Contents - AL-Tax

4.3 Required Return on Debt and Equity Capital 61 Determining the yield to maturity on this sample of issues, given the prevailingmarket price and maturity date of each issue.Alternatively, taxing authorities might agree to utilize a safe harbor range of interestrates, such as the U.S. Applicable Federal Rates (AFRs), published monthly. 12This alternative would significantly reduce compliance costs.4.3.3 Non-Cash Charges and InvestmentDepreciation, amortization and investment by individual group members are directlyreflected on, or easily derived from, consolidating or member-specific financialstatements.4.3.4 Data RequirementsAs indicated above, in applying the required return methodology to determine thetax liability of an individual member of a controlled group, and absent any agreementamong taxing authorities to simplify and standardize the analytical steps, onewould need the following data:1. The affiliated company’s estimated beta, along with the risk-free rate and theestimated price of risk;2. The estimated fair market value of the affiliated company’s equity capital;3. The affiliated company’s debt outstanding and borrowing terms, its arm’s lengthcost of debt and its non-cash charges and investment in tangible property, workingcapital and intangible property; and,4. The affiliated company’s tax credits, deductions, loss carryforwards, etc.4.3.5 SummaryIn summary, a required return transfer pricing methodology has the virtue ofbuilding on well-established and widely accepted financial principles. However,estimating a subsidiary’s cost of debt and equity, and quantifying the fair marketvalue of its equity capital, are neither easy nor uncontroversial tasks. It also necessitatesa degree of subjective judgement. For these reasons, numerical norms havea very important role to play here as well. That is, tax authorities could stipulateto, and publish on a monthly basis, industry-specific betas, as well as risk-free ratesof return, the market risk premium and safe harbor loan rates. 13 With regard to thevaluation of equity capital, the most labor-intensive and subjective analytical step,12 See Treas. Reg. Section 1.482-2(a)(2)(iii).13 This approach is analogous to the safe harbor contained in the current U.S. transfer pricingregulations, pertaining to the cost of debt on intercompany loans.