Contents - AL-Tax

42 3 Overview and Critique of Existing Transfer Pricing Methodsa broad geographic reach, the nexus between geographic location and particularprofit-generating activities is, in the view of many practitioners, not clearly drawn,and standalone firms operating in a single geographic market are not comparableessentially by definition. This perceived lack of fixed correspondence between contributionand location, and the dearth of genuinely comparable standalone firms,effectively precludes other traditional transfer pricing methods as well. In lieu ofthe “separate entity” approach that underlies all the conventional U.S. and OECDtransfer pricing methods, 40 the IRS has more or less endorsed a formulary apportionmentmethodology for certain types of global trading firms. 41In Notice 94–40, issued in 1994, the IRS described certain key characteristicsof Advance Pricing Agreements (APAs) that it has negotiated with taxpayersengaged in the global trading of derivative financial instruments or commoditieson a “functionally fully integrated” basis. According to the Notice, fullyintegrated trading operations manage their business “as one global position forpurposes of risk management rather than several discrete businesses.” The tradingbook is not independently maintained for each trading location, but instead,one book (the “global book”) is passed from one trading location to anotherin the adjacent time zone at the close of each trading day. To facilitate theeffective management of risk, a central credit department monitors the group’scredit-related exposure and establishes credit guidelines and customer creditlimits to be applied by traders in all locations. In addition, in a functionallyfully integrated global trading operation, the book for each product (or groupof products) typically has one head trader who allocates trading limits for eachtrading location and determines guidelines for the book. The head trader is alsoresponsible for the economic performance of that book, and, as such, he or sheis in frequent communication with, and oversees, other traders employed by thecompany.Notice 94–40 is “not intended to prescribe a method or factors that will necessarilyapply in all APAs with functionally fully integrated global trading operations,limit the use of other methods or factors” 42 or be used to allocate the trading profitsof firms that are not functionally fully integrated.The U.S. Treasury Department issued proposed transfer pricing regulationsaddressing transactions among participants in a global dealing operation in 1998. 43For purposes of these proposed regulations, a global dealing operation “consists ofthe execution of customer transactions, including marketing, sales, pricing and risk40 The “separate entity” approach is part and parcel of the arm’s length standard, in that the objectiveis to determine the amount of taxable income that each member of a controlled group wouldearn on a separate, standalone basis.41 See Notice 94–40, Global Trading Advance Pricing Agreements, 1994-1 C.B. 351; 1994 IRBLEXIS 213; 1994-17 I.R.B. 22, April 25, 2004.42 Ibid.43 IRS Proposed Rules on Allocation and Sourcing of Income and Deductions Among TaxpayersEngaged in Global Dealing Operations, REG-208299-90, 63 Fed. Reg. 11177, 3/6/98.