(i) FP, is a foreign company that designs, manufactures and sells industrial equipment. FP has developed proprietary components that are incorporated in its products. These components are important in the operation of FP’s equipment and some of them have distinctive features, but other companies produce similar components and none of these components by itself accounts for a substantial part of the value of FP’s products. (ii) FP licenses its U.S. subsidiary, USSub, exclusive North American rights to use the patented technology for producing component X, a heat exchanger used for cooling operating mechanisms in industrial equipment. Component X incorporates proven technology that makes it somewhat more efficient than the heat exchangers commonly used in industrial equipment. FP also agrees to provide technical support to help adapt component X to USSub’s products and to assist with initial production. Under the terms of the license agreement USSub pays FP a royalty equal to 3 percent of sales of USSub equipment incorporating component X. (iii) FP does not license unrelated parties to use component X, but many similar components are transferred between uncontrolled taxpayers. Consequently, the district director decides to apply the comparable uncontrolled transaction method to evaluate whether the 3 percent royalty for component X is an arm’s length royalty. (iv) The district director uses a database of company documents filed with the Securities and Exchange Commission (SEC) to identify potentially comparable license agreements between uncontrolled taxpayers that are on file with the SEC. The district director identifies 40 license agreements that were entered into in the same year as the controlled transfer or in the prior or following year, and that relate to transfers of technology associated with industrial equipment that has similar applications to USSub’s products. Further review of these uncontrolled agreements indicates that 25 of them involved components that have a similar level of technical sophistication as component X and could be expected to play a similar role in contributing to the total value of the final product. (v) The district director makes a detailed review of the terms of each of the 25 uncontrolled agreements and finds that 15 of them are similar to the controlled agreement in that they all involve – (A) The transfer of exclusive rights for the North American market; (B) Products for which the market could be expected to be of a similar size to the market for the products into which USSub incorporates component X; (C) The transfer of patented technology; (D) Continuing technical support; (E) Access to technical improvements; (F) Technology of a similar age; and (G) A similar duration of the agreement. (vi) Based on these factors and the fact that none of the components to which these license agreements relate accounts for a substantial part of the value of the final products, the district director concludes that these fifteen intangibles have similar profit potential to the component X technology. (vii) The 15 uncontrolled comparables produce the following royalty rates: License Royalty rate (percent) 1 1.0 2 1.0 3 1.25 4 1.25 5 1.5 6 1.5 7 1.75 8 2.0 9 2.0 10 2.0 11 2.25 12 2.5 13 2.5 14 2.75 15 3.0 (viii) Although the uncontrolled comparables are clearly similar to the controlled transaction, it is likely that unidentified material differences exist between the uncontrolled comparables and the controlled transaction. Therefore, an appropriate statistical technique must be used to establish the arm’s length range. In this case the district director uses the interquartile range to determine the arm’s length range. Therefore, the arm’s length range covers royalty rates from 1.25 to 2.5 percent, and an adjustment is warranted to the 3 percent royalty charged in the controlled transfer. The district director determines that the appropriate adjustment corresponds to a reduction in the royalty rate to 2.0 percent, which is the median of the uncontrolled comparables ...

(i) USpharm, a U.S. pharmaceutical company, develops a new drug Z that is a safe and effective treatment for the disease zeezee. USpharm has obtained patents covering drug Z in the United States and in various foreign countries. USpharm has also obtained the regulatory authorizations necessary to market drug Z in the United States and in foreign countries. (ii) USpharm licenses its subsidiary in country X, Xpharm, to produce and sell drug Z in country X. At the same time, it licenses an unrelated company, Ydrug, to produce and sell drug Z in country Y, a neighboring country. Prior to licensing the drug, USpharm had obtained patent protection and regulatory approvals in both countries and both countries provide similar protection for intellectual property rights. Country X and country Y are similar countries in terms of population, per capita income and the incidence of disease zeezee. Consequently, drug Z is expected to sell in similar quantities and at similar prices in both countries. In addition, costs of producing and marketing drug Z in each country are expected to be approximately the same. (iii) USpharm and Xpharm establish terms for the license of drug Z that are identical in every material respect, including royalty rate, to the terms established between USpharm and Ydrug. In this case the district director determines that the royalty rate established in the Ydrug license agreement is a reliable measure of the arm’s length royalty rate for the Xpharm license agreement ...

DSM Produtos Nutricionais Brasil S.A. had based the intragroup pricing of imported goods on the “RPL-60 method” which applied in Brazil up until 2012. “Article 18, II of Law 9430/1996, as amended by Law 9. 959/2000, provides that the transfer price, in the case of goods and rights imported for application in the productive process, calculated by the resale price minus method – PRL-60 method -, is the arithmetic average of the resale prices of goods or rights, calculated by excluding unconditional discounts, taxes, commissions brokerage and profit margin of 60%, the latter calculated on the resale price after deducting the mentioned production costs and also the added value calculated from the proportional participation of each imported good, service or right in the formation of the final price, as provided by law and detailed in the normative instruction” However, according to the Tax authorities the calculations had not been in accordance with the instructions given in the legislation. On that basis the prices were adjusted for FY 2007 and an assessment issued. The assessment was brought to court by DSM. Judgement of the Regional Court The Court dismissed the appeal in regards of the transfer pricing adjustment. “1 – Transfer pricing is the price charged in transactions for the transfer of goods, rights or services performed between related legal entities, with the purpose of reducing their tax burden. In order to avoid the undue reduction of the tax burden, rules are issued to control such price. 2 – For such, the Resale Price Less Method – RPL 60 was created, ruled by art. 18, II and its paragraphs, of Law 9430/96, with the wording given by Law 959/00 and regulated by IN/SRF no. 32/2001. 3 – Due to the methodological imprecision of IN/SRF no. 32/2001, the Federal Revenue Office issued IN/SRF no. 243/2002, which better reflected the intention of the regulated law with regard to transfer price control, i.e. to prevent tax evasion in commercial transactions with related companies based abroad. 4 – IN/SRF no. 243/2002 no longer considers the net sale price of the product produced, as IN 32/2001 did, using the parameter price of the goods, services or rights imported from the affiliate based abroad in the composition of the price of the product produced here, ascertained according to the methodology provided for in its article 12, §§ 10 and 11 and its subsections. As to the profit margin, it established that it must be determined by applying a percentage of 60% on the participation of the imported goods in the sale price of the good produced, to be used in the determination of the price parameter 5 – the sole purpose of IN/SRF no. 243/2002 was to determine, with greater accuracy, the price as a parameter, upon import of goods, services or rights of an affiliate based abroad, intended for production and, thereafter, through the mechanism of comparison of such price with prices of identical or similar products practiced in the market by independent companies (arm’s length principle), the taxable income and the tax bases of the IRPJ and CSLL are calculated, through the PRL-60 method, in the transactions carried out between the taxpayer and its affiliate based abroad, reproducing the scope provided for by the legislator when it enacted Law No. 9430/96, with the wording given by Law No. 9. 430/96, with the wording given by Law 9959/2000, aiming at restricting tax avoidance. 6 -There is no need to mention the recalculation of the parameter prices by Law no. 12.715/2012, since, as stated in the records, the tax assessment notice aims at the collection of debts of the calendar year 2007, therefore, prior to its effectiveness. 7 – Interlocutory Appeal Dismissed.” Click here for English Translation Click here for other translation ...