and B’s relative expenditure on the intangible in that year. (It should be noted that this assumption will not always be true in ) Assume A and B exclusively sell products to third parties. Assume that it is determined that the most appropriate method to be used is a ... Read more

65. Company A, resident in Country A, is the parent company of Retail Group, an MNE group engaged in the retail fashion industry. Over the years, Company A has developed know-how and has enhanced the value of the trademark and associated goodwill of its business through intensive marketing activities. In this case, the intangibles developed and owned by Company A do not qualify as hard-to-value intangibles. 66. To expand the business into the Country B market, Company A enters into an agreement with Company B, a member of Retail Group resident in Country B. Under this agreement, Company A grants to Company B the rights to utilise the know-how and to use the trademarks for the purpose of fashion retailing in Country B. Company B has extensive experience in retail fashion distribution and has a strong track record in building brand recognition and loyalty in Country B through its in-house team which develops and implements innovative marketing strategies and activities ... Read more

59. Company A, resident in Country A, Company B, resident in Country B, and Company C, resident in Country C, are members of an MNE group. Companies A and B undertake the design and manufacturing of products and their activities in this regard are highly integrated. Additionally, Company A and Company B are responsible for the marketing and distribution of the products to unrelated customers in Country A and in Country B, respectively. Company C is responsible for the benchmarkable marketing and distribution of products purchased from Company A and Company B to unrelated customers in Country C. 60. Company A and Company B enter into an agreement to buy and sell pieces, moulds and components to manufacture the different models of the products. These transactions may also relate to semi-finished products to effectively meet customers’ demands in a timely fashion. As a result of their broad experience in the sector, Company A and Company B have each developed unique ... Read more

51.  The success of an electronics product is linked to the innovative technological design both of its electronic processes and of its major component. That component is designed and manufactured by associated company A; is transferred to associated company B which designs and manufactures the rest of the product; and is distributed by associated company C. Information exists to verify by means of a resale price method that the distribution functions, assets and risks of Company C are being appropriately rewarded by the transfer price of the finished product sold from B to C. 52.  The most appropriate method to price the component transferred from A to B may be a CUP, if a sufficiently similar comparable could be found. See paragraph 2.15 of the Guidelines. However, since the component transferred from A to B reflects the innovative technological advance enjoyed by company A in this market, which is found to be a unique and valuable contribution by company A, in this ... Read more

46. Company A designs, develops and produces a line of high technology industrial products. A new generation of the product line incorporates a key component developed and created by Company B, an associated enterprise of Company A. This key component is highly innovative, incorporating unique and valuable intangibles. This innovation represents the key point of difference in the new generation of products. The success of the new generation of products is heavily dependent upon the performance of the key component made by Company B. The key component is specifically tailored for the new generation of products and cannot be used in any other products. 47. The key component was developed entirely by Company B. The accurate delineation of the transaction determines that Company B performs all the control functions and assumed all the risks in relation to the development of the component, with no involvement by Company A. 48. The accurate delineation of the transaction also finds that Company A ... Read more

42. ACo, resident in Country A, and BCo, resident in Country B, are members of AB Inc, an MNE Group. ACo owns worldwide patents on Compound A and BCo owns worldwide patents on Enzyme B. Compound A and Enzyme B are both unique. ACo and BCo have each developed their respective compound or enzyme by their own efforts, for different purposes, but each found that they were not able to be used as they had originally intended. As a result, neither Compound A nor Enzyme B has significant value at this time. 43. However, engineers from ACo and BCo working together subsequently determine that the combination of Compound A and Enzyme B creates a unique and valuable drug which is very effective in treating a specific disease and is likely to be highly valuable. 44. ACo and BCo enter into a contract according to which ACo grants BCo the right to use Compound A. BCo will combine both components to ... Read more

38. Company A is the parent company of M Group, an MNE group engaged in the manufacturing and distribution of electronic devices. Company A has the exclusive right to sell the devices in all territories. 39. Company A decides to subcontract the manufacturing of the electronic devices to Company B, another member of M Group. Under the terms of the contract, Company B will follow the directions of Company A to produce the devices. Company B will source and supply the materials necessary to produce the different parts of the final products. A key component in the manufacturing process is sourced from Company A. Company B sells the finished goods to Company A, which in turn will market and distribute the product to unrelated customers. 40. To perform the manufacturing activities, Company B has invested in machinery and tooling that is specifically adapted to the production of the electronic devices sold by M Group. Company B has no other customer ... Read more

