Regs Clarify Coordination of Transfer Pricing Rules

 Clarification of the Coordination of the Transfer Pricing Rules with Other Code Provisions

ACTION: Final and temporary regulations.

SUMMARY: This document contains temporary regulations that clarify the coordination of the application of the arm's length standard and the best method rule under section 482 of the Internal Revenue Code (Code) in conjunction with other provisions of the Code. The text of the temporary regulations also serves in part as the text of the proposed regulations (REG-139483-13) published in the Proposed Rules section of this issue of the Federal Register. This document also contains final regulations that add cross-references in the existing final regulations under section 482 to relevant sections of these temporary regulations.

DATES: Effective date: These regulations are effective on September 14, 2015.

Applicability date: For dates of applicability, see § 1.482-1T(j)(7)(i).

FOR FURTHER INFORMATION CONTACT: Frank W. Dunham III, (202) 317-6939 (not a toll-free call).

Regulations under section 482 published in the Federal Register (33 FR 5848) on April 16, 1968, provided guidance on methods for applying the arm's length standard to evaluate controlled transactions, including transfers of tangible and intangible property, the provision of services, and loans or advances. Subsequent revisions and updates of the transfer pricing regulations were published in the Federal Register on July 8, 1994, Dec. 20, 1995, May 13, 1996, Aug. 26, 2003, Aug. 4, 2009, Dec. 22, 2011, and Aug. 27, 2013 (59 FR 34971, 60 FR 65553, 61 FR 21955, 68 FR 51171, 74 FR 38830, 76 FR 80082, and 78 FR 52854, respectively).

Explanation of Provisions

I. Overview -- Consistent Valuation of Controlled Transactions for All Code Purposes

Section 482 authorizes the Secretary, and the regulations under section 482 authorize the IRS, to adjust the results of controlled transactions to clearly reflect the income of commonly controlled taxpayers in accordance with the arm's length standard and, in the case of the transfer of intangible property (within the meaning of section 482, the tax treatment of controlled transactions is also governed by other Code and regulatory rules applicable to both controlled and uncontrolled transactions. Controlled transactions always remain subject to section 482 in addition to these generally applicable provisions. These temporary regulations clarify the coordination of section 482 and the regulations thereunder with such other Code and regulatory provisions.

The coordination rules in these temporary regulations apply to controlled transactions, including controlled transactions that are subject in whole or part to both sections 367 and 482. Transfers of property subject to section 367 that occur between controlled taxpayers require a consistent and coordinated application of sections 367 and 482 to the controlled transfer of property and any related transactions between controlled taxpayers. The controlled transactions may include transfers of property subject to section 367(a) or (e), transfers of intangible property subject to section 367(d) or (e), and the provision of services that contribute significantly to maintaining, exploiting, or further developing the transferred properties. All of the transactions (and any elements thereof) must be analyzed and valued on a consistent basis under section 482 in order to achieve the intended purposes of sections 367 and 482.

The consistent analysis and valuation of transactions subject to multiple Code and regulatory provisions is required under the best method rule described in § 1.482-1(c). A best method analysis under section 482 begins with a consideration of the facts and circumstances related to the functions performed, the resources employed, and the risks assumed in the actual transaction or transactions among the controlled taxpayers, as well as in any uncontrolled transactions used as comparables. See § 1.482-1(c)(2)(i) and (d)(3). For example, if consideration of the facts and circumstances reveals synergies among interrelated transactions, an aggregate evaluation under section 482 may provide a more reliable measure of an arm's length result than a separate evaluation of the transactions. In contrast, an inconsistent or uncoordinated application of section 482 to interrelated controlled transactions that are subject to tax under different Code and regulatory provisions may lead to inappropriate conclusions.

