Contents - AL-Tax

62 4 Some Alternative Approaches to Transfer Pricingtax authorities could require benchmark valuations every 3–5 years absent significantchanges in individual group members’ business. Estimates of annual percentageincreases or decreases in value, based on observed changes in the value of publiclyheld firms operating in the same lines of business and adjusted further for firmspecificfactors, could be used to update the benchmark valuation in the interim.4.4 Joint Venture-Based Profit SplitAs discussed in Chapter 3, the residual profit split method described in the U.S.transfer pricing regulations incorrectly measures income attributable both to totalassets and to intangible assets. Moreover, U.S. practitioners typically value intangibleassets by application of mechanical accounting-based capitalization and amortizationrules; the results do not necessarily bear any relationship to the fair marketvalue of these assets. The comparable profit split method is squarely based onequally unfounded assumptions. By (a) substituting after-tax free cash flows forbefore-tax operating profits, and (b) using more accurate valuation methodologiesto establish the fair market value of tangible and intangible assets (where feasible),or, alternatively, by using arm’s length joint venture arrangements to developapproximations of relative asset values, one eliminates the need to:(1) Assume a predictable relationship between, or directly equate: The functions that independent companies and individual affiliated group membersperform and the accounting rates of return (or other profit level indicators)that they should realize; Affiliated group members’ historical R&D, advertising and other “intangiblescreating”expenditures and the current fair market value of their respective intellectualproperty; Before-tax operating profits and after-tax free cash flows; and, Accounting rates of return and economic rates of return.(2) Construct hypothetical multinational firms by analytically combining independentcompanies.Joint venture companies mimic a multinational firm structure in several analyticallyimportant respects, albeit with much more limited incentives to engage innon-arm’s length dealings. Joint venture partners contribute resources to a commonundertaking, make important operational and strategic decisions jointly, and act tomaximize the joint venture’s combined profits. At the same time, each joint venturepartner ultimately acts on behalf of its separate shareholders. In marked contrast,two independent companies that are combined analytically for purposes of applyingthe comparable profit split method do not act to maximize their joint profits andcannot realize the benefits of acting in concert. As such, joint venture partnershipsresemble a multinational group much more closely. Moreover, in any given year,the distribution of realized profits between two independent companies may bear no