Contents - AL-Tax

13 Concluding Observations 185The required return methodology is an improvement over existing transfer pricingmethods in a theoretical sense, but its applicability is somewhat limited from apractical standpoint. More particularly, the required return method should be appliedonly under one of the following circumstances:Scenario A The tested party has recently been valued in the normal course of business fornon-tax purposes, and the valuation is not potentially distorted by intercompanypricing; and, Tax authorities agree on the use of specific industry betas, interest rates oncorporate debt of various kinds (or their safe harbor equivalents), risk-freerates and the market price of risk, and publish all such betas and rates on amonthly basis.Scenario B Taxing authorities accept a baseline valuation done at multi-year intervals(e.g., every 3 years) absent significant changes in the business, with informedestimates of percentage increases or decreases in value in the interim; and Tax authorities agree on the use of, and publish, industry betas, interest rateson corporate debt, risk-free rates, and the market price of risk.Scenario C A sufficient number of comparable companies can regularly be found to calculatevaluation multiples (for which the denominator is independent of transferprices), and these multiples fall within a reasonably narrow range; and, Tax authorities agree on both (a) industry-specific valuation multiples, and (b)the use of published industry betas, interest rates on corporate debt, risk-freerates, and the market price of risk.The formulary apportionment method, as described in Notice 94–40 (publishedin 1994) and the proposed global dealing regulations (published in 1998), incorrectlymeasures the pool of allocable income, and allocates such income on anarbitrary basis. One can significantly improve on the IRS’ formulary apportionmentmethodology by substituting assets for “factors”, fair market values for weights,and after-tax free cash flows for the accounting-based measure of profits put forth inNotice 94–40. With these modifications, which the proposed simplified profit splitmethod incorporates, the approach has a far more solid economic footing.Lastly, the 2005 proposed U.S. cost-sharing regulations, and the companionCoordinated Issue Paper on cost-sharing issued in 2007, are fundamentally flawed.The income method is strongly advocated in the latter document, although it is justone of a number of valuation methodologies put forth in the proposed cost-sharingregulations. The income method, as interpreted in the Coordinated Issue Paper, cannotbe consistent with the arm’s length standard, for the simple reason that participants(other than those making external contributions) would have no incentive to