The best method rule requires a determination of the arm's length result of controlled transactions under the method, and particular application of that method, that provides the most reliable measure of an arm's length result. Under the regulations, the reliability of the measure depends on the economics of the controlled transactions, not their formal character. See, e.g., §§ 1.482-2A(e)(3)(vii) and 1.482-3(c)(3)(ii)(D) (use of sales agent's commission as comparable for reseller's appropriate markup under the resale price method); §§ 1.482-2A(e)(4)(iv) and 1.482-3(d)(3)(ii)(D) (use of purchasing agent's commission as comparable for producer's appropriate gross profit percentage under the cost-plus method); and § 1.482-9(i)(4) and (5), Examples 1 and 3 (reference to charges for transfers of property as relevant to the determination of a contingent-payment services charge). Realistic alternative transactions that, on a risk-adjusted basis, reflect arrangements that are economically equivalent to those in the controlled transactions may provide the basis for application of unspecified methods to determine the most reliable measure of an arm's length result in the controlled transactions. See, e.g., §§ 1.482-1(f)(2)(ii)(A), 1.482-3(e)(1), 1.482-4(d)(1), 1.482-7(g)(8), and 1.482-9(h). Thus, although a taxpayer may choose among different transactional forms -- for example, a long-term license, research and development services, a cost sharing arrangement, or a transfer subject to section 367 -- specified and unspecified methods applicable to each form will provide consistent arm's length results for economically equivalent transactions.

Based upon taxpayer positions that the IRS has encountered in examinations and controversy, the Treasury Department and the IRS are concerned that certain results reported by taxpayers reflect an asserted form or character of the parties' arrangement that involves an incomplete assessment of relevant functions, resources, and risks and an inappropriately narrow analysis of the scope of the transfer pricing rules. In particular, the Treasury Department and the IRS are concerned about situations in which controlled groups evaluate economically integrated transactions involving economically integrated contributions, synergies, and interrelated value on a separate basis in a manner that results in a misapplication of the best method rule and fails to reflect an arm's length result. Taxpayers may assert that, for purposes of section 482, separately evaluating interrelated transactions is appropriate simply because different statutes or regulations apply to the transactions (for example, where section 367 and the regulations thereunder apply to one transaction and the general recognition rules of the Code apply to another related transaction). These positions are often combined with inappropriately narrow interpretations of § 1.482-4(b)(6), which provides guidance on when an item is considered similar to the other items identified as constituting intangibles for purposes of section 482. The interpretations purport to have the effect, contrary to the arm's length standard, of requiring no compensation for certain value provided in controlled transactions despite the fact that compensation would be paid if the same value were provided in uncontrolled transactions.

As discussed in the following portion of this preamble, these temporary regulations address the aforementioned concerns by clarifying the coordination of the application of section 482 in conjunction with other Code and regulatory provisions in determining the proper tax treatment of controlled transactions.

II. Detailed Explanation of Provisions

A. Compensation Independent of the Form or Character of Controlled Transaction -- § 1.482-1T(f)(2)(i)(A)

New § 1.482-1T(f)(2)(i)(A) provides that arm's length compensation must be consistent with, and must account for all of, the value provided between the parties in a controlled transaction, without regard to the form or character of the transaction. For this purpose, it is necessary to consider the entire arrangement between the parties, as determined by the contractual terms, whether written or imputed in accordance with the economic substance of the arrangement, in light of the actual conduct of the parties. This requirement is consistent with the principles underlying the arm's length standard, which require arm's length compensation in controlled transactions equal to the compensation that would have occurred if a similar transaction had occurred between similarly situated uncontrolled taxpayers. See § 1.482-1(b)(1). Accordingly, no inference may be drawn from any provision in the section 482 regulations that any transfer of value may be made without arm's length compensation.

B. Aggregate or Separate Analysis, Depending on Economic Interrelatedness of Controlled Transactions, including Synergies -- § 1.482-1T(f)(2)(i)(B)

Section 1.482-1T(f)(2)(i)(B) clarifies § 1.482-1(f)(2)(i)(A), which provided that the combined effect of two or more separate transactions (whether before, during, or after the year under review) may be considered if such transactions, taken as a whole, are so interrelated that an aggregate analysis of such transactions provides the most reliable measure of an arm's length result determined under the best method rule of § 1.482-1(c). Specifically, a new clause is added to clarify that this aggregation principle also applies for purposes of an analysis under multiple provisions of the Code or regulations. In addition, a new sentence elaborates on the aggregation principle by noting that consideration of the combined effect of two or more transactions may be appropriate to determine whether the overall compensation is consistent with the value provided, including any synergies among items and services provided. Finally, § 1.482-1(f)(2)(i)(B) does not retain the statement in § 1.482-1(f)(2)(i)(A) that transactions generally will be aggregated only when they involve "related products or services, as defined in § 1.6038A-3(c)(7)(vii)." The eliminated sentence had the unintended potential to be misconstrued by taxpayers as limiting the aggregation analysis pursuant to the best method rule.

