In January, the IRS issued a generic legal advice memo on periodic adjustments and the arm’s length standard. Although the “GLAM” states that it merely “clarifies” and “updates” a prior memo, it contains insights into the IRS’s aggressive thinking on this topic. And the very fact that the IRS issued the memo now suggests that disputes over periodic adjustments are heating up in audits and litigation.

Background. The new memo “addresses the relationship” between “the general arm’s length standard” and “the specific periodic adjustments rules” in the section 482 regulations. Since 1986, the second sentence of section 482 has required the income from the transfer of intangible property to “be commensurate with the income attributable to the intangible.” The agency takes the position that this statutory language authorizes the IRS (and only the IRS) to adjust the income of a transferor of IP based on the actual income earned by the transferee. The agency views these “periodic adjustments” as a necessary palliative when considering IP with a high—but uncertain—profit potential.Continue Reading A “Capacious” Arm’s Length Standard?

Multinational groups constantly evolve, grow, and consolidate, and operational facts and circumstances always change. Say a growing company decides to expand internationally. It may choose to incorporate new foreign subsidiaries that will operate a manufacturing facility in one country and a limited-risk distributor in another.

The tax department will probably pay a lot of attention to the proper transfer pricing for transactions between these related parties of the growing multinational group. When it does so, it should ensure that the intercompany transactions, including the arm’s-length pricing, are memorialized in written intercompany agreements. We’ll address the most common questions you might have about these agreements.Continue Reading How Intercompany Agreements Can Mitigate Transfer Pricing Risk

In most transfer pricing disputes, the taxpayer squares off with the IRS or some other taxing authority, and the issue is the amount of tax due. But, in some cases, a company’s transfer pricing policies can lead to disputes between private parties. It is important for tax-department personnel to be aware of the risks from these private disputes so that they can take them into account when setting up intercompany documentation and transfer pricing policies. Examples include:Continue Reading Private Transfer Pricing Disputes

“Implicit support” comes charging out of the gates as an early candidate for Word or Phrase of the Year for 2024. 

Before year’s end, the IRS Office of Chief Counsel dropped a new generic legal advice memorandum (“GLAM”), AM 2023-008, titled “Effect of Group Membership on Financial Transactions under Section 482 and Treas. Reg. § 1.482-2(a).” The GLAM visits some familiar territory, including the “realistic alternatives” principle, this time in the intracompany lending context.  Continue Reading Happy New Year.  Here’s a GLAM on Implicit Support.

In a recent case, Villa-Arce v. Commissioner,[1] a whistleblower sent information to the IRS that he believed showed that the company was using improper transfer pricing practices and taking unjustified deductions. The IRS opened an examination that resulted in other adjustments, but none based on the information from the whistleblower. For that key reason, the D.C. Circuit affirmed the Tax Court decision that the whistleblower was not entitled to an award for the collection of proceeds from the unrelated adjustments. Yet while the whistleblower walked away empty-handed, the case illustrates a unique type of transfer pricing and audit risk that comes from whistleblowers that companies should recognize. And given the indefinite nature of transfer pricing and the potential amount of dollars at stake, we will likely see more whistleblower actions involving transfer pricing.Continue Reading Blowing the Whistle on Transfer Pricing

In November, the IRS Office of Chief Counsel issued a generic legal advice memorandum (“GLAM”) AM-2022-006, titled “Realistic Alternatives and Tax Considerations in the Application of Sections 482 and 367(d).” As the title suggests, the GLAM analyzes the realistic alternatives principle, which was codified in section 482 by the Tax Cuts and Jobs Act (Pub. L. No. 115-97).

The realistic alternatives principle, of course, is not new and has been part of the section 482 regulations since 1993. See Treas. Reg. § 1.482-1(d)(3)(iv); 58 Fed. Reg. 5253, 5266, 5275 (Jan. 21, 1993). But the realistic alternatives regulatory provisions were short on practical substantive guidance. Thus, the GLAM provides new insight into how the IRS currently thinks the realistic alternatives principle ought to be applied. In sum, the GLAM applies concepts from the corporate finance discounted cash flow (“DCF”) valuation method to make its realistic alternative comparisons.Continue Reading GLAM’s Realistic Alternatives Analysis Adopts Corporate Valuation DCF Concepts

Amount B aims to standardize the remuneration of related party distributors that perform baseline marketing and distribution activities in a manner that is aligned with the arm’s length principle. Its purpose is two-fold: First, Amount B is intended to simplify the administration of transfer pricing rules for tax administrations and reduce compliance costs for taxpayers. Second, Amount B is intended to enhance tax certainty and reduce controversy between tax administrations and taxpayers.

Pillar One assumes that distribution and marketing activities would be identified as in-scope based on a narrow scope of activities, set by reference to a defined “positive list” and “negative list” of activities that should and should not be performed to be considered in scope. Quantitative indicators would then be applied to further support and validate the identification of in-scope distributors. It is anticipated that amount B could be based on return on sales, with potentially differentiated fixed returns to account for the different geographic locations and/or industries of the in-scope distributors. Given the narrow scope of Amount B, there is currently no provision for Amount B to increase with the functional intensity of the activities of in-scope distributors. Amount B would not supersede advance pricing agreements or mutual agreement proceeding settlements agreed before the implementation of Amount B.

