Page 4 - Altera And Cost-Sharing Requirements Under Section 482 By Jerald David August
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In effect, the regulation was purely theoretical in contrast to being factually supportable.
and its related affiliate companies locat- ed in different tax jurisdictions. Such allocations among MBEs affect the inter- company price for services, goods, licensing of intangibles, and shared costs of research and development expenses.
From the multinational business per- spective, transfer pricing may be a key element in reducing the effective rate of tax on worldwide operations by allo- cating profits to functions conducted by affiliates. Shifting profits to tax havens or low tax jurisdictions is often the end- game feature of an MBE’s transfer pric- ing strategy. It is important for an MBE to reduce or limit the risk that there is a form of economic double taxation with respect to its tax base that could result from a dispute between two coun- tries as to the determination of the arms length amount to support cross-border transactions involving associated enter- prises. 9 Unless a corresponding adjust- ment is required under a bilateral income tax convention or a foreign tax credit is allowed, double taxation may result.10
On the other hand, there may be management incentives to increase tax- able profits of the operation of a for- eign subsidiary or affiliate of an MBE in order to meet target levels of profitabil- ity tied into compensation bonuses. There are competing interests at work in the entire sphere of transfer pricing as
countries are constantly attempting to increase the size of their tax base by allocating profits to or reducing cost or expense allocations from their jurisdic- tions. The U.S. has spent and continues to spend considerable resources in audit- ing the transfer tax policies and their impacts on United States companies engaged in foreign operations, and for- eign companies engaged in making inbound investments and operating businesses within the U.S.11
Section 482
Section 482 is rather straightforward in its language and short in words:
Allocation of income and deduc- tions among taxpayers.
In any case of two or more organi- zations, trades, or businesses (whether or not incorporated, whether or not organized in the United States, and whether or not affiliated) owned or controlled directly or indirectly by the same interests, the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among such organizations, trades or businesses, if he determines that such distribu- tion, apportionment, or allocation is necessary in order to prevent evasion of taxes or to clearly reflect the income of any such organizations, trades, or businesses. In the case of any trans- fer (or license) of intangible proper-
ty (within the meaning of section 936(h)(3)(B)), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangi- ble.”12 (italics added for emphasis).
For transfer pricing as well as for other tax purposes, intangible assets are broadly defined and include pro- duction-based intangibles such as copyrights, formulas and patents, con- sumer-oriented intangibles such as trade names and trademarks, and also various unprotected forms of business know-how that has commercial value such as methods of production, sur- veys, analysis, and formulas. 13
Broad Powers Granted. Section 482 grants the Service broad powers to allo- cate income and deductions to prevent tax evasion, or, as is more customarily relevant, to clearly reflect income.14 Par- ties under common control should charge each other for goods, services, leases, loans, or transfers of tangible or intangible property based on what inde- pendent or unrelated parties would charge in an arm’s-length transaction.15
Where commonly controlled compa- nies are operating solely within the U.S., Section 482 applies. This would include transactions between members of the same consolidated group of corpora- tions. The section applies of course where one of the parties to a transaction is a for- eign affiliate under common control.16 And Section 482 can apply where the owners of a business are either foreign or domestic. Accordingly, both U.S. corpo- rations with foreign subsidiaries and for- eign corporations with U.S. subsidiaries are within the scope of the section.17 The adjustments made under Section 482 by the Service may affect not only the com- putation of each related party’s taxable income, but also the jurisdictional allo- cation of income between one or more foreign-based controlled entities and the consequences attendant to application of other Code provisions.18 If the rules of Section 482 are not adhered to, the Ser- vice may impose penalties of up to 40% of the resulting deficiency in income tax under Section 6662(e).
January/February 2016

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