C. Aggregation and Allocation for Purposes of Coordinated Analysis under Multiple Code or Regulatory Provisions -- §§ 1.482-1T(f)(2)(i)(C) and 1.482-1T(f)(2)(i)(D)

Section 1.482-1T(f)(2)(i)(C) provides that, for one or more controlled transactions governed by more than one provision of the Code and regulations, a coordinated best method analysis and evaluation of the transactions may be necessary to ensure that the overall value provided (including any synergies) is properly taken into account. A coordinated best method analysis of the transactions includes a consistent consideration of the facts and circumstances of the functions performed, resources employed, and risks assumed, and a consistent measure of the arm's length results, for purposes of all relevant Code and regulatory provisions. For example, situations in which a coordinated best method analysis and evaluation may be necessary include (1) two or more interrelated transactions when either all such transactions are governed by one regulation under section 482 or all such transactions are governed by one subsection of section 367, (2) two or more interrelated transactions governed by two or more regulations under section 482, (3) a transfer of property subject to section 367(a) and an interrelated transfer of property subject to section 367(d), (4) two or more interrelated transactions where section 367 applies to one transaction and the general recognition rules of the Code apply to another interrelated transaction, and (5) other circumstances in which controlled transactions require analysis under multiple Code and regulatory provisions.

Section 1.482-1T(f)(2)(i)(D) provides that it may be necessary to allocate the arm's length result that was properly determined under a coordinated best method analysis described in § 1.482-1T(f)(2)(i)(C) among the interrelated transactions. Any such allocation must be made using the method that, under the facts and circumstances, provides the most reliable measure of an arm's length result for each allocated amount.

D. Examples of Coordinated Best Method Analysis under Multiple Code or Regulatory Provisions -- § 1.482-1T(f)(2)(i)(E)

Section 1.482-1T(f)(2)(i)(E) provides eleven examples to illustrate the guidance in § 1.482-1T(f)(2)(i)(A) through (D). Examples 1 through 4 are materially the same as the Examples in § 1.482-1(f)(2)(i)(B). The Treasury Department and the IRS do not intend for the revisions to those examples to be interpreted as substantive. The rest of the examples are new.

Section 1.482-1T(f)(2)(ii)(B) replaces § 1.482-1(f)(2)(ii)(B). The Example included in § 1.482-1T(f)(2)(ii)(B) is materially the same as the old example and has been updated to replace the term "district director" and to include cross-references to Examples 7 and 8 in § 1.482-1T(f)(2)(i)(E). The Treasury Department and the IRS do not intend for the revisions to this example to be interpreted as substantive.

No inference is intended as to the application of the provisions amended by these temporary regulations under current law. The IRS may, where appropriate, challenge transactions, including those described in these temporary regulations and this preamble, under currently applicable Code or regulatory provisions or judicial doctrines.

Effective/Applicability Date

These regulations apply to taxable years ending on or after September 14, 2015.

Special Analyses

Certain IRS regulations, including this one, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a regulatory impact assessment is not required. It has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to this regulation. For applicability of the Regulatory Flexibility Act (5 U.S.C. chapter 6), refer to the cross-referenced notice of proposed rulemaking published elsewhere in this issue of the Federal Register. Pursuant to section 7805(f) of the Internal Revenue Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

Drafting Information

The principal author of these regulations is Frank W. Dunham III of the Office of the Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in the development of the regulations.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

Sections 1.482-1 and 1.482-1T are also issued under 26 U.S.C. 482. * * *

Par. 2. Section 1.482-0 is amended by revising the entries for § 1.482-1(f)(2)(i) and (f)(2)(ii)(B) to read as follows:

§ 1.482-0 Outline of regulations under section 482.

* * * * *

§ 1.482-1 Allocation of income and deductions among taxpayers.

