Contents - AL-Tax

52 4 Some Alternative Approaches to Transfer Pricingdistribution activities and its assumption of related inventory and other risks,absent exceptional circumstances. “First tier” trademarks owned by a distributor(i.e., marks that are household names) might, for example, entitle it to an additional8% of net sales, second tier marks, 5%, and third tier marks, 2%. Theseincremental revenues would be offset by the associated intangibles developmentexpenses borne by the distributor.The safe harbor services provisions in the U.S. Temporary Regulations couldbe expanded along the same lines. For example, services requiring relativelyunskilled labor and limited tangible assets that cannot be analyzed under the servicescost method could be charged out at a standardized cost plus 5%, servicesrequiring higher-level skills, 10%, and services requiring very specialized skills(e.g., those requiring a Ph.D. or a particular talent to perform), 15%. (This proposedsafe habor provision should not apply where the services at issue can onlybe rendered in conjunction with intangible property. In this case, the providershould be compensated for both the services it renders and its contribution ofintellectual property.)The numerical standards approach has the obvious virtue of greatly reducingcompliance, audit and dispute resolution costs and the likelihood of doubletaxation.It is also equitable. (The second and third case studies, in Chapters 6 and7, respectively, illustrate the numerical standards approach, as well as the resaleprice, comparable uncontrolled price, comparable uncontrolled transaction andcomparable profits methods.) Required Return Method. For more complex cases, including those involvinggenuinely unique intangible property, one can, in principle, determine individualgroup members’ tax liabilities by assuming that they will earn their estimatedrequired return on debt and equity capital per annum. A required return analysisnecessitates that one quantify (a) the fair market value of individual group members’equity capital, (b) their required return thereon, and (c) their arm’s lengthcost of debt. As such, this methodology would be extremely laborious unlesstaxing authorities agree on certain valuation conventions. The required returnmethodology may also produce a fairly wide range of results, and the scope forsuch variability in results should be bounded by agreed-on conventions as well.Lastly, certain standard valuation methodologies, such as the discounted cashflow method, cannot be used to determine the fair market value of individualgroup members’ assets (and, thereby, their equity capital), because such cashflows incorporate potentially non-arm’s length transfer pricing.However, in circumstances where a group member has a reliable measureof its fair market value and cost of capital, or if taxing authorities can agree on(a) the use of valuation methods that do not reflect transfer pricing, and (b) certainconventions that reduce the scope for subjective judgement, the required returnmethod may be a viable approach. Moreover, a required return analysis has a farmore solid theoretical foundation than the current transfer pricing methodologies.Finally, as noted, the required return methodology can be used in situationswhere one or both parties utilize unique or highly valuable intangible assets,inasmuch as the value of these assets will be reflected in the value of the group