Comparability Analysis for Tangible Goods Transactions, Lecture notes of Functional Analysis

Download Comparability Analysis for Tangible Goods Transactions and more Lecture notes Functional Analysis in PDF only on Docsity! LB&I International Practice Service Process Unit – Overview Shelf Business Outbound Volume 1 Income Shifting Outbound UIL Code N/A Part N/A N/A Level 2 UIL N/A Chapter N/A N/A Level 3 UIL N/A Sub-Chapter N/A N/A Unit Name Comparability Analysis for Tangible Goods Transactions – Outbound Document Control Number (DCN) ISO/PUO/V_1_01(2014) Date of Last Update 09/04/2014 Note: This document is not an official pronouncement of law, and cannot be used, cited or relied upon as such. Further, this document may not contain a comprehensive discussion of all pertinent issues or law or the IRS's interpretation of current law. 2 DRAFT 2 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Table of Contents (View this PowerPoint in “Presentation View” to click on the links below) Introduction Process Overview Detailed Explanation of the Process Process Applicability Summary of Process Steps Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Comparability Analysis for Tangible Goods Transactions – Outbound 5 DRAFT 5 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A A comparability analysis, including the functional, risks, contractual and economic analyses, is a tool used to establish the facts and circumstances for IRC § 482 issues. While this analysis is a critical part of any transfer pricing audit, it may also be useful in analyzing a variety of tax issues other than transfer pricing, such as:  Non-income Shifting Transfer of Intangibles  Substantial Contribution to Contract Manufacturing (Subpart F exception)  Domestic Production Deduction  Worthless Stock deductions (under IRC 165(g)(3))  Research and Experimental expenditure identification This Building Block will not cover the analysis in these above mentioned areas. However, members of the domestic and international audit team and specialists should coordinate information gathering to avoid duplication of work for the exam team and/or making duplicative requests for information from the taxpayer. Back to Table Of Contents Introduction (cont’d) 6 DRAFT 6 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Process Overview Comparability Analysis for Tangible Goods Transactions – Outbound Taxpayer’s documents may not provide enough information to analyze all the functions, assets, risks, terms, economic conditions, property and services related to controlled transactions. Sometimes information provided by the taxpayer needs to be verified as part of the due diligence process. The examiner should know how to conduct a comparability analysis to determine the degree of comparability of transactions between related parties as compared to unrelated parties. Comparability analysis involves tracing the transaction at various stages from conceptualization to final sale. The comparability factors listed in Treas. Reg. 1.482-1(d)(3) are:  Functions  Contractual Terms  Risks  Economic Conditions  Property or Services Comparability analysis requires examination of all factors that may impact comparability. It is important to note that the comparability factors are interrelated and that the list of factors in Treas. Reg. 1.482-1(d)(3) is not an exhaustive list. There may be other unlisted factors that could materially affect comparability. Thus, a comparability analysis may require consideration of factors not discussed in this Process Building Block. All the factors of comparability are related and must be looked at in tandem. For example, the fact that two parties perform identical manufacturing functions is virtually irrelevant if no consideration is given to the other factors, such as the contractual terms or economic conditions. The examiner should identify and understand all the economically significant activities performed in connection with the controlled transaction. An economically significant activity is one that materially affects the price charged in a transaction and the profit earned from a transaction. Back to Table Of Contents Comparability Analysis for Tangible Goods Transactions – Outbound 7 DRAFT 7 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A After completing the comparability analysis and reviewing all the factors that might affect comparability, the examiner can determine if the comparables relied upon by the taxpayer are appropriate or whether they require adjustments or perhaps an alternative set of comparables is necessary. The focus of this Building Block is how to conduct a comparability analysis relating to the transfer of tangible goods between controlled parties and will focus on the use of the Comparable Profits Method (CPM). This analysis is conducted on the entity that engages in routine activities and is the least complex of the controlled taxpayers (tested party). The tested party in a tangible goods