Internal Revenue Code Section 482 and Transfer Pricing - Assignment Example

Internal revenue section 482 and Transfer Pricing The Internal revenue Service of the United s of America, Treasury department has various codes to deal with different tax paying options and requirements. Section 482 of the IRS code specifies the legalities and other modalities to be followed, so that there is no evasion of tax payment by the controlled taxpayers. The code further empowers the IRS to adjust various allowances, credits or loans as well as other deductions, while computing the income for the purpose of payment of tax, which mainly incorporates transfer pricing. Section 482 broadly deals with the prices charged by a company while transferring goods from their one associate to the other. This is deemed as an inter company transaction and under the section 482 such transactions should result in the same taxation procedure as would have been if the transaction was taking place between the MNC and its non-affiliate. The aim is usually to ensure that the tax payment is done in a reasonably fair manner, without any bias and there is no attempt to evade tax............(reported by IRS, transfer pricing) Section 482—allocation and deductions As per the IRS section code 482, the secretary responsible for deduction of taxes, can decide on the deductions and allocation of income, credit or allowances etc, in case the same can prevent the evasion of taxes; while two or more trade organizations, whether affiliated or not, transact business among themselves. Modification of revenue procedure 2006-9 (sec 2.01) further states that IRS and the tax payers can resolve all the issues related to the transfer pricing under section 482 of the internal revenue Code under Income tax regulations, on a prospective basis. This is defined in the “advanced Pricing Agreement” (APA) program, which provides for the resolution of all the issues between the tax payer and the authorities under certain income tax treaties, codes or regulations, within the relevant transfer pricing principals. This will be determined in relation to the income generated by the taxpayer company within and outside of United States, and other concerned issues related with the same. While aiming at the more tax compliance by the taxpayers, the APA program is based on the openness and cooperation as well as discussion, to encourage the taxpayer for presenting all relevant facts so that a better transfer pricing methodology can be in place. This should result in a mutually satisfied agreement between the taxpayer and the regulators.............( as per modification of Rev proc 2006-9) Analysis of section 482 and transfer pricing Internal Revenue Code under section 482 has provided regulations for the controlled taxpayers like multinational companies with regard to their intra company pricing for the tax purposes. These provisions clearly state that the prices and fees charged by such entities for the goods, services or loans as well as property, that they will transfer between different associates of the company, should be same as they would have done if the transaction was with a business house outside the company group. However, what could be these prices etc. for the transfer transaction remains a big question. Certain anomalies are found between the legislations laid out under section 482 and the implementation of the same. The reasons for this can be summarized as below: Section 482 legislation and the regulations for implementation of the same are working diversely as these regulations are ambiguous, thus vulnerable to many interpretations by the revenue officials. While dealing with the issues of intra-company pricing, the need is to have experts in the economic and financial fields to decide and implement the section 482 according to its true legislative meaning. However, the dearth of such expertise with IRS results in varied implementation of the legislation and thus the resolution of any pricing issue becomes a subject of multiple interpretations. The other reason could be that the US congress, which has passed such legislative laws like section 482 of IRC code, have provided that these laws mandate the availability of expertise and sources to IRS for interpreting and implementing the rules in the proper manner. However, the fact remains that this is just a showcase to inform the taxpayers and MNCs in particular, that a tough regulation is in place; as there are no clear cut tax laws with regard to the inter company transfer pricing. The legislations could be the result of certain political motivation also, while keeping in view the interests of some individual members..........................(Transfer pricing, book by King page 5-7 ) Disparity between section 482 legislation and administrative practice There can be several reasons for such disparity. One reason is the glaring gap between the actual tax collections and the figures that were mandated for such tax hauls. If it is the fault on part of the administrative and treasury deptt.,. for improper implementation, then either the tax laws or the administrative practices need to be reformed to bring the two closer. However, if the US congress is collectively satisfied with the actual tax collections that show huge deficit of collection from the large companies, then the legislation can be only a “window dressing” exercise, which means a costly revenue loss. Hence, the need to review the legislative and implementation procedures with regard to transfer pricing. Reasons for having a uniform transfer pricing system. Although, the reasons can be many, a few ones that are more prominent are given below: Corporations that have same circumstantial environment with regard to the transfer of goods, services etc, are not treated uniformly by the administrative officials while implementing the section 482 requirements. The need, therefore is to have technical expertise within the system responsible for implementation of section 