Contents - AL-Tax

5.3 Analysis Under Existing Regime 79USS is in the business of purchasing polished stones primarily from IS and secondarilyfrom third parties, for resale to U.S. retailers. (USS generally procures85%–95% of its polished stones from IS and the balance from third parties.) USShas royalty-free rights to use the trademarks owned by IS. The return to IS’ intangibleassets is reflected in the premium pricing of proprietary stones. Consistent withthe function of intellectual property in the diamond industry more generally, USShas built on IS’ trademarks and proprietary designs to secure exclusive marketingarrangements with certain key U.S. retailers. These arrangements benefit both ISand USS by ensuring a certain level of demand for polished stones.Broadly speaking, USS’ employees present inventory to customers on a regularbasis, ascertain the combination of stones (distinguished by color, quality and size)that customers want to take into their own inventory, negotiate which of these stoneswill be purchased outright and which will be provided on memo, and negotiate priceand terms on the former transactions. As with IS, USS sells a substantial percentageof polished stones on memo and offers its customers extended terms on outrightsales. Therefore, USS’ inventory-carrying costs are quite high relative to distributorsof other luxury goods, although its inventory risk is low. USS also employs gemologists,a shipping staff of 10 and a staff of 22 who collectively perform accountingHR, IT, marketing, memo reconciliation and office management functions.As with IS’ purchases of rough diamonds from FP, USS purchases generic polisheddiamonds from IS at a percentage discount from the published price lists containedin the Rapaport Diamond Report. The discounts from RAP on IS’ pricing toUSS are smaller (and the prices are therefore higher) than FP’s discounting on salesto IS. IS sells proprietary stones at a fixed price.5.2 Transfer Pricing IssuesThe fact pattern described above gives rise to several transfer pricing issues: FP’s pricing of rough diamonds on sales to IS; IS’ pricing of generic polished diamonds on sales to USS; and, IS’ pricing of proprietary polished stones to USS.5.3 Analysis Under Existing RegimeFor purposes of analyzing FP’s sales of rough stones to IS, and IS’ sales of genericpolished stones to USS, the CUP method is unlikely to be considered a viableapproach under the current transfer pricing regime. First, with regard to FP’s intercompanysales, there are obvious data limitations: FP does not sell rough stones tothird parties, and market prices for rough are not published. Moreover, as describedin detail above, no two rough or polished stones are identical, and adjustments for