Contents - AL-Tax

3.2 Resale Price and Cost Plus Methods 17Clearly, differences in accounting rates of return across firms could not beascribed solely to transfer pricing, even if such comparisons were otherwisemeaningful.3.1.5 Summary and Practical ImplicationsIn short, the imputation of accounting rates of return, operating markups or operatingmargins derived from unaffiliated companies to individual members of controlledgroups, to determine the latter firms’ tax liabilities, cannot be justified byeconomic principles. Moreover, the implicit assumption that such financial ratioswill be equalized across small samples of firms on a year-by-year basis is indefensibleon empirical grounds alone, in view of the wide range of results reportedby sample companies in most instances. Consequently, a tested party’s tax liabilityunder the CPM/TNMM is entirely dependent on the particular profit level indicatorchosen and the specific unaffiliated companies included in one’s firm sample. Differentprofit level indicators and/or different sample companies can produce markedlydifferent allocations of income across countries. Moreover, because the comparabilitycriteria applied under the CPM and TNMM are not restrictive, the universe ofpotential sample companies is quite large.Therefore, even if companies correctly anticipate that the IRS will utilize theCPM in assessing their tax liability after the fact, they will not be able to determinewith a reasonable degree of certainty, before the fact, how much taxable income theyshould report in the United States. As previously noted, this state of affairs imposesboth explicit and opportunity costs, the former in the form of professional and legalfees (and, potentially, double taxation and penalties), and the latter resulting frommonies held in reserve, in conformity with the FASB’s standards of practice visa-visuncertain tax liabilities. Moreover, if firms maximize their after-tax free cashflows, and gauge their country-specific tax liabilities incorrectly, this will result in asub-optimal allocation of resources.3.2 Resale Price and Cost Plus MethodsConsider next the resale price and cost plus methods. Both are transactions-basedmethods that the OECD favors over the CPM/TNMM.accounting rates of return in most cases involving manufacturing firms. Because distributors’assets are composed principally of inventories and accounts receivables, for which book valueapproximates market value, the potential for distortion is not as problematic, except as regardsintercompany pricing.