482, while providing for better coordination among the institutions, technically, by involving attorneys, economists and international examiners. This will help in deriving a smooth and uniform transfer pricing strategy. The exercise can be unproductive resulting in revenue loss for the authorities, as many multinationals will try to invest certain tax liability reduction amount to further claim more gains in the process. This ambiguity needs to be addressed in an effective manner. Keeping the above in view, there is a need to reform and modify the interpretive regulations of the treasury and IRS, as well as the administrative procedures adopted for dispute resolution. This will certainly help in bringing the gap closer between the mandated figures and actual collections. Alternatively, the US congress can amend and reform the legislative laws to be more prudent and in line with the actual ground situation. (As published in book, “Transfer pricing” by King Page-6-9) Tax Reforms Act of 1986 The US Congress amended section 482 in 1986 with certain tax reforms incorporated in the same, particularly with reference to the transfer prices of assets as certain substantial sums of taxable income was being shifted off-shore outside the country to save on the taxes. In the tax reforms act of 1986, this ambiguity was removed to certain extent by adding to the statute that any transfer or license of any intangible property under section 936(h)(3)(B) which involved income paid to the transferor by way of license fees or otherwise shall be part of the income attributed to the particular intangible asset. However, the Congress committee report accompanying the amendment act of 1986 also suggested concept of some “periodic adjustment” in the amount paid for such transfer, as the income attributable to such property may change in future due to certain circumstances, that were not factored at the time of transfer. But this suggestion did not find its way into the final statutory clause of 1986 amendments. In addition to the above, the congress committee report also directed the treasury department to act as per the following guidelines. This was done to be in line with the “arm’s length” principle, while implementing the “commensurate with income” requirement that may make it necessary to modify the existing rules. 1. The income derived from transferred intangible property should be the basic factor to determine the transfer prices for such assets. 2. As both the licensor and licensee involved in the transfer of license of such assets carry certain amount of risks, the allocation of the income as result of the transfer should reflect the contribution of each party with regard to the risks and economics involved. 3. There may be cases where the changes in the income due to the intangible asset occur, not foreseen at the time of the initial transfer. Therefore, such major changes in the income should result in the corresponding changes in the related transfer payments. 4. While the valid agreements between the parties towards cost sharing pattern will be permitted as before, such agreement should be well written and each party should make genuine and trust worthy effort to share the cost of research and development, keeping in view the benefits proportionately attributable to them from the same. The interpretive guidelines needed for implementation of these statutory changes have kept the treasury department and IRS officials engaged. Hence, an attempt in this direction resulted in the formation of a discussion paper issued on Oct 18, 1988, also called “White Paper” Further certain revised temporary regulations were released on Jan 24, 1992 and finally over ridding the same temporary revised regulations of April 1993 came into force which remain effective at present. These regulations specifically address to the pricing methodology adopted with regard to the transfer of intangible property, within a controlled group. The 1993 regulations relate in detail to the profit split methodology, to be applied under certain special conditions. However, there have been reservations to the 1993 regulations and the main representation came from the Tax Executives Institute, which have subsequently filed their plea with the authorities, while commending for the bold amendments made to earlier rules through the 1993 regulations. ( as reported in book-“Transfer pricing” by .. King.. page 21 to 26) Tax Executives Institute (TEI) plea Tax executives institute being a leading corporate tax association having around 4800 members representing 2400 corporate business in North America, usually advises its members on the best tax planning and administrative procedures. The institute filed certain comments towards the compliance of IRS temporary and proposed regulations under IRC 482, with regard to inter company transfer pricing. IRS issued these regulations on Jan 13, 1993. Subsequently these regulations were published on Jan 21 in the federal register and in the internal revenue bulletin on March 8. Along with these temporary and proposed regulations, IRS also issued other proposed rules under section 6662(e) and 6662(h) of the code, providing for imposition of penalties under section 482 for any miscalculations and gross violations. TEI filed its comments against this in April 1993. While commending IRS for removing certain controversies raised by the issuance of 1992 regulations like Comparable profit interval (CPI) checks, related with the pricing methodology, it did show its concern on the requirement of too much documentation, limits on the profit split use and other methods to arrive at the transfer price. As these are interconnected with the proposed penalties, TEI wanted the resolution of same The penalties regulations are based on the experience of IRS examinees, who think that the inter company pricing methodology and its explanation is not properly documented. However, TEI has made a plea that the excessive documentation required under