Contents - AL-Tax
Contents - AL-Tax Contents - AL-Tax
22 3 Overview and Critique of Existing Transfer Pricing Methodstransactions that the IRS analyzes under the CPM, the two (or more) tax authoritiesare likely to arrive at different conclusions regarding the arm’s length allocationof income thereon, even if the sample companies are identical. This preference fordifferent methods defeats one of the key purposes of the existing transfer pricingregime: To minimize the incidence of double-taxation.3.3 Comparable Uncontrolled Price MethodIn this segment, we review the comparable uncontrolled price method.3.3.1 Description of Comparable Uncontrolled Price MethodThe CUP method (aka the “comparable uncontrolled transactions method” asapplied to intangible property and the “comparable uncontrolled services pricemethod” as applied to services) entails comparing the prices, royalty rates orservices fees that one member of a controlled group charges other members andunaffiliated companies, respectively. As with the resale price and cost plus methods,one can also apply the CUP method when two companies, one of which is a memberof a controlled group and one of which is a standalone entity, sell virtually identicalproducts, license the same intangible assets or perform the same services, in theformer instance to (or for) affiliated buyers, and in the latter instance, to (or for)independent companies.The standard of comparability applied under the CUP method is very high. Underthe U.S. regulations, and in relation to tangible property, the transactions must beclosely similar in terms of product type, functionality and quality, contractual terms,level of market, geographic market, timing, associated intangible property, foreigncurrency risks, and alternatives realistically available to buyers and sellers. If theproducts or transactions are dissimilar along any of these dimensions (that is, ifthe CUPs are “inexact”), price comparisons are valid only insofar as one can makereliable adjustments to the arm’s length price to reflect such differences. The OECDGuidelines, similarly, emphasize product comparability, coupled with adjustmentsfor differences. However, they also note that “[t]he difficulties that arise in attemptingto make reasonably accurate adjustments should not routinely preclude the possibleapplication of the CUP method. Practical considerations dictate a more flexibleapproach to enable the CUP method to be used ...” 12In relation to intangible property, the assets licensed to affiliated and unrelatedcompanies, respectively, must either be identical or “comparable” under the U.S.regulations. One intangible asset will be considered comparable to another only12 See para. 2.9, Chapter II, Transfer Pricing Guidelines for Multinational Enterprises and TaxAdministrations, Organization for Economic Cooperation and Development, July 1995.
3.3 Comparable Uncontrolled Price Method 23if they are used in connection with similar products or processes within the samegeneral industry or market and have similar profit potential. In comparing controlledand arm’s length transfers of intangible assets, one should also consider the termsand circumstances of the transfers, the assets’ respective stages of development, thelicensees’ rights to receive updates, the duration of the license, liability risks andcollateral transactions. As applied to services transactions, one should consider thesimilarity of services, the intangible assets used in providing them (if any), contractualterms, and the economic conditions in which the transactions take place. 133.3.2 Underlying Economic RationaleWith regard to tangible property and services, the (exact) CUP method presupposesthat competitive pressures will cause prices and services fees to be equalized. Withregard to intangible property, the comparable uncontrolled transactions method presupposesthat an individual licensor will generally charge independent licensees thesame royalty rate for the same rights to identical property, as will two licensorsof comparable intangible property. This reasoning, in turn, implies one of severaleconomic backdrops:1. Different licensees value the intellectual property available from a single licensorequally, and have similar bargaining power in relation to the licensor (that is, theyhave similar alternatives available to them);2. An individual licensor cannot effectively price discriminate in establishing itslicense terms and royalty fees, whether due to the costs of ascertaining the valueof the intellectual property to different prospective licensees or because it is precludedfrom price discriminating as a practical or legal matter; or,3. Two unaffiliated licensors of comparable intellectual property, dealing with separatelicensees, will either independently negotiate precisely the same contractualterms and royalty rates or be forced to charge a uniform royalty rate and offerstandardized terms by some unarticulated competitive dynamic.3.3.3 Critique of Economic ReasoningWith regard to tangible property and services, prices and fees may or may not beequalized, depending on the degree to which the market at issue is competitive. Inthis context, the OECD Guidelines’ and Draft Issue Notes’ emphasis on comparabilityanalyses, beginning with a broad-based analysis encompassing the industry,value-drivers, the nature of competition, and economic and regulatory factors, iswell placed.13 See Treas. Reg. Section 1.482-9T(c)(2).
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22 3 Overview and Critique of Existing Transfer Pricing Methodstransactions that the IRS analyzes under the CPM, the two (or more) tax authoritiesare likely to arrive at different conclusions regarding the arm’s length allocationof income thereon, even if the sample companies are identical. This preference fordifferent methods defeats one of the key purposes of the existing transfer pricingregime: To minimize the incidence of double-taxation.3.3 Comparable Uncontrolled Price MethodIn this segment, we review the comparable uncontrolled price method.3.3.1 Description of Comparable Uncontrolled Price MethodThe CUP method (aka the “comparable uncontrolled transactions method” asapplied to intangible property and the “comparable uncontrolled services pricemethod” as applied to services) entails comparing the prices, royalty rates orservices fees that one member of a controlled group charges other members andunaffiliated companies, respectively. As with the resale price and cost plus methods,one can also apply the CUP method when two companies, one of which is a memberof a controlled group and one of which is a standalone entity, sell virtually identicalproducts, license the same intangible assets or perform the same services, in theformer instance to (or for) affiliated buyers, and in the latter instance, to (or for)independent companies.The standard of comparability applied under the CUP method is very high. Underthe U.S. regulations, and in relation to tangible property, the transactions must beclosely similar in terms of product type, functionality and quality, contractual terms,level of market, geographic market, timing, associated intangible property, foreigncurrency risks, and alternatives realistically available to buyers and sellers. If theproducts or transactions are dissimilar along any of these dimensions (that is, ifthe CUPs are “inexact”), price comparisons are valid only insofar as one can makereliable adjustments to the arm’s length price to reflect such differences. The OECDGuidelines, similarly, emphasize product comparability, coupled with adjustmentsfor differences. However, they also note that “[t]he difficulties that arise in attemptingto make reasonably accurate adjustments should not routinely preclude the possibleapplication of the CUP method. Practical considerations dictate a more flexibleapproach to enable the CUP method to be used ...” 12In relation to intangible property, the assets licensed to affiliated and unrelatedcompanies, respectively, must either be identical or “comparable” under the U.S.regulations. One intangible asset will be considered comparable to another only12 See para. 2.9, Chapter II, Transfer Pricing Guidelines for Multinational Enterprises and <strong>Tax</strong>Administrations, Organization for Economic Cooperation and Development, July 1995.
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