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Baker & McKenzie Transfer Pricing Annual Update
Source: WG&L Journal of International Taxation
WG&L Journals Journal of International Taxation (WG&L) Journal of International Taxation 2008 Volume 19, Number 06, June 2008
Baker & McKenzie's Transfer Pricing Annual Update, generally covering summer 2006 through March 2008, summarizes major transfer pricing related developments in the United States, Canada, and Mexico.1 This Update first covers recent significant U.S. transfer pricing developments, including cost sharing and buy-in related matters, the advance pricing agreement (APA) annual report and guidance, and U.S. state and local tax developments. After the U.S. discussion are OECD, Canadian, and Mexican transfer pricing developments.
CIP on Cost-Sharing Buy-In Adjustments
The main U.S. transfer pricing developments during 2006-2007 relate to intangible property and, in particular, cost sharing matters. On September 27, 2007, the IRS issued a coordinated issue paper (CIP) on cost sharing buy-in adjustments (LMSB-04-0907-62). The CIP followed several developments regarding the cost sharing Regulations including two Industry Directives. 2 The CIP provides guidance to IRS personnel regarding methods to use to determine arm's-length consideration for the transfer of pre-existing intangible property rights to a cost sharing arrangement (CSA). The CIP concludes that the income or forgone profits method generally is the most reliable method of measuring arm's-length consideration for the transfer of pre-existing intangible property on the formation of the CSA, and that the acquisition price method generally is the best method of measuring the arm's-length consideration for making the pre-existing intangible property acquired in an acquisition available to a CSA. The CIP further states that the comparable uncontrolled transaction and residual profit split methods generally do not provide a reliable measure of an arm's-length buy-in payment. The CIP also addresses the scope of intangible property rights subject to a buy-in payment and certain other issues.
The CIP focuses on a presumed “typical” fact pattern involving a CSA between a U.S. parent corporation (U.S.P) and a related controlled foreign corporation (CFC). The CIP assumes that the U.S.P has significant self-developed intangibles and a research and development (R&D) capability consisting of fixed assets, an experienced workforce, and a record of successfully developing products or technologies; and that the CFC performs limited functions, has limited capabilities, owns no intangible property, performs no R&D, and merely provides cash to partially fund the R&D performed by the U.S.P. The CIP makes other factual assumptions, including that the CFC does not bear significant development risk, that a particular “platform intangible” exists that controls essentially all value arising out of future R&D activity, that this control over the value of future R&D activity lasts essentially forever, and that the prior history of a particular R&D team is the principal determinant of future success.
The CIP concludes that certain methods are the best methods for determining buy-in payments based only on certain assumed hypothetical facts. 3 The proper application of the best method rule, however, requires a thorough analysis of all of the facts and circumstances of each case and the reliability of the various pricing methods in the context of those facts and circumstances (Reg. 1.482-1(c)). A thorough analysis of the facts is also required by the arm's-length standard of Section 482, to which CSAs are subject. 4 Moreover, in deciding Section 482 cases, the courts prefer to rely on evidence of actual transactions between unrelated parties rather than generic economic theories based on hypothetical facts. 5
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