Contents - AL-Tax

5.3 Analysis Under Existing Regime 81price is reportedly approximately 10.0% above its buying price. 26 Inasmuch asthe DTC’s sales of rough to sightholders are considered primary market transactions,the primary/secondary market spread is presumably somewhat higherthan 10.0%. It was also reported, circa mid-2005, that “[c]urrent premiums [are]15% on DTC-sourced boxes in the secondary market ...Many sightholders ...are not cutting their rough at this point in time, but re-selling their boxes withimmediate profit.” 27The above information is indicative of the gross margin that FP should earn (and,therefore, the selling price it should charge) on its resale of rough diamonds toIS. Because secondary market prices for rough diamonds are not published, moreprecise estimates of the primary/secondary market price differential are difficult tocome by. However, the Group is able to assess this differential with a high degreeof accuracy, given its substantial and continuous presence in the primary and secondarymarkets. Hence, FP’s gross margin on sales of rough to IS in a given periodshould be equated to the prevailing primary/secondary market price differential forDTC boxes in that period. It is also important that FP maintain documentation thatsubstantiates the magnitude of the price differential in each period, for purposes ofsupporting its transfer prices to the satisfaction of the relevant taxing authorities.5.3.2 IS’ Sales of Generic Polished Stones to USSAs previously noted, we utilize the comparable profits method to establish IS’ pricingon sales of generic polished stones to USS (with USS serving as the tested party).As is often the case, the rub lies in identifying quasi-comparable companies. Mostfirms operating as wholesale distributors of diamonds are privately held. LazareKaplan, the one publicly held U.S. firm that performs functions similar to thoseof USS, is also a sightholder (as is FP) and manufactures polished diamonds (asdoes IS); as such, Lazare Kaplan’s results of operations do not provide any basis fordetermining the arm’s length division of income among FP, IS and USS. 28Moreover, the unique structure of the diamond industry, the fact that participantsare overwhelmingly family-owned businesses where personal relationshipsare centrally important, and the practices of providing product to retailers on memoand offering very extended payment terms distinguish diamond wholesalers frommany other wholesalers of luxury goods. Furthermore, even if such distinctions26 Unofficially, the DTC’s gross margin on stones procured from other producers might be somewhathigher than 10.0%.27 Slegers, Paul, “The Diamond Industry in 2005 – Halfway Review,” Pricescope Diamond Journal,July 29, 2005.28 While we identified two arm’s length distribution agreements, between Stuller Settings andCharles & Colvard, Ltd., and Rio Grande and Charles & Colvard, Ltd., respectively, all pertinentpricing information was redacted from these documents. Stuller Settings and Rio Grande are twoof the largest wholesale distributors of loose stones and finished jewelry in the United States; bothare privately held.