Contents - AL-Tax

132 9 Sale of Assets with Embedded Intellectual Propertyused in enforcement, surveillance and security applications. Under the terms of itsdistribution agreement, Image Sensing Systems, Inc. is granted exclusive rights todistribute Wireless Technologies’ products in the transportation, retail and bankingmarkets, and non-exclusive rights in the security, military and law enforcementmarkets. Image Sensing Systems, Inc. agrees to (a) use its best efforts to promote,market and distribute Wireless Technologies’ products, (b) commit the financial,intellectual and human resources necessary to grow the market for these products,(c) provide appropriate training to its salesforce, and (d) provide Wireless Technologieswith a detailed business plan, inclusive of marketing and strategic plans. Withregard to pricing, “[t]he parties agree that the prices to Image Sensing Systemsfor Wireless Technologies’ products shall be 50% of Wireless Technologies’list price ....” 3Inasmuch as Image Sensing Systems, Inc. likely offers discounts from list priceto its customers, and presumably incurs certain above-the-line costs other than thepurchase price of product, its gross margins on the resale of Wireless Technologies’products are likely within the range of our sample companies’ results, as summarizedabove.As noted, we determine USS’ arm’s length gross profits on its equipment sales byapplying the median resale margin reported by our sample companies to the adjustedselling price of FP’s equipment to U.S. end-users. USS’ cost of goods sold (per unit)is therefore readily quantifiable. The purchase price of product constitutes 85% ofUSS’ cost of goods on equipment. Therefore, FS’ arm’s length price on sales ofequipment to USS is also readily quantifiable. As previously noted, USS should paythe same transfer price for all ETC systems sourced from FP, regardless of whetherUSS resells the equipment or retains ownership thereof, because FP’s contributionsare the same in both cases.9.4 Analysis Under Alternative RegimeWe utilize the “required return” method to analyze this case under the proposedalternative transfer pricing regime. As discussed in Chapter 4, to apply the requiredreturn methodology, we require the following data:1. USS’ estimated beta, along with the risk-free rate and the estimated price of risk;2. The estimated fair market value of USS’ equity capital;3. USS’ arm’s length interest costs, outstanding debt, principal repayments, noncashcharges and investment in tangible property, working capital and intangibleproperty; and4. USS’ tax credits, deductions, loss carryforwards, etc.For purposes of our analysis, we assume that taxing authorities have agreed to,and publish, industry-specific betas, the risk-free rate, the market risk premium and3 See Image Sensing Systems, Inc.’s Form 10QSB, filed with the Securities and Exchange Commissionon August 13, 2001. We do not include Image Sensing Systems, Inc. in our sample ofcomparable wholesale distributors because it does not function purely as a distributor.