transaction is typically the distributor. Distributors generally are the least complex entity in a controlled party enterprise and generally do not own valuable intangibles or unique assets that would distinguish it from potential uncontrolled comparables. Although this Building Block focuses on comparability analysis for an outbound distributor, a similar analysis can be applied in a situation where a foreign MNE is the manufacturer and a U.S. entity/subsidiary is the distributor. See IPS Unit ISI/PUO/V6.7.1_01(2014): Comparability Analysis for Tangible Goods Transactions – Inbound. This Building Block does not cover how to select the “best method.” For selecting the best method see the IPS unit entitled Best Method Determination of an Inbound Distributor ISI/9422.09_04. While that unit is for an inbound transaction, the concepts are the same and can also be applied to an outbound transaction. NOTE: The functional analysis is only one of the five factors of comparability listed in the regulations. In practice, often the term “functional analysis” is used to describe the complete “comparability analysis.” Technically, the regulations describe the functional analysis as limited to the evaluation of the functions performed and resources employed by taxpayers in transactions. Comparability analysis includes all of the five factors listed in Treas. Reg. 1.482-1(d)(3), including the functional analysis. Back to Table Of Contents Process Overview (cont’d) 10 DRAFT 10 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A A comprehensive comparability analysis generally includes physically touring the taxpayer’s sites of operation. The observations made during a site visit will result in a thorough understanding of the comparability factors and will enable the examiner to identify additional issues. As a result, the examiner’s report will have better descriptions of facts. Prior to an interview or site visit the examiner should:  Identify personnel to be interviewed and sites to be visited;  Determine which Service personnel will attend and participate in asking questions;  Agree and coordinate interviewees (with taxpayer);  Prepare a list of topics to be covered and outline of questions in advance;  See IRM 4.61.3-1 Exhibit, On-Site Visitations. The Examiner should identify personnel to be interviewed and sites to be visited.  Find out who the decision makers are for each of the comparability factors under analysis.  Obtain organizational charts for each transacting party. The charts should identify entities, departments, personnel, and the functions they perform and risks they assume and to whom personnel report.  Obtain personnel credentials including skill level and education possessed.  Obtain personnel compensation levels including salaries, bonuses and stock based compensation.  Obtain job descriptions.  Request employee performance evaluations if relevant to the transfer pricing analysis. Detailed Explanation of the Process (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Back to Table Of Contents 11 DRAFT 11 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Detailed Explanation of the Process (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Analysis In some instances, it may be necessary for the examiner to interview personnel no longer employed by the taxpayer. The purpose of an interview and on-site visitation is to identify the functions performed, contractual terms, risks assumed, economic conditions and property or services provided. The Service personnel responsible for identifying and developing issues should attend interviews and site visits including: the examiner; the economist assigned to the case; and the manager responsible to the issue. If the taxpayer’s operations are highly technical, an engineer should attend the site visits and interviews. Consider inviting Counsel to attend any interviews or site visits. The Service personnel attending interviews and site visits should choose a primary interviewer in advance. Usually an experienced team member is chosen as a primary interviewer. Service personnel not acting as the primary interviewer should plan on taking notes. Notes should be compared among team members. The Examiner should coordinate interview and site visits with the taxpayer. The examiner and the taxpayer should agree:  Who will be interviewed,  Which sites will be toured;  A timetable for the interviews and site visits; and  The length of time allowed for each interview; allowing enough time for note taking and follow-up questions. A site visit may involve a tour of various facilities. The examiner should get a description of what will be toured and know which taxpayer personnel they will be meeting with beforehand. It may be convenient to interview personnel the same day the facilities are being toured. Therefore, obtaining a list of personnel and their work location can prove helpful. Back to Table Of Contents 12 DRAFT 12 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Special