Contents - AL-Tax

5.4 Analysis Under Alternative Regime 855.3.3 IS’ Pricing of Proprietary Polished Stones Sold to USSIt remains to determine the price premium that IS should charge USS on its salesof proprietary polished stones. This price premium should be established so as toensure that IS earns all income attributable to its designs, and a reasonable share ofincome attributable to its trademarks (reflective of its share of the associated developmentexpenditures). Because USS sells both generic and polished stones to thesame third parties on the same terms, the premium that is jointly attributable to IS’designs and trademarks at this market level can readily be calculated, in both dollarand percentage terms. The price premium per dollar of sales to retailers can alsoreadily be translated into a price premium per dollar of sales to USS by multiplyingthe former ratio by the ratio of retail to wholesale selling prices.As noted above, a portion of the total price premium represents a return to designsowned exclusively by IS, and should be allocated solely thereto. The balance of theprice premium should be divided between USS and IS based on their relative advertisingexpenditures in prior years. This allocation methodology requires estimatingthe relative values of designs and trademarks. However, this determination cannotbe made on a systematic basis, because only proprietary designs are sold underthe Group’s trademarks. (Stated differently, the intangible assets are only used incombination, as previously noted.) Absent a more systematic method, we make theadmittedly arbitrary assumption that 50% of the price premium represents a returnto designs, and 50% to trademarks.In sum, in computing IS’ prices on sales of proprietary polished stones to USS,its pricing of generic stones should be increased to reflect its share of intangibleincome, consisting of (a) 50% of the price premium, which we ascribe to the designsthat it owns, and (b) 65% of the remaining price premium (or 32.5% of the totalprice premium), which we ascribe to trademarks. The latter division reflects the factthat IS has historically borne approximately two-thirds of the combined advertisingexpenditures of IS and USS.5.4 Analysis Under Alternative RegimeUnder the proposed alternative transfer pricing regime, we utilize numerical standardsto establish FP’s arm’s length pricing of rough stones to IS, and the modifiedinexact CUP method to establish IS’ arm’s length prices on sales of generic polishedstones to USS. Our analysis of IS’ pricing of proprietary polished stones to USSunder the alternative regime is the same as our analysis under the current regime.5.4.1 FP’s Intercompany Sales of Rough Stones to ISFP has very limited below-the-line expenses (other than interest, a non-operatingexpense), and its resale and operating margins differ by a relatively small magnitude.