the revised rules of 1993 will result in wastage of time while being an expensive affair as well. TEI has further pleaded that the requirement of documentation should be reduced to bare minimum so that it is not a burden to the taxpayer, resulting in discouragement of filing the returns properly. As the temporary regulations requirement relates to taxpayers to do the mandatory analysis of all their cross border transactions, those tax payers that do routine transactions will find such regulations quite cumbersome. Thus, TEI has pleaded that the total amount of documentation and functional analysis required should vary from corporate to corporate, depending on the nature of their inter company transactions. Certain companies that have internal comparable uncontrolled price audit should not be required to produce excessive documentation, as the internal comparables should suffice the purpose. With reference to the profit-split methodology, TEI feels that the same is a one way road as the IRS officials can question the use and procedure adopted for this purpose, while the taxpayer cannot appeal under this method to defend its tax structure. Further, the regulations require that the taxpayers under the expanded use of profit-split methodology make a binding election to its use while following the other procedural requirements. TEI has been most concerned with the provisions of the temporary regulations with regard to the penalty imposition for transfer pricing under section 6662(e) of IRC 482. While TEI feels that the penalty imposition stipulated for certain procedural failures cannot be treated at par with the penalties imposed for non-complaint behavior towards the payment of required taxes. The main plea of TEI has been that the regulations should not be an overburden on the taxpayer in terms of more than required documentation and procedural wrangles, which may not result in any substantial revenue gain. While commending on the revised regulations of 1993 that have replaced the earlier rules of 1992, TEI is of the opinion that the new regulations of 1993 must be further reformed and clarified while taking into account the method of transactions and other business procedures adopted by the multinationals in the current scenario.... ( TEI bulletin... page 1 to 4) Some basics of transfer pricing methodology under section 482 IRS have laid out certain factors under the IRC 482- IT (c) (1) Temp. Regulations section 1, for determining the transfer pricing methodology for comparing such pricing methods used by controlled taxpayers and uncontrolled tax payers under same comparable conditions, while engaged in comparable transactions. The factors used for evaluating such comparability will broadly be the following as per the guidelines of the authorities: (a) Functions and risks To determine the importance and relevance of the pricing method used, the regulations clearly define that the analysis of functions and risks are necessary for application of any pricing method. Further, the regulations state that two companies having identical products or two transactions involving same type of products cannot be sufficiently comparable for the purpose of “cup method” pricing, if their functions and risks as well as other factors are different. However, TEI feels that functional analysis is an economic exercise and not a tax or accounting practice and this analysis may require the costly services of an expert economist. Therefore, TEI has suggested that instead of having a blanket mandate for such analysis, IRS should take a flexible approach keeping in view that the exercise does not put unnecessary burden on the taxpayer for analyzing data. Hence, the taxpayer may be permitted to represent their cases under various pricing procedures like CUT or CUP method etc.. (b) Contractual terms and economic conditions The pricing methodology, using the comparables as the basis of derivation needs to factor various mutual terms of agreement and economic conditions prevalent at the time of such transfer of assets or services. However, the IRS officials and other implementation as well as administrative staff have to be satisfied with sufficient documentation justifying the pricing methodology thus used for such transfers. TEI again feels that the documentation required is more of a waste as it will result in additional burden on the taxpayer with increased expenses, without realizing any substantial changes in the revenue gains...(TEL publication page 5) Bibliography Works cited references IRS, transfer pricing, Internal Revenue Service, United States Treasury deptt. Publication page for transfer pricing and section 482, updated Nov. 28, 2007.. Ref: IRS transfer pricing publication, June 9 2008 MODIFICATION OF REV. PROC. 2006-9 Section 2.01 of Rev. Proc. 2006-9 Ref: King A. Elizabeth, “Transfer pricing and valuation in corporate taxation” (page 1 to 5) published by Published by Springer, 1994 ISBN 0792393929, 978079239392 King A. Elizabeth, “Transfer pricing and valuation in corporate taxation” (page 5 to 7) published by Published by Springer, 1994 ISBN 0792393929, 978079239392 King A. Elizabeth, “Transfer pricing and valuation in corporate taxation” (page 6 to 9) published by Published by Springer, 1994 ISBN 0792393929, 978079239392 King A. Elizabeth, “Transfer pricing and valuation in corporate taxation” (page 21 to 27) published by Published by Springer, 1994 ISBN 0792393929, 978079239392 Temporary and proposed section 482 regulations – inter company transfer pricing, Tax The Executive bulletin Sep-Oct 1993, page 1 to 4. Ref: Temporary and proposed section 482 regulations – inter company transfer pricing, Tax The Executive bulletin Sep-Oct 1993, page 5. Ref: SOURCES King A. Elizabeth, “Transfer pricing and valuation in corporate taxation” published by Published by Springer, 1994 ISBN 0792393929 Temporary and proposed section 482 regulations – inter company transfer pricing, Tax The Executive publication Sep-Oct 1993, Ref: Read More