§ 1.482-9(f)(3) Example 3.

Category: (f) Comparable profits method, Transfer Pricing Guidelines, US IRC Section 482 on Transfer Pricing, § 1.482-9 Methods to determine taxable income in connection with a controlled services transaction | Tag: , , , ,
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Material difference in accounting for stock-based compensation.

(i) Taxpayer, a U.S. corporation the stock of which is publicly traded, performs controlled services for its wholly-owned subsidiaries. The arm’s length price of these controlled services is evaluated under the comparable profits method for services in paragraph (f) of this section by reference to the net cost plus profit level indicator (PLI). Taxpayer is the tested party under paragraph (f)(2)(i) of this section. The Commissioner identifies the most narrowly identifiable business activity of the tested party for which data are available that incorporate the controlled transaction (the relevant business activity). The Commissioner also identifies four uncontrolled domestic service providers, Companies A, B, C, and D, each of which performs exclusively activities similar to the relevant business activity of Taxpayer that is subject to analysis under paragraph (f) of this section. The stock of Companies A, B, C, and D is publicly traded on a U.S. stock exchange. Assume that Taxpayer makes an election to apply these regulations to earlier taxable years.

(ii) Stock options are granted to the employees of Taxpayer that engage in the relevant business activity. Assume that, as determined under a method in accordance with U.S. generally accepted accounting principles, the fair value of such stock options attributable to the employees’ performance of the relevant business activity is 500 for the taxable year in question. In evaluating the controlled services, Taxpayer includes salaries, fringe benefits, and related compensation of these employees in “total services costs,” as defined in paragraph (j) of this section. Taxpayer does not include any amount attributable to stock options in total services costs, nor does it deduct that amount in determining ”reported operating profit” within the meaning of § 1.482-5(d)(5), for the year under examination.

(iii) Stock options are granted to the employees of Companies A, B, C, and D. Under a fair value method in accordance with U.S. generally accepted accounting principles, the comparables include in total compensation the value of the stock options attributable to the employees’ performance of the relevant business activity for the annual financial reporting period, and treat this amount as an expense in determining operating profit for financial accounting purposes. The treatment of employee stock options is summarized in the following table:

Salaries and other non-option compensation Stock options fair value Stock options expensed
Taxpayer 1,000 500 0
Company A 7,000 2,000 2,000
Company B 4,300 250 250
Company C 12,000 4,500 4,500
Company D 15,000 2,000 2,000

(iv) A material difference in accounting for stock-based compensation (within the meaning of § 1.482-7T(d)(3)(i)) exists. Analysis indicates that this difference would materially affect the measure of an arm’s length result under this paragraph (f). In making an adjustment to improve comparability under §§ 1.482-1(d)(2) and 1.482-5(c)(2)(iv), the Commissioner includes in total services costs of the tested party the total compensation costs of 1,500 (including stock option fair value). In addition, the Commissioner calculates the net cost plus PLI by reference to the financial-accounting data of Companies A, B, C, and D, which take into account compensatory stock options.






Related Guidelines

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  2. TPG2022 Chapter VII paragraph 7.57As a second step, the MNE group should identify and remove from the pool those costs that are attributable to services performed by one group member solely on behalf of one other group member. In creating a pool of payroll costs, for example,...
  3. TPG2022 Chapter VII paragraph 7.52This subsection sets out the elements of a simplified charge mechanism for low value-adding intra-group services. This simplified method is premised on the proposition that all low value-adding service costs incurred in supporting the business of MNE group members should be allocated to...
  4. TPG2022 Chapter VII paragraph 7.50The following examples illustrate an important element of the definition of low value-adding intra-group services, namely, that they should not include services which are part of the MNE’s core business. Services that may seem superficially similar in nature (in the example, credit risk...
  5. TPG2022 Chapter VII paragraph 7.55While low value-adding intra-group services may provide benefits to all recipients of those services, questions may arise about the extent of the benefits and whether independent parties would have been willing to pay for the service or perform it themselves. Where the MNE...
  6. TPG2022 Chapter VII paragraph 7.24In some cases, an indirect-charge method may be necessary due to the nature of the service being provided. One example is where the proportion of the value of the services rendered to the various relevant entities cannot be quantified except on an approximate...
  7. TPG2022 Chapter VII paragraph 7.62Subject to the provisions of paragraph 7.55, the charge for services to any member of the electing MNE group shall be the sum of (i) the costs incurred by another group member in providing services specifically to the member under the second step...
  8. TPG2022 Chapter VII paragraph 7.44This section discusses the definitional issues related to low value-adding intra-group services for applying the elective, simplified approach discussed under Section D.2. It starts by indicating the characteristics that services must have in order to qualify as low-value-adding intra-group services for applying the...
  1. April 2019: UN Manual – Financial Transactions and Profit SplitsA new version of the UN Practical Manual on Transfer Pricing for Developing Countries is due by 2021. According to the mandate the new manual will make further improvements in usability and practical relevance, updates and improvements to existing text, including on Country...
  2. Additional guidance on the attribution of profits to permanent establishmentsThe OECD has released additional guidance on the attribution of profits to permanent establishments. This additional guidance sets out high-level general principles for the attribution of profits to permanent establishments arising under Article 5(5), in accordance with applicable treaty provisions, and includes examples...

Related Case Law

  1. Australia vs. Chevron Australia Holdings Pty Ltd . October 2015, Federal Court of Australia, case No. 3 and 4The Australien Chevron case was about a $US 2.5 billion intercompany loan between Chevron Australia and its US subsidiary, Chevron Texaco, and whether the interest paid on the loan by Chevron Australia exceeded the arm’s length price. Chevron Australia had set up a company in the US,...
  2. Panama vs “Pharma Distributor S.A.”, July 2021, Administrative Tax Court, Case No TAT-RF-066An adjustment for FY 2013 and 2014 had been issued to a pharmaceutical company in Panama “Pharma Distributor S.A” that resulted in an income adjustment of 19.5 million dollars, which in turn resulted in additional taxes of 2.4 million dollars. The resale price...
  3. US vs Medtronic, August 2018, U.S. Court of Appeals, Case No: 17-1866In this case the IRS was of the opinion, that Medtronic erred in allocating the profit earned from its devises and leads between its businesses located in the United States and its device manufacturer in Puerto Rico. To determine the arm’s length price...
  4. Italy vs Rohm and Haas Italia s.r.l, February 2020, Supreme Court, Case No 3599 13/02/2020At issue was deduction of VAT on purported costs incurred for intra-group services, which had been deemed non-deductible for tax as well as VAT purposes by the Italien Tax Authorities, as the taxpayer had not been able to prove the effectiveness and relevance...