International Tax

Transfer Pricing: Alternative Practical Strategies (Portfolio 890)

  • This Portfolio presents a case study in selecting a transfer pricing methodology and analyzes three alternative strategies: advance pricing agreements, cost sharing arrangements, and the use of joint ventures.


The Detailed Analysis consists of Chapters 7, 8, 9, and 10 of the Tax Management Transfer Pricing Portfolio Series.

Chapter 7, “Transfer Pricing — A Case Study (Methods and Documentation),” uses a case study involving a fictional company to provide a practical background on how to prepare a transfer pricing study to meet the regulatory and administrative documentation requirements in the United States and under the OECD Guidelines. The chapter uses this fictional example, explanatory text, numerous tables, and sample documents in the Worksheets to take the reader step-by-step through a transfer pricing study. Worksheets also provide an illustrative documentation report, prepared under §6662(e), regarding the intercompany transactions presented in the Case Study. Similar studies are used by taxpayers to ensure that their transfer prices with related entities will meet the requirements of taxing authorities and fiduciary standards.

Chapter 8, “Advance Pricing Agreements,” discusses the factors to consider in deciding whether to seek an APA, and details the considerations to take into account and the steps to take at each stage of the APA process, including the prefiling conference, submission of the APA application and supporting data, negotiating the APA, and administering the APA. The chapter also generally discusses foreign APA procedures.

Chapter 9, “Cost Sharing Arrangements,” describes the considerations in deciding whether affiliated parties that are developing intangible property should use a cost sharing arrangement to share the costs of development and allocate ownership of such property. The chapter describes the methods for developing and documenting a qualified cost sharing arrangement, including selecting an intangible development area, selecting participants, measuring the costs to be shared, selecting the method for sharing costs, and required tax filing and document maintenance. The chapter also discusses the tax treatment of cost sharing payments and arrangements, buy-in and buy-out payments, international acceptance of cost sharing arrangements, the IRS’s authority to reallocate cost sharing payments and to impose cost sharing, and the use of advance pricing agreements to obtain IRS approval of the terms of cost sharing agreements.

Chapter 10, “Transfer Pricing — International Joint Ventures,” analyzes how to establish the absence of common control under §482 and avoid hidden or “creeping” control in joint ventures. The chapter also discusses other tax planning issues in the joint venture context, such as tax cooperation agreements, choice of entity, sham treatment, taxation of formation transactions, taxation of operating income, repatriation of income and foreign tax credit planning, and the termination of a joint venture.