34. Company L, a resident of Country L, and Company M, a resident of Country M, are part of an MNE group, LM Corporation. Companies L and M offer international trade facilitation, freight forwarding and customs broking services to unrelated customers. Together, Companies L and M, provide customers with services including receipt of goods in the exporting country, customs clearance in the exporting country, containerisation, organising shipment of the container, delivery of containers to and from the ship, de-containerisation, customs clearance in the importing country, and delivering the goods to their destination. Customers may be importers or exporters and Companies L and M facilitate imports and exports from both countries. Customers typically pay for these services based on a combination of the volume and weight of the goods. 35. The accurate delineation of the transaction determines that Companies L and M perform the same trade facilitation, freight forwarding and customs broking services jointly in a highly integrated manner. Companies L ... Read more

26. ASSET Co is the parent company of an MNE group that provides asset management services to unrelated parties. It has two subsidiaries, Company A in Country A and Company B, in Country B. 27. FUND Co is an independent asset management company that offers collective investment vehicles to retail investors in Country A and Country B. The investment vehicles commercialised by FUND Co are mirror funds that contain equity holdings from both Country A and Country B. 28. FUND Co hires ASSET Co to provide portfolio management services for the funds. FUND Co pays ASSET Co a fee based on the combined assets under management of the funds sold to retail investors in Country A and Country B. 29. ASSET Co enters into a contract with Company A and Company B such that both companies will provide the portfolio management services. Company A employs portfolio managers who specialise in Country A equity and Company B employs portfolio managers who ... Read more

20. WebCo is a member of an MNE group that develops IT solutions for business customers. Recently, WebCo designed the architecture of a web crawler to collect pricing data from internet sites. WebCo has written the code of the program so it is able to systematically scan web pages in a more efficient and faster way than any other similar search engines available in the market. 21. At this stage, WebCo licenses the program to ScaleCo, a company in the same MNE group. ScaleCo is responsible for scaling-up the web crawler and for deciding the crawling strategy. ScaleCo is a specialist in designing add-ons for the web crawler and in customising the product to address gaps in the market. Without these contributions, the system would not be able to meet potential customers’ needs. 22. Under the terms of the licence, WebCo will continue developing the underlying base technology and ScaleCo will use these developments to scale up the web crawler ... Read more

16. The facts in this example are the same as in Example 3, except that the marketing activities performed by Company B are more limited and do not significantly enhance the goodwill or reputation associated with the trademark. Company B has a mechanism whereby customer feedback on the products it sells is relayed to Company A, but this is a relatively simple process, and does not constitute a unique and valuable contribution. In sum, its distribution activities are not a particular source of competitive advantage in its industry. In particular, the potential success of the new line of products is largely dependent on its technical specifications, its design, and the price at which the products are sold to final customers. 17. The functional analysis concludes that Company A assumes the risks associated with the design, development and manufacturing of the product and Company B assumes the risks relating to marketing and distribution. 18. Marketing and distribution risks assumed by Company ... Read more

10. Company A and Company B are members of an MNE group that sells electronic appliances. For the launch of a new line of products, Company A will be responsible for its design, development and manufacturing whereas Company B will undertake the marketing functions and the global distribution of the goods. 11. In particular, Company A performs the research and development functions and decides on the lines of research and the timelines. For the manufacturing of the new line of products, Company A decides on the levels of production and performs the quality controls. In doing so, Company A uses its valuable know-how and expertise regarding the manufacturing of electronic appliances. 12. Once the products are manufactured, they are sold to Company B, which develops and executes cutting-edge global marketing activities relating to the new line of products. In particular, Company B is responsible for designing the marketing strategy, deciding on the level of marketing expenditure in each country where ... Read more

5. A Co, a member of T Group, is a company incorporated in Country A whose principal activity is the growing and processing of tea. A Co identifies, acquires and cultivates land with extremely good soil for growing tea. A Co has developed extensive know- how in respect of tea-growing, including maximising the desirable qualities of the tea it grows through its cultivation methods. The properties of the soil together with the cultivation methods give A Co’s tea a highly sought after flavour. 6. A Co processes tea by undertaking the following activities: sorting leaf, grading, full or partial fermenting, and blending and packaging for export as per customer order specifications. Blending entails using extensive proprietary know-how to mix the various teas in order to get blends with the unique tastes appreciated by customers of T Group. Tea produced by A Co has won international acclaim for its unique taste and aroma. 7. A Co sells its tea to B ... Read more

1. Company A is the parent company of an MNE group in the pharmaceutical sector. Company A owns a patent for a new pharmaceutical formulation. Company A designed the clinical trials and performed the research and development functions during the early stages of the development of the product, leading to the granting of the patent. 2. Company A enters into a contract with Company S, a subsidiary of Company A, according to which Company A licenses the patent rights relating to the potential pharmaceutical product to Company S. In accordance with the contract, Company S conducts the subsequent development of the product and performs important enhancement functions. Company S obtains the authorisation from the relevant regulatory body. The development of the product is successful and it is sold in various markets around the world. 3. The accurate delineation of the transaction indicates that the contributions made by both Company A and Company S are unique and valuable to the development ... Read more