Transfer Pricing Update: Issues in 2006
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Getting It Right in the US in 2006
Recently proposed cost sharing rules and changes to the rules governing
Advance Pricing Agreements (APA) will impact multinational companies with
intercompany transactions (a U.S. parent with foreign subsidiaries or a
foreign parent with U.S. subsidiaries.)
|"Recently proposed cost sharing
rules and changes to the rules governing Advance Pricing Agreements
will impact multinational companies with intercompany transactions…"
A global issue, transfer pricing compliance should address the concerns
of all the jurisdictions where a multinational does business.
Of interest to multinationals with valuable intangible assets, proposed
regulations on cost sharing arrangements (CSAs) were recently issued by
the Internal Revenue Service (IRS). Substantially changing the existing
regime to an “investor” model, the new rules have generated criticism and
comments from the business community. Under a CSA, related parties agree
to share the costs and risks of intangible development in proportion to
their share of reasonably anticipated benefits from exploiting the intangibles.
Under the new rules CSA participants make an investment to earn a return
appropriate for the risks of the CSA. In most CSAs, the U.S. party makes
an earlier and greater investment.
In the IRS’s view the current rules undervalue this investment when it
is contributed to a CSA as a buy-in. As a result, the new rules re-characterize
the buy-in as a “Preliminary or Contemporaneous Transaction” (PCT) and bring
it front and center as an integral part of the CSA. The PCT must be analyzed
ex ante – at the time it is entered into. The preamble to the new rules
calls an ex ante analysis “fundamental to achieving arm’s length results.”
To further ensure adequate compensation for a PCT, companies must compare
their transaction to a hypothetical “reference transaction” that reflects
exclusive and perpetual rights in the relevant resources or capabilities.
Also, investors in a CSA must anticipate a return at least equal to an alternative
investment “realistically available” to it.
Among other important changes, the rules clarify that only the IRS can
make periodic adjustments when intangibles generate results differing significantly
from ex ante projections. Note that the current regulations remain in force
until the Service finalizes the proposed rules, which may take a year or
The IRS recently released a new version of the rules governing the Advance
Pricing Agreement Program (Revenue Procedure 2006-9).
User Fees. The new rules both simplify and raise the user fees.
- No separate requests. Taxpayers requesting an APA on more than one
line of business no longer need to determine when the filing constitutes
a separate request requiring an additional fee. Rather, all filings by
one taxpayer within a 60-day period count as one request.
Standard APA Request
$50,000 (previously $15,000-25,000)
Small Business/Small Transactions
$22,500 (previously $5,000)
Renewals $35,000 (previously $7,500)
Amendments $10,000 (previously 0)
Taxpayers’ responsibilities. The rules emphasize the importance
of a complete submittal. Taxpayers must update their own information and
their economic analysis throughout the APA process.
Case Plans. APA management will address severe deviations from
the case plan by either side (in the hope of keeping cases moving forward.)
Expedited renewals. The IRS will make its best effort to advise
taxpayers during a prefiling conference whether or not they will be able
to take advantage of the expedited renewal process.
IRS officials recently stated that the proposed regulations on intercompany
services may become final this year. The most controversial provision would
replace the current cost safe harbor with a new “simplified cost-based method”
that adds considerable complexity to the analysis of non-integral services.
Getting It Right Abroad in 2006
Transfer pricing enforcement continues as a top agenda item for the taxing
authorities of our most important trading partners.
Taking a “conservative” tax position in the U.S. may reflect prudent
tax planning here, but could raise audit questions abroad. Foreign-initiated
adjustments--cases in which a foreign government (rather than the IRS) makes
a tax adjustment that results in double taxation--account for two-thirds
of the IRS inventory of double-tax cases. An IRS official recently called
this a trend that he expects to continue. The U.S. provided complete relief
from double tax in 88 percent of its cases this year. Foreign governments
actively audit transfer pricing, but also work cooperatively with the Internal
Revenue Service through tax treaties to avoid double taxation.
|"Transfer pricing enforcement
continues as a top agenda item for the taxing authorities of our
most important trading partners."
Canada. Canada and the United States recently took unprecedented
steps to better eliminate double taxation. Turning around years of lethargic
case processing and a growing backlog, three Memoranda of Understanding
(MOU) signed this year detail the governments’ plan.
The countries committed to providing relief for double taxation in all
cases (Canada provided complete relief in only 80% of its cases this year),
moving the backlog of existing unresolved cases and quickly reaching agreement
on the facts of a case. The two countries have struggled over factual disputes,
often at the heart of transfer pricing cases, such as whether a manufacturer
takes the risks of a full-fledged or a contract manufacturer. Failure to
agree to the facts quickly will send a case to the recently created administrative
entity, the Appeals Review Panel (ARP), consisting of Appeals personnel
from Canada and the U.S. Both governments hope that the threat of the ARP
will encourage agreements.
Japan. Japan believes strongly in the Advance Pricing Agreement
(APA) process: APAs make up the majority of its double-tax case inventory.
Reflecting years of practical experience negotiating transfer pricing cases,
Japan has added two methods to its list of three acceptable methods for
resolving transfer pricing disputes. They are the Transaction Net Margin
Method (a close parallel to the profit-based comparable profits method widely
used in the U.S.) and the Profit Split Method. These methods open up new
options for resolving transfer pricing disputes with Japan.
China. China’s State Administration of Taxation (SAT) aggressively
audits transfer pricing issues. It opened 193 audits in 2005, and entered
into 178 advance pricing agreements in 2004. According to government officials,
starting in 2008, the SAT plans to add transfer pricing penalties and to
charge interest on adjustments. Other than its first bilateral case with
Japan, all of China’s APAs are unilateral, covering companies with affiliates
in the Far East.
Mexico. If approved, reforms circulating in Mexico’s Congress
will impact companies doing business in Mexico. Mexico’s proposed legislation
implements a new hierarchy of transfer pricing methods and commits its tax
authority to more transfer pricing audits. The reforms respond to a peer
review by the Organization for Economic Cooperation and Development which
generally praised Mexico’s transfer pricing enforcement, but pointed out
deficiencies in the areas slated for reform.
The proposed legislation also imposes strict independence requirements
for CPAs. Mexican companies, public or not, reaching a stated threshold
must have a CPA file a tax report with their audited financial statements.
Also, auditors will no longer be able to provide tax advice to tax compliance
clients. We will update the progress of the legislation as it becomes available.
India. Meeting on a regular (though infrequent) basis since 1999,
India and the U.S. regularly settle double tax cases including transfer
pricing matters. Indian officials said they recently had their most productive
meeting yet with the U.S., settling seven cases, 50 percent of their total
inventory. The governments discuss transfer pricing cases, but India has
not yet established an APA Program.
Greenberg Traurig offers comprehensive transfer pricing services including
planning, documentation, audit support and APA representation.
This Alert was written by
Carolyn Fanaroff in the
Washington, D.C. offices. Please contact Ms. Fanaroff at 202-331-3119 or
firstname.lastname@example.org or your Greenberg
Traurig liaison with any questions regarding the subject matter of this
© 2006 Greenberg Traurig
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