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12 3 Overview and Critique of Existing Transfer Pricing Methodsrisk and execute transactions on behalf of customers. 1 The proposed global dealingregulations do not formally encompass the global trading of physical commodities(as distinct from financial products), although “the IRS solicit[ed] comments onwhether these regulations should be extended to cover dealers in commodities ...” 2In this section, we consider the merits and shortcomings of the CPM, frequentlythe IRS’ and U.S. practitioners’ method of choice. For those readers who are notfamiliar with the U.S. and OECD transfer pricing regulations, certain key terms aredefined below: A “controlled group of companies” is a multinational firm. A “tested party” is an individual member of a controlled group that one selects tobe the subject of analysis under certain transfer pricing methods. It is generallythe entity that owns little or no intangible assets and performs comparativelysimple functions. A “profit level indicator” refers to one of several financial ratios that constituteaccounting measures of operating results. The “arm’s length standard” is the guiding principle underlying all transfer pricingmethods. It requires individual members of a controlled group of companiesengaging in intra-group transactions to charge the same prices, fees, androyalty or loan rates in such transactions that they would charge unafffiliatedcompanies.3.1.1 Description of CPM and TNMMThe CPM is used to establish arm’s length prices or royalty rates for (a) tangibleproperty sold to, (b) intangible property licensed or otherwise transferred to, or(c) services performed on behalf of, affiliated companies. Application of the CPMentails assembling a sample of standalone companies that are similar to the testedparty principally in terms of resources employed and risks assumed. Functional andproduct comparability between the tested party and the unaffiliated companies withwhich it is compared is considered significantly less important under the CPM thanunder other transfer pricing methods. 3 Unaffiliated firms need only perform broadlysimilar functions and operate in broadly similar product markets as the tested party.1 More specifically, as defined in the relevant proposed regulations, a global dealing operation“consists of the execution of customer transactions, including marketing, sales, pricing and riskmanagement activities, in a particular financial product or line of financial products, in multipletax jurisdictions and/or through multiple participants ...The taking of proprietary positions is notincluded within the definition of a global dealing operation unless the proprietary positions areentered into by a regular dealer in securities in its capacity as such a dealer ...”. See Prop. Treas.Reg. 1.482-8(a)(2).2 Ibid.3 See Treas. Reg. Section 1.482-5(c)(2)(ii) and (iii).
3.1 Comparable Profits Method and TNMM 13In a second series of steps, one (a) computes accounting rates of return (or oneof several other profit level indicators) for each sample company 4 ; (b) applies theresulting arm’s length profit level indicators to the tested party’s correspondingdenominator (operating assets, sales, total cost, etc.); (c) establishes a range of thetested party’s potential arm’s length results thereby (the “arm’s length range”); (d)determines the interquartile range of such results; and (e) generally selects a profitlevel contained in the interquartile range. This level of profitability directly determinesthe tested party’s tax liability; its affiliated counterparty’s operating incomeand tax liability are determined as a residual. 5Application of the CPM to establish arm’s length services fees entails essentiallythe same steps, except that the sample selection criteria (or “comparability requirements”)differ, and the U.S. Temporary Regulations favor a different profit levelindicator. The Temporary Regulations emphasize accounting consistency for sampleselection purposes under the CPM as applied to services, rather than resourcesemployed and risks assumed. 6 The use of similar intangible assets in performingthe subject services, if any, is also an important sample selection criterion. Whereasan accounting rate of return is the profit level indicator of choice under the CPMvis-a-vis intra-group tangible or intangible property transfers, operating profits overtotal cost is the preferred profit level indicator vis-a-vis services. This preferencepresumably reflects the fact that services providers often employ limited assets, anddo not consistently report cost of services separately from total cost.The OECD Guidelines’ TNMM closely resembles the CPM, although the Guidelinesdo not favor the use of statistical tools, such as the interquartile range, to selecta particular value within the arm’s length range. Rather, the Guidelines focus oncomprehensive comparability analyses (a point forcefully reiterated in the seriesof Draft Issue Notes released by the OECD’s Center for <strong>Tax</strong> Policy and Administrationon May 10, 2006). 7 More generally, the OECD Guidelines take a lessformulaic approach to comparability standards and differentiate between methodsin establishing comparability criteria to a lesser extent. In all cases, the character ofthe property or service, the functions performed by the parties, contractual terms,4 Under the U.S. regulations, an accounting rate of return is the preferred profit level indicator forpurposes of applying the CPM to transfers of tangible or intangible property. Other profit levelindicators include operating profits to sales or total cost, gross profits to operating expenses, etc.5 Application of the CPM to establish arm’s length royalty rates reflects the proposition, incorporatedinto the U.S. transfer pricing regulations, that an unaffiliated licensee would not retain anyincome attributable to the licensed intangible asset. Rather, all such income would be transferredto the licensor by means of royalty payments. See Treas. Reg. Section 1.482-(4)(f)(2).6 However, the examples given in Treas. Reg. Section 1.482-9T(f)(3) to illustrate how the comparabilityrequirements should be applied indicate that the CPM is the preferred method when onecannot ascertain whether unaffiliated companies follow the same accounting conventions as thetested party.7 See Comparability: Public Invitation to Comment on a Series of Draft Issue Notes, Centerfor<strong>Tax</strong> Policy and Administration, Organization for Economic Cooperation and Development, May10, 2006.
Page 2 and 3: Transfer Pricing and Corporate Taxa
Page 4 and 5: Elizabeth KingBeecher Consulting, L
Page 6 and 7: AcknowledgementsI have worked with
Page 8 and 9: xContents3.5.3 SummaryandPracticalI
Page 10 and 11: xiiContents8.3 Analysis Under Exist
Page 12 and 13: Part IEconomic and Accounting Rates
Page 14 and 15: 8 2 Economic vs. Accounting Profit
Page 16 and 17: 10 2 Economic vs. Accounting Profit
Page 20 and 21: 14 3 Overview and Critique of Exist
Page 56 and 57: Chapter 4Some Alternative Approache
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Page 60 and 61: 4.3 Required Return on Debt and Equ
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4.6 Franchise Model 63relationship
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Part IIICase Studies
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68 5 Intercompany Sale of Diamonds5
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70 5 Intercompany Sale of Diamonds
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72 5 Intercompany Sale of Diamondsa
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76 5 Intercompany Sale of Diamondsw
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78 5 Intercompany Sale of DiamondsI
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84 5 Intercompany Sale of DiamondsF
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86 5 Intercompany Sale of DiamondsT
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90 6 Intercompany Sale of Medical D
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Chapter 7Performance of Intercompan
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7.1 Summary of Key Facts 103orders,
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7.3 Value of Customer Relationships
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7.4 Analysis Under Existing Regime
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7.5 Analysis Under Alternative Regi
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Chapter 8Replication of Internet-Ba
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8.1 Summary of Key Facts 117in a se
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8.3 Analysis Under Existing Regime
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8.4 Analysis Under Alternative Regi
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8.5 Conclusions 123USP should also
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126 9 Sale of Assets with Embedded
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138 10 Provision of CDN Services to
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146 11 Global Trading of Commoditie
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162 12 Decentralized Ownership of I
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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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