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GT Alert

Transfer Pricing Update: Issues in 2006

January 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.

Cost Sharing

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 more.

APA Program

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.
  • Increased fees:

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.

Intercompany Services

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 or your Greenberg Traurig liaison with any questions regarding the subject matter of this Alert.

© 2006 Greenberg Traurig

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This GT ALERT is issued for informational purposes only and is not intended to be construed or used as general legal advice. Greenberg Traurig attorneys provide practical, result-oriented strategies and solutions tailored to meet our clients’ individual legal needs.