International tax, transfer pricing, FBAR
The IRS dedicates enormous resources toward dealing with taxpayers who are involved with any form of transfer pricing. The transfer pricing provisions of IRC 482 address four general types of transactions between commonly owned or controlled parties.
1- Use or transfer of tangible property
4- Use or transfer of intangible property (especially cost sharing arrangements)
Use of tangible property: When one member of a controlled group rents or leases property to another member of the group, the price paid for use of such property must be appropriate for an arm’s length amount. Per Treas. Reg. 1.482-2(c)(2)(i), the arm’s length amount is determined by reference to the amount that would have been charged between independent parties for use of the same or similar property under similar circumstances.
Determination of what is arm’s length for fair rental value transactions:
a) Period of use
b) Location of use
c) Owner’s investment in property or rent paid
d) Expenses of maintaining the property
e) Type of property
f) Condition of property
Transfer of tangible property: When sales or transfers of tangible property are made between related parties (sales of goods), the arm’s length price generally is the price that an unrelated party would pay for similar property under similar circumstances.
Determination of what is arm’s length for inter-company sales: The regulations specify six methods used to determine whether an arm’s length amount has been charged between members of a controlled group. Treas. Reg.1.482-3(a), states that the “best method” should be used to determine arm’s length price. The IRS views the “best method” as the method that produces the most reliable results based on facts and circumstances. The IRS is well aware of the fact that many transfer-pricing studies are prepared with the intention to validate year-end inter-company cost of sales regardless of whether they are arm’s length just to avoid the IRC 6662 penalties taxpayers would be best served if transfer-pricing studies were prepared by knowledgeable experts in the field.
Inter-company Services: When one member performs services for another member of a controlled group, an arm’s length price is necessary. This includes services such as marketing, management, technical services, or any other type of service. Such services can be provided by one party for the joint benefit of all members, or can be provided between two members of the controlled group.
Determination of what is arm’s length for inter-company services: The arm’s length standard for services between related parties is found in Treas. Reg. 1.482-2(b)(3) which states, “ an arm’s length charge for services rendered shall be the amount which was charged or would have been charged for the same or similar services in independent transactions with or between unrelated parties under similar circumstances considering all relevant facts.” The arm’s length charge for services between related parties will depend upon the facts related to the services provided. The pricing rules fall within three categories:
1) An arm’s length charge will be based on the amount that would have been charged by an unrelated party. This generally means that the price should be based on reimbursement of cost, plus a mark-up for profit.
2) An arm’s length charge may be based on only the costs incurred, provided that certain criteria are met.
3) No charge is necessary, if certain criteria are met.
The area that concerns the IRS most with these types of transactions is technical services with regard provided by larger U.S corporations to their foreign CPC’s, which are not charged for these services. In regards to smaller cases, the IRS typically examines management fees in detail to ensure they are arm’s length.
Inter-company Loans: In the context of IRC 482, most of the areas of conflict in this area revolve around interest. When loans are made between members of a controlled group, interest rates charged do not always meet the required arm’s length standard.
Determination of what is arm’s length for inter-company loans: The arm’s length standard for loans between related parties is found in Treas. Reg. 1.482-2(a)(2) which states that “ an arm’s length rate of interest shall be a rate of interest which was charged, or would have been charged, at the time the indebtedness arose, in independent transactions with or between unrelated parties under similar circumstances.”
Factors that are listed in Treas. Reg. 1.482-2(a)(2) that should be considered in determining arm’s length interest are:
a) The principle amount and duration of the loan.
b) The security involved
c) The credit standing of the borrower
d) The prevailing interest rate where the loan was made
The regulations provide further guidance in the following areas:
a) Safe harbor rules
b) Ordering rules
c) Determination of bona fide indebtedness
d) Period for which interest is charged
Transfers of intangible properties: When transfers of intangible property are made between controlled parties, the arm’s length price is often difficult to determine, in part because the property’s value derives from intellectual capital such as ideas, the outcome of research and development or creation of software.
Determination of what is arm’s length for transfer of intangible property: The regulations specify four methods to determine whether an arm’s length amount has been charged between the members of a controlled group with respect to the transfer or use of intangible property. Treas.Reg.1.482-4 (a) states that the “best method” should be used to determine the arm’s length price between related parties. Controlled parties may enter into a qualified cost sharing arrangements to share costs related to developing intangibles. They may also contribute existing intangibles for use in further development or for use in developing new and distinct intangibles.
The following general rules of Treas.Reg.1.482-7 (a) and (b) apply to qualified cost sharing arrangements:
a) Two or more controlled participants agree to share the costs of developing intangibles.
b) Costs are shared based on each participant’s share of reasonably anticipated benefits from the intangibles to be developed.
c) A “buy-in” must be paid to the participant that contributes pre-existing intangible property to the qualified cost sharing arrangement.
As with transfer pricing reports, cost-sharing agreements should be prepared by qualified experts who are knowledgeable in this area. The ideal candidate would probably be someone with decades of experience preferably with the IRS in the international taxation area. Said ideal candidate should also of course be a CPA. If examined by the IRS, the cost sharing agreement will be reviewed in detail. For further guidance refer to the Coordinated Issue Paper utilized as a guideline for the IRS personnel dated June 5th 2009.