Contents - AL-Tax

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Chapter 7Performance of Intercompany ServicesOur third case study involves a multinational group consisting of two legal entitiesin different taxing jurisdictions (the United States and Indonesia). Collectively, theforeign parent (FP) and its U.S. subsidiary (USS) develop, manufacture and marketthin-film disks (thin film magnetic media on rigid disk platters) for incorporationinto disk drives. FP performs engineering and manufacturing functions, is thecontract party on all transactions with third parties, and owns all of the Group’stechnology and other manufacturing-related intellectual property. USS performsR&D/engineering and customer relationship management functions.Disk drives are composed of magnetic media, a spindle assembly powered by aspindle motor, read/write heads mounted onto an arm assembly and a base casing.Magnetic disks and heads are the most technologically demanding of these componentsand perform the core functions of digital storage (in the case of disks) and therecording and retrieval of data (in the case of heads). Disk suppliers sell their outputon an OEM basis to disk drive manufacturers. The latter, in turn, sell primarily onan OEM basis to computer manufacturers. While both disk and disk drive supplierswere once plentiful, both demand and supply sides of the market for thin filmdisks have consolidated dramatically over the past decade, despite rapidly increasingdemand for digital storage. The need for extremely rapid technical improvements,the high cost of R&D programs and exceedingly high fixed manufacturing costshave been the impetus behind such consolidation.As one often observes in industries with a small number of incumbent suppliersand customers, high fixed manufacturing costs and high switching costs,individual magnetic disk producers have long since paired up with individual magneticdisk customers. This feature, in addition to high fixed costs per se, makesentry virtually impossible. Because established customer relationships are a verysignificant, if not insurmountable, barrier to entry, a fairly extensive analysis ofmarket structure is necessary in this case to determine whether USS should earnabove-normal returns, given its key role in establishing and maintaining customerrelationships.We analyze the intercompany transactions between USS and FP under both thecomparable profits method and our alternative numerical standards approach.E. King, Transfer Pricing and Corporate <strong>Tax</strong>ation,DOI 10.1007/978-0-387-78183-9 7, C○ Springer Science+Business Media, LLC 2009101
102 7 Performance of Intercompany Services7.1 Summary of Key FactsUSS engages in the following principal activities: Product and process developmentservices, product prototyping services and customer relationship management services.USS’ research facilities are located in close proximity to its customers’ designcenters. Broadly stated, the objective of the Group’s research is to increase areal (orstorage) density. Over the past two decades, storage density has increased at a rateof approximately 40% per annum. Storage density is determined jointly by:1. Flying height (the minimum distance at which read/write heads can reliably passover the surface of a disk to detect a change in magnetic polarity when readingfrom the disk);2. Signal-to-noise ratio (the ability of the head to discriminate a signal from backgroundmedia noise); and,3. Coercivity (the strength of the magnetic field required to change the polarity ofa bit of data on the magnetic layer of a disk when writing).USS’ research team of approximately 300 individuals works on projects in eachof these areas. As the above determinants indicate, increases in storage density areaccomplished through technological improvements in both disks and heads, and thetwo components must remain “in sync.” As such, one-sided improvements in heads(or disks) generally have to be accompanied by corresponding changes in disks(or heads). Additionally, independent suppliers’ disks must work in conjunctionwith the relatively wide range of heads used by their customers. For these reasons,research activities are highly collaborative, involving thin film disk suppliers, headsuppliers and disk drive suppliers.Given the structure of the market for magnetic disks (described below), andthe fact that FP supplies disks to only three principal customers, there is a limitedrole for sales and marketing in the traditional sense. Instead, USS is engaged predominantlyin maintaining already-established customer relationships. Its accountmanagers and customer service specialists collectively deal with order placement,delivery scheduling and addressing customers’ day-to-day concerns. They are alsoresponsible for sales forecasting on a Group-wide basis. Individual staff membersare dedicated to individual customers.FP has volume purchase agreements in place with all three of its customers,although the latter do not make binding commitments through these vehicles. Twoof these customers have internal disk manufacturing capacity, and look to the Groupas a secondary supplier. Therefore, these suppliers’ volume “commitments” to FPare honored only insofar as their own disk manufacturing capacity falls short of theirrequirements by the full amount of such commitments. Customers are not penalizedfor the cancellation of orders, and only individual purchase orders are regarded asfirm for production planning purposes.FP owns all of the Group’s manufacturing facilities and intangible assets,performs all manufacturing functions, acts as the principal in transactions withcustomers, bears all associated risks and engages in extensive process andequipment development and testing. More concretely, FP enters and processes
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Transfer Pricing and Corporate Taxa
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Elizabeth KingBeecher Consulting, L
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AcknowledgementsI have worked with
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xContents3.5.3 SummaryandPracticalI
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xiiContents8.3 Analysis Under Exist
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Part IEconomic and Accounting Rates
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8 2 Economic vs. Accounting Profit
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10 2 Economic vs. Accounting Profit
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Chapter 13Concluding ObservationsTh
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13 Concluding Observations 185The r
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Chapter 1IntroductionNational tax a
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2 1 Introductionof specific transfe
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4 1 Introductionvenues. The propose
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188 IndexBusiness Judgment Rule, 28
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190 IndexFamily-owned, 81FASB, see
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192 IndexNumerical standards, 51-52
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194 IndexSwing lines, 149, 154, 158
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