* * * * *

(f) * * *

(2) * * *

(i) [Reserved]

(ii) * * *

(B) [Reserved]

* * * * *

Par. 3. Section 1.482-1 is amended by revising paragraphs (f)(2)(i) and (f)(2)(ii)(B) and adding paragraph (j)(7) to read as follows:

§ 1.482-1 Allocation of income and deductions among taxpayers.

* * * * *

(f) * * *

(2) * * *

(i)(A) through (E) [Reserved]. For further guidance see § 1.482-1T(f)(2)(i)(A) through (E).

(ii) * * *

(B) [Reserved]. For further guidance see § 1.482-1T(f)(2)(ii)(B).

* * * * *

(j) * * *

(7) [Reserved]. For further guidance see § 1.482-1T(j)(7).

Par. 4. Section 1.482-1T is added to read as follows:

§ 1.482-1T Allocation of income and deductions among taxpayers (temporary).

(a) through (f)(2) [Reserved]. For further guidance see § 1.482-1(a) through (f)(2).

(i) Compensation independent of the form or character of controlled transaction --

(A) In general. All value provided between controlled taxpayers in a controlled transaction requires an arm's length amount of compensation determined under the best method rule of § 1.482-1(c). Such amount must be consistent with, and must account for all of, the value provided between the parties in the transaction, without regard to the form or character of the transaction. For this purpose, it is necessary to consider the entire arrangement between the parties, as determined by the contractual terms, whether written or imputed in accordance with the economic substance of the arrangement, in light of the actual conduct of the parties. See, e.g., § 1.482-1(d)(3)(ii)(B) (identifying contractual terms) and (f)(2)(ii)(A) (regarding reference to realistic alternatives).

(B) Aggregation. The combined effect of two or more separate transactions (whether before, during, or after the year under review), including for purposes of an analysis under multiple provisions of the Code or regulations, may be considered if the transactions, taken as a whole, are so interrelated that an aggregate analysis of the transactions provides the most reliable measure of an arm's length result determined under the best method rule of § 1.482-1(c). Whether two or more transactions are evaluated separately or in the aggregate depends on the extent to which the transactions are economically interrelated and on the relative reliability of the measure of an arm's length result provided by an aggregate analysis of the transactions as compared to a separate analysis of each transaction. For example, consideration of the combined effect of two or more transactions may be appropriate to determine whether the overall compensation in the transactions is consistent with the value provided, including any synergies among items and services provided.

(C) Coordinated best method analysis and evaluation. Consistent with the principles of paragraphs (f)(2)(i)(A) and (B) of this section, a coordinated best method analysis and evaluation of two or more controlled transactions to which one or more provisions of the Code or regulations apply may be necessary to ensure that the overall value provided, including any synergies, is properly taken into account. A coordinated best method analysis would include a consistent consideration of the facts and circumstances of the functions performed, resources employed, and risks assumed in the relevant transactions, and a consistent measure of the arm's length results, for purposes of all relevant statutory and regulatory provisions.

(D) Allocations of value. In some cases, it may be necessary to allocate one or more portions of the arm's length result that was properly determined under a coordinated best method analysis described in paragraph (f)(2)(i)(C) of this section. Any such allocation of the arm's length result determined under the coordinated best method analysis must be made using the method that, under the facts and circumstances, provides the most reliable measure of an arm's length result for each allocated amount. For example, if the full value of compensation due in controlled transactions whose tax treatment is governed by multiple provisions of the Code or regulations has been most reliably determined on an aggregate basis, then that full value must be allocated in a manner that provides the most reliable measure of each allocated amount.

(E) Examples. The following examples illustrate the provisions of this paragraph (f)(2)(i). For purposes of the examples in this paragraph (E), P is a domestic corporation, and S1, S2, and S3 are foreign corporations that are wholly owned by P.

(B) Example. The following example illustrates this paragraph (f)(2)(ii):

(7) Certain effective/applicability dates -- (i) Paragraphs (f)(2)(i)(A) through (E) and (f)(2)(ii)(B) of this section apply to taxable years ending on or after September 14, 2015.

(ii) Expiration date. The applicability of paragraphs (f)(2)(i)(A) through (E) and (f)(2)(ii)(B) of this section expires on or before September 14, 2018.