Under one proposal, the implementation of Amount B would operate under a rebuttable presumption, namely, that an entity that acts as a buy/sell distributor and performs the defined baseline marketing and distribution activities qualifying for the Amount B return would render it in scope, but that it will be possible to rebut the application of Amount B by providing evidence that another transfer pricing method would be the most appropriate to use under the arm’s length principle. While one group of OECD members prefers a narrow approach, another group prefers a broader approach that would also provide standardized remuneration for commissionaires or sales agents, or for distribution entities whose profile differs from the baseline marketing and distribution activities discussed below.Continue Reading OECD’s Pillar One Blueprint: Amount B

Overview.  As discussed in prior blog posts, Amount A is a proposed new taxing right over a share of residual profit of MNE groups that fall within its defined scope.  The calculation and allocation of Amount A will be determined through a formula that is not based on the Arm’s Length Principle (ALP).  The formula will apply to the tax base of a group (or segment where relevant) and will involve three components:  Step 1:  a profitability threshold to isolate the residual profit potentially subject to reallocation;  Step 2: a reallocation percentage to identify an appropriate share of residual profit that can be allocated to market jurisdictions under Amount A (the “allocable tax base”); and Step 3: an allocation key to distribute the allocable tax base amongst the eligible market jurisdictions (i.e. where nexus is established for Amount A).  This three-step formula to determining the Amount A quantum could be delivered through two approaches:  a profit-based approach or a profit margin-based approach.  A profit-based approach would start the calculation with the Amount A tax base determined as a profit amount (e.g. an absolute profit of EUR 10 million) whereas a profit-margin approach would start the calculation with the Amount A tax base determined as a profit margin (e.g. a PBT to revenue of 15%).  Both approaches would apply the three steps of the allocation formula similarly, and hence would deliver the same quantum of Amount A taxable in each market jurisdiction.
Continue Reading OECD’s Pillar One Blueprint: Profit Allocation

In transfer pricing analysis, the determination of the entity or entities within a multinational enterprise that are entitled to share in the returns derived by the group from exploiting intangibles is crucial. A related issue is which entity or entities within the group should bear the costs, investments and other burdens associated with the development, enhancement, maintenance, protection and exploitation of intangibles. The Organization for Economic Cooperation and Development has addressed this topic as part of its 2017 Transfer Pricing Guidelines, and that guidance is the subject of this post. Although the legal owner of an intangible may initially receive the proceeds from exploitation of the intangible, other members of the legal owner’s group may have performed functions, used assets, or assumed risks that are expected to contribute to the value of the intangible. Members of the group performing such functions, using such assets and assuming such risks must be compensated for their contributions under the arm’s length principle.

Legal rights and contractual arrangements form the starting point for any transfer pricing analysis of transactions involving intangibles. The terms of a transaction may be found in written contracts, public records such as patent or trademark registrations, or in other communications between the parties. In identifying the legal owner of intangibles, an intangible and any license relating to that intangible are considered to be different intangibles for transfer pricing purposes, each having a different owner. While determining legal ownership and contractual arrangements is an important first step in the analysis, these determinations are separate from the question of remuneration under the arm’s length principle. For transfer pricing purposes, legal ownership of intangibles, by itself, does not necessarily confer any right ultimately to retain returns derived by the group from exploiting the intangible. Identification of legal ownership, combined with the identification and compensation of relevant functions performed, assets used, and risks assumed by all contributing members, provides the analytical framework for identifying arm’s length prices and other conditions for transactions involving intangibles.

The arm’s length principle requires that all members of the group receive appropriate compensation for any functions they perform, assets they use, and risks they assume in connection with the development, enhancement, maintenance, protection and exploitation of intangibles. An important question is how to determine the appropriate arm’s length remuneration to members of a group for their functions, assets and risks within the framework established by the taxpayer’s contractual arrangements, the legal ownership of intangibles, and the conduct of the parties. The determination of arm’s length compensation for functional contributions should consider the availability of comparable uncontrolled transactions, the importance of the functions performed to the creation of the intangible value, and the realistically available options of the parties. In assessing whether the compensation provided in the controlled transaction is consistent with the arm’s length principle, reference should be made to the level and nature of activity of comparable uncontrolled entities performing similar functions, the compensation received by comparable uncontrolled entities and the anticipated creation of intangible value by comparable uncontrolled entities.Continue Reading DEMPE Functions

On September 1, 2020, the IRS issued final regulations regarding the base erosion and anti-abuse tax (“BEAT”) codified in IRC §59A. These regulations finalize the proposed BEAT regulations published on December 6, 2019 with certain refinements. Among other guidance, the final BEAT regulations provide detailed rules that allow corporate taxpayers to waive deductions for purposes of BEAT. Although waiving deductions will likely result in additional tax costs, the waiver election may be an easier and less costly solution than the alternative of making substantive business model or supply chain changes to mitigate BEAT.
Continue Reading Waiving BEAT Deductions – The Smart Election for Multinational Taxpayers?