Table of Contents


7:I. Introduction

7:II. Documentation Rules

7:III. Use of Case Study Format

7:IV. Functional Analysis

Introductory Material

A. The Importance of the Functional Analysis

B. How to Develop a Functional Analysis

7:V. Application of Functional Analysis to CPC Organization

Introductory Material

A. Products

B. Market for Health and Beauty Products

C. Functions

D. Intercompany Transactions

E. Contractual Terms

F. Economic Conditions

G. Functions

1. Research and Development

2. Manufacturing

3. Brand Development

4. Marketing and Sales

H. Assets

I. Risks

7:VI. Financial Results

A. CPC-Canada

B. CPC-France


D. CPC-Ireland

7:VII. Transfer Pricing Methodology

A. U.S. Regulations

1. General Principles and History

2. Arm’s-Length Standard

3. Standards of Comparability

4. Best Method Rule

B. Transfer Pricing Methods for Transfers of Tangible Property

1. Comparable Uncontrolled Price (“CUP”) Method

2. Resale Price Method (RPM)

3. The Cost Plus Method (CPLM)

4. The Comparable Profits Method (CPM)

5. Profit Split Methods

a. Comparable Profit Split

b. Residual Profit Split

6. Other Methods

C. Application of the Comparable Profits Method

1. Identifying the Tested Party

2. Selection of Profit Level Indicator

D. Transfer Pricing Methods for Transfers of Intangible Property

E. Transfer Pricing Methods for Provision of Intercompany Services

1. Services Regulations

2. Selection of Method for Analyzing Service Transactions

F. OECD Guidelines

1. OECD Model Tax Convention and Guidelines

2. Reaffirmation of the Arm’s-Length Principle

a. Transaction-Based Pricing Methods

b. Profit-Based Methods

c. Aggregation of Transactions

3. Special Rules for Intangible Property Transactions

7:VIII. Comparables Analysis

A. Comparables Search Guidelines

B. The Search for Comparable Transactions

1. Internal and External Comparable Transactions

2. Potential Sources of Comparable Transaction Data

C. The Search for Comparable Companies

D. Comparability Adjustments

E. Identifying Potentially Comparable Companies

F. The Use of Databases in Comparable Company Searches

G. North American Distributors of Consumer Products

1. Unadjusted Results

2. Adjustments for Working Capital Differences

3. Adjusted Results

H. European Distributors of Consumer Products

1. Unadjusted Results

2. Adjusted Results – CPC-France

3. Adjusted Results – CPC-UK

I. Comparable License Agreements

J. Consumer Products Manufacturers

1. Unadjusted Results

2. Adjusted Results

K. Contract R& D Service Providers

1. Unadjusted Results

2. Adjusted Results

7:IX. Summary and Conclusions

7:X. Application of the Residual Profit Split Method

A. Comparables Analysis and Valuation of Wholesale Distribution Functions

1. Pricing Method

2. Identification and Selection of Comparables

3. Overview of Comparables

4. Application of CPM

5. Working Capital Adjustments

6. Determination of Arm’s-Length Range

B. Comparables Analysis and Valuation of Manufacturing Functions

1. Pricing Method

2. Identification and Selection of Comparables

3. Overview of Comparables

4. Application of CPM

5. Application of Additional Quantitative Adjustments

6. Determination of Arm’s-Length Range

C. Application of Pricing Methodology to the Allergy Segment

D. When the Tested Party Result Is Outside the Determined Range

E. Application of Pricing Methodology Beyond 2000

Chapter 8: ADVANCE PRICING AGREEMENTS by Michael F. Patton, Esq. Ernst & Young, LLP Los Angeles, California

8:I. Organization of this Chapter

8:II. The APA Process in General

8:III. Factors to Consider in Deciding Whether to Seek an APA

A. Certainty of Result

B. Disclosure Issues

C. Choosing a TPM

D. Cost of Seeking an APA

E. Other Factors to Consider

8:IV. APAs as an Alternative Dispute Resolution Mechanism

A. Rollbacks

B. Comparison to Other ADR Procedures

1. Accelerated Issue Resolution

2. Joint Appeals and Competent Authority (aka SAP – Simultaneous Appeals Procedure)

3. Arbitration

4. Delegation Order 236

5. Prefiling Agreement Procedure

8:V. IRS Guidance – The APA Process in Transition: From Rev. Proc. 91-22 to Rev. Proc. 2006-9, CCDM Directives Manual Provisions, and Beyond

A. Rev. Procs. 96-53, 2004-40 and 2006-9

1. General Policy and Principles of Rev. Proc. 2006-9

2. Rollbacks

3. Competent Authority Coordination

4. Case Management

5. Case Management: Document Preparation

6. Case Management: Other Procedures

7. Who’s Who in the APA World

8. What’s Not Said

B. Chief Counsel Directives Manual Provisions Chapter (42)(10)

1. Unilateral APAs

2. Bilateral and Multilateral APAs

3. Miscellaneous

C. Conclusion

8:VI. The Prefiling Conference

A. General

1. Roles of IRS Offices in APA Process

2. Verification of Taxpayer Information

3. Acceptability of a Bilateral or Unilateral APA

4. Bilateral APA Issues

5. Timing Issues

B. Preliminary Discussion of Substantive Issues

1. Extent of Specific Factual Disclosures and Economic Analysis

2. Specifying Covered and Non-Covered Product Lines, Transactions, or Affiliates

3. Preliminary Identification of Comparables

4. Acceptability of Taxpayer’s Proposed TPM

5. Confirming Methods

6. Establishing an Appropriate Range of Results

7. Identifying Critical Assumptions

C. Economists and Other Experts

1. Taxpayer and IRS Use of Economists

2. Independent Experts

8:VII. The APA Application and Supporting Data

8:VIII. Negotiating the APA

8:IX. Foreign APA Procedures

8:X. Administering the APA

8:XI. APA Program Accountability and Recent Developments

Chapter 9: COST SHARING ARRANGEMENTS by Zion Levi, Womble Carlyle Sandridge & Rice, Washington, D.C.

9:I. What Is a Cost Sharing Arrangement?

9:II. Cost-Benefit Analysis of a Cost Sharing Arrangement

9:III. International Aspects of Cost Sharing Arrangements

9:IV. The 1995 and 2009 U.S. Cost Sharing Rules

9:V. Qualified Cost Sharing Arrangement

9:VI. Participant

9:VII. Intangible Development Costs

9:VIII. Anticipated Benefits

9:IX. Cost Allocations

9:X. Allocations of Income, Deductions or Other Items to Reflect Transfers of Intangibles (Buy-In)

9:XI. Character of Payments Made Pursuant to a QCSA

9:XII. Accounting Requirements

9:XIII. Administrative Requirements

9:XIV. Effective Date

9:XV. IRS Authority to Impose Cost Sharing

9:XVI. Coordination With Advance Pricing Agreements

Chapter 10: TRANSFER PRICING – INTERNATIONAL JOINT VENTURES by Kenneth J. Krupsky, Esq., and Karl L. Kellar, Esq., Jones Day, Washington, D.C.

10:I. Introduction

10:II. Legal Framework

10:III. Establishing Absence of Common Control

10:IV. Hidden or “Creeping” Control

10:V. Joint Venture Pricing as an Arm’s Length Comparable

10:VI. Additional Tax Planning Issues

10:VII. Conclusions