planning needs to be taken when planning a foreign site visit. Examiner should obtain a written invitation from the taxpayer’s foreign affiliate. The foreign government will need to know that the foreign affiliate has granted permission for the visit. Examiner should request permission to travel abroad well in advance. Foreign travel requests. Once you have collected all the information regarding the comparative analysis, get formal concurrence from the taxpayer that the information documented is factually correct. An efficient way of doing this is to issue an IDR with all the facts gathered and ask the taxpayer to provide any corrections and/or additional information. Attempt to resolve any open issues with the taxpayer. This document should be part of the case file and included in Form 886A. Back to Table Of Contents Detailed Explanation of the Process (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Analysis 15 DRAFT 15 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Summary of Process Steps (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Process Steps The key factors that determine comparability (functions, contractual terms, risks, economic conditions, and property or services) should all be addressed as part of the comparative analysis. After performing the first five steps it will be possible to evaluate in Step 6 whether the controlled transaction is comparable to transactions between unrelated parties in order to establish whether the controlled transactions are priced at arm’s length. Step 5 How to conduct a property and services analysis. Step 6 How to determine if transactions are comparable based on the factors analyzed in the comparability analysis. Back to Table Of Contents 16 DRAFT 16 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 1: Functional Analysis Comparability Analysis for Tangible Goods Transactions – Outbound Step 1 Functional analysis involves tracing the flow of products at various stages from the conceptualization to final sale to understand what entities perform which functions Considerations Resources Functional Analysis involves tracing the flow of products at various stages from the conceptualization to its final sales. The stages may include:  Conceptualization  R&D  Various stages of production  Testing and quality control  Assembly, packaging and labeling  Inventory management  Transportation and warehousing  Marketing and promotion  Sales or internal use  Warranty administration  Various stages of financing the production and inventory  Treas. Reg. 1.482-1(d)(3)(i), Functional analysis  Transfer Pricing Roadmap [Plan the audit timeline and discuss the timeline with your manager and team coordinator.]  IRM 4.61.3-4 Functional Analysis Questionnaire  Checklist - IRC 482 Transfer Pricing Case Development Tool  Transfer Pricing Study  Intercompany Agreements Back to Table Of Contents 17 DRAFT 17 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 1: Functional Analysis (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 1 Functional analysis involves tracing the flow of products at various stages from the conceptualization to final sale to understand what entities perform which functions. Considerations References / Resources In order to understand specific processes performed by USP and CFC, inquires need to be made into :  Manufacturing;  Selling and distribution;  Assets, including intangible assets; and  Resources employed Determine if you need to take the following actions to gather information to understand the specific processes-  Do you need to issue IDRs or summons?  Do you need to interview taxpayer employees?  Do you need to contact IRS engineers?  Do you need to contact third parties (outside experts, former employees)?  Do you need to visit taxpayer’s sites related to transactions?  Treas. Reg. §1.482-1(d)(3)(i), Functional Analysis  Transfer Pricing Study  Transfer Pricing Roadmap  IRM 4.61.3-4 Functional Analysis Questionnaire  Checklist - IRC 482 Transfer Pricing Case Development Tool  IRM 4.61.3.4.5 – How to Develop a Section 482 Case  OJT for IEs-Development of Transfer Pricing Sec 482 Issues Back to Table Of Contents 20 DRAFT 20 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Considerations Resources Form of consideration charged or paid: Determine if the form of consideration paid was cash, accounts receivable, a debt instrument, or other form of consideration. Verify the above terms by reviewing the general ledger for an accounts receivable account related to the inventory purchase. Verify that the contract, invoice and general ledger accounts are all coordinating such that the substance follows the form. Sale or purchase volume: The examiner will need to identify the quantity of product purchased by CFC from USP. Generally, market dynamics indicate that a higher purchase volume will result in a lower purchase price because of volume discounts. However, this could be dependent on the industry in which the taxpayer participates. Not all markets are the same. A minimum or required purchase volume could reduce CFC’s profit if the sub cannot sell all the inventory and the inventory can not be returned.  Transfer Pricing Roadmap  Transfer Pricing Study  Intercompany Agreements  Invoices  Books and Records (G/L, Receivables and Payables Ledger, etc.)  Treas. Reg. §1.482-1(d)(3)(ii)(C), Contractual term - Example 1 Step 2: Contractual Terms (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 2 A contractual terms analysis requires analyzing the tangible property sale to discover the terms and conditions of the sale. Back to Table Of Contents 21 DRAFT 21 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 2: Contractual Terms (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 2 A contractual terms analysis requires analyzing the tangible property sale to discover the terms and conditions of the sale. Considerations Resources Scope and terms of warranties provided: Identify the warranties provided and which party is responsible for processing, repairing and paying any claims. Generally, a distributor will not be liable for warranties. Most often, the manufacturer is responsible for the warranty and replacement of defective goods. Rights to updates, revisions or modifications: Today, products are constantly going through design improvements. The contract generally determines if a taxpayer is eligible for these improvements automatically, or if they would need to be separately negotiated. The contract(s) should be read to see if there is any language addressing design improvements. If not, determine how design improvements are dealt with or controlled. Determine if the taxpayer is eligible to automatically receive inventory subject to updated design specifications or if a new contract is required to be negotiated.  Treas. Reg. §1.482-1(d)(3)(ii)  Transfer Pricing Roadmap  Transfer Pricing Study  Intercompany Agreements  Invoices  Books and Records (G/L, Receivables and Payables Ledger, etc.) Back to Table Of Contents 22 DRAFT 22 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 2: Contractual Terms (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 2 A contractual terms analysis requires analyzing the tangible property sale to discover the terms and conditions of the sale. Considerations Resources Duration of relevant licenses, contracts or other agreements, and termination or renegotiation rights: Contracts can be short-term (one year or less) or long-term (greater than one year). A longer term contract provides more stability. Rights to terminate or renegotiate can mitigate transactions or potential trouble areas not foreseen (e.g. labor, economy or weather). Determine how termination rights are handled. Determine if modification rights exist and how they are handled. Collateral transactions or ongoing business relationships between parties including ancillary or subsidiary services : Identify if other transactions, business relationships or services exist between the buy and seller. A better price may be negotiated depending on the relationship between the buyer and seller and how many different transactions for products and/or services are involved. (For example; it is cheaper to purchase bundle services from your cable provider to get telephone, cable and internet service combined as opposed to pricing each service out separately.)  Treas. Reg. §1.482-1(d)(3)(ii)  Intercompany Agreements  Transfer Pricing Roadmap  Transfer Pricing Study Back to Table Of Contents 25 DRAFT 25 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 3: Risk Analysis (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 3 Considerations Resources The results found from the risk analysis of the US Sub transaction will be used to find comparable internal or external transactions to evaluate the intercompany transfer price. There are several significant risks that could affect the comparability of the transaction(s). The particular facts and circumstances of each case must be addressed. CONSULTATION: Consult with Counsel, Economist, Financial Products Specialist and/or Transfer Pricing Specialist as necessary. The Specialists can assist in assessing many areas of risk with the related party transaction(s).  Treas. Reg. §1.482-1(d)(3)(iii), Risk  IRM 4.61.3 - Development of IRC 482 Issues IRM 4.61.3.5.3, Risk Analysis Back to Table Of Contents 26 DRAFT 26 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 3: Risk Analysis (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 3 Risk analysis requires identification of which related party bears each type of significant risk. Considerations Resources The following, not all inclusive, is a list of potential risks to examine. In each case, an interview of the taxpayer should be performed to develop the particular facts and circumstances.  Market risk  Inventory risk  Product liability risk  Warranty risk  Credit risk  Foreign exchange risk  Advertising and marketing risk  Research and development risk  Intangibles risk  General business risks related to the ownership of property, plant and equipment.  IRM 4.61.3 - Development of IRC 482 Issues IRM 4.61.3.5.3, Risk Analysis  Transfer Pricing Roadmap  Transfer Pricing Functional Analysis Questionnaire Back to Table Of Contents 27 DRAFT 27 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 3: Risk Analysis (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 3 Risk analysis requires identification of which related party bears each type of significant risk. Considerations Resources Market risk : The risk that the distributor may be unable to resell the products at a price that will allow it to generate a profit or may be unable to resell the products (at all). This risk may result from business cycles, increased competition, declines in market demand, or changes in market perceptions. Normally, distributors bear market risk. Identify which party bears market risk. Inventory risk : The risk to the change in value of raw materials, work in process and finished goods due to changes in market prices, damage, defects, or obsolescence. A distributor would normally hold inventory of finished product. Determine which party bears inventory risk.  Transfer pricing study  Intercompany agreements  Purchase contracts and invoices  Internal manuals on inventory processing  Trial balance  Audited financial statements Back to Table Of Contents 30 DRAFT 30 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 3: Risk Analysis (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 3 Risk analysis requires identification of which related party bears each type of significant risk. Considerations Resources Advertising and marketing risk: The risk associated with spending to promote the brand and other marketing intangibles to achieve intended results. Distributors should generally not be the economic owner of valuable brand intangibles and would not bear the related costs. Distributors may have marketing intangibles, such as corporate name, customer list, customer relationships, etc. Determine which party incurs advertising and marketing risk. Research and development (R&D) risk: The risk of unsuccessful R&D spending. Risk may include failure to produce new product, product improvement or design, intangible asset, etc. which assist the company in increasing profits. Distributors do not generally incur any R&D costs. Identify which party incurs research and development risk.  Transfer pricing study  Intercompany agreements  Financials  Trademark and trade name registrations Back to Table Of Contents 31 DRAFT 31 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 3: Risk Analysis (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 3 Risk analysis requires identification of which related party bears each type of significant risk. Considerations Resources Intangibles ownership risk: The risk of obsolescence of existing intangibles and the risk of infringing on the intellectual property (IP) rights of unrelated enterprises. Distributors generally are not the economic owners of any valuable intangibles. Determine which related party assumes intangibles ownership risk. General business risks: The risks related to the ownership of property, plant and equipment (PP&E). The risk of ensuring the PP&E is protected against physical loss, wear and tear, obsolescence, or damage. Determine which party bears the general business risks.  Royalty agreements  Intercompany licensing agreements  U.S. Patent & Trademark Office  Financial Statements  Books and records  Property records search (Accurint)  Insurance policies Back to Table Of Contents Comparability Analysis for Tangible Goods Transactions – Outbound Step 4 An economic conditions analysis requires a comparison of the significant economic conditions that could affect the prices that would be charged, or the profit that would be earned, in each of the transactions. 32 DRAFT 32 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Considerations Resources In order to determine the degree of comparability of the controlled transaction with an uncontrolled comparable transaction it is necessary to compare the economic conditions that could affect the price of the transaction or the profit resulting from the transaction. The following economic conditions can affect prices or profits:  Similarity of geographic markets;  Relative size of each market and its level of economic development;  Level of the market;  Applicable market shares for the relevant products, properties or services;  The location specific costs of production and distribution;  Extent of competition in each market for the relevant products or services;  Economic condition of the particular industry; and  Alternatives realistically available to the buyer and seller.  Treas. Reg. §1.482-1(d)(3)(iv), Economic conditions  IRM 4.61.3 - Development of IRC 482 Issues IRM 4.61.3.5.5, Economic Conditions CONSULTATION: Consult with Counsel, an Economist, or a Transfer Pricing Specialist to assist in determining if economic conditions are comparable to the transaction being analyzed. Back to Table Of Contents Step 4: Economic Conditions 35 DRAFT 35 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 5: Property and Services Comparability Analysis for Tangible Goods Transactions – Outbound Step 5 A property and services analysis requires analyzing the tangible property sale to discover if any other property or any services are embedded in the transaction. Considerations Resources A property and services analysis requires analyzing the tangible property sale to discover if other property or services are embedded in the transaction. Any additional property or services embedded in the transaction will also need to be considered for the comparables selected. There may be circumstances where the embedded property or service must be separately evaluated, and there may be other situations where the property or services may need to be aggregated. The tangible property sale invoice and/or contract may not discuss embedded property or services. Therefore, the examiner may need to take additional steps to ensure the distributor has no additional embedded property or services in the transaction that would need to be valued. An example of embedded property could be a valuable intangible asset which accompanies the tangible inventory product or inventory may come with free service repair for one year. These items could be valuable embedded property or services. The facts and circumstances of each case will dictate whether there is audit risk in this area. This analysis will occur concurrently with the other comparability factors analysis.  Treas. Reg. §1.482-1(d)(3)(v), Property or services  Treas. Reg. §1.482-3(f), Coordination with intangible property rules and -9(m)(1), Coordination with transfer pricing rules for other considerations for separate evaluation of embedded transactions  IRM 4.61.3 - Development of IRC 482 Issues IRM 4.61.3.5.6, Property and Services  Form 5471 Information Return of U.S. Persons With Respect to Certain Foreign Corporations (Schedule M) Back to Table Of Contents 36 DRAFT 36 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 6: Comparability Comparability Analysis for Tangible Goods Transactions – Outbound Step 6 Finding an exact comparable will be highly unlikely. An examiner will need to evaluate comparables that are not exact but are very similar to CFC. Considerations Resources To determine the correct arm’s length price for the sale of the inventory you must find comparable transactions to compare the taxpayer related-party transactions. Comparable transactions do not need to be identical to the taxpayer’s controlled transaction. The comparable does need to be sufficiently similar so that it provides a reliable measure of an arm’s length result. For all transfer pricing methods, the degree of comparability between the tested party (controlled taxpayer) and the uncontrolled taxpayer (comparables) depends on all the relevant facts and circumstances. One pricing method, the Comparable Profits Method compares the profitability of the tested party, measured by a profit level indicator (PLI), to the profitability of uncontrolled taxpayers in similar circumstances. PLIs are generally based on operating profit. Operating profit is usually less sensitive than gross profit to product differences. Therefore, reliability under the CPM is less dependent on product similarity than other methods. This means that when using the CPM, the products will not need to be exactly the same.  Treas. Reg. §1.482-1(d)(2), Standard of comparability  Transfer Pricing Study  IPS Unit: CPM Simple Distributor Inbound ISI/9422.07_07(2013) discusses how to use the CPM method as applied to a distributor  IPS Unit: Comparability Analysis for Tangible Goods Transactions Inbound ISI/9422.07_01 thru _06(2013) for an inbound distributor discusses selection of the tested party Back to Table Of Contents 37 DRAFT 37 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Step 6: Comparability (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Step 6 Finding an exact comparable will be highly unlikely. An examiner will need to evaluate comparables that are not exact but are very similar to CFC. Considerations Resources To following steps can be used to evaluate comparables:  Review the comparables from the taxpayer’s transfer pricing study. The comparables may be attached as an exhibit to the transfer pricing study or the examiner may need to request them.  Also request the rejected comparables and the evaluation process and steps used to narrow the comparables.  The examiner must evaluate these comparables and decide if the Government agrees with the list of comparables. The examiner should search for additional comparables using Capital IQ.  Economists have access to Compustat and if assigned to the case will also evaluate the comparables and search for additional comparables.  Findings should be shared with the taxpayer. Any differences should be discussed with the taxpayer.  Transfer pricing study  Capital IQ  Compustat Back to Table Of Contents 40 DRAFT 40 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Examples of the Process Comparability Analysis for Tangible Goods Transactions – Outbound Description The following examples illustrate how comparability impacts the selection of comparables. BAA Co is labeled as a wholesale parts distributor in CFC’s comparables. However, further investigation shows it is a parts manufacturer and a distributor. BAA does not segment its financial data and it is impossible to reliably extract the distributor profit from the manufacturer profit. This demonstrates the importance of looking to the actual activity of a potential comparable. The example demonstrates the importance of performing research into the actual activity of the comparable. If the financials had been segmented, it may have been possible to use BAA Co as a comparable, but without segmented data (as in this example) there is no reliable way to use BAA Co’s financial data for assessing results from its distribution activities. MAA Co is labeled as a wholesale parts distributor in CFC’s comparables. The company is a public company and vast data is available online. It is determined that while MAA Co is a parts distributor, it also repairs the parts it distributes and does all the warranty service on the parts. However, reliable segmented data was available. The Economist reviewed the data and felt that reliable adjustments could be made and were made properly in the transfer pricing study. The example demonstrates that segmented data can be used and reliable adjustments can be made to meet the standards of comparability. The International Examiner and Economist should work together to perform the comparability analysis. Back to Table Of Contents 41 DRAFT 41 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Examples of the Process (cont’d) Comparability Analysis for Tangible Goods Transactions – Outbound Description The following examples illustrate how comparability factors impact the selection of comparables PAA Co is labeled as a wholesale parts distributor in CFC’s comparables. The entity reports a loss. Further examination shows that the business is in the start up phase. The Government rejects the comparable due to the stage of business cycle. The loss reported was not the imperative fact; the imperative fact was the stage of the business cycle. The example demonstrates that loss companies can be used as comparables and should not be rejected due to a reported loss. The example also demonstrates the importance of looking beyond the loss for the reason of the loss. A start up company is not generally comparable to an established company. DAA Co is labeled as a wholesale parts distributor in CFC’s comparables. Upon reviewing the comparable data used by the taxpayer, the examiner notices that for the three year’s subject of the calculation, two year’s have N/A listed as the profit. A Capital IQ and Compustat search for this company also show only one of the three year’s worth of data reported. The Government rejects the comparable due to lack of data. The example demonstrates that multiple year’s worth of data must be used to calculate an accurate arm’s length price. If three year’s worth of data is being used to calculated the arm’s length price and two of those year’s worth of data are missing for the comparable company, then the comparable may likely need to be removed from the comparable set. Using only one year’s worth of data may unduly influence the results, especially in a period of rising or falling economy. Back to Table Of Contents 42 DRAFT 42 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Training and Additional Resources Comparability Analysis for Tangible Goods Transactions – Outbound Type of Resource Description(s) and/or Instructions for Accessing References CENTRA sessions  2012 (IBC) CPE CENTRA - Performing Functional Analysis by Engineering International Issues Team (HHR344383).  2011 (TPO) CPE CENTRA - Economic Analysis (Day 3)  2011 (TPO) CPE CENTRA - Risk and Comparability (Day 3)  2013 (TPO) CPE CENTRA - PLIs in a CPM World (FPM304428)  2012 (TPO) CPE CENTRA - Comparable Profits Method (LHL430034)  Text Issue Toolkits  Overview of IRC 482  Transfer Pricing Roadmap  Transfer Pricing Functional Analysis Questionnaire  IRM 4.61.3.4.5 – How to Develop a Section 482 Case  Checklist – IRC § 482 (Transfer Pricing)  Text Back to Table Of Contents 45 DRAFT 45 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Acronym Definition TP Transfer Pricing UIL Uniform Issue List USP United States Parent UTP Uncertain Tax Position WIP Work in Process Back to Table Of Contents Glossary of Terms and Acronyms (cont’d) 46 DRAFT 46 Volume Part Chapter Sub-Chapter [Enter the Volume Name Here] [Enter the Part Name Here] [Enter the Chapter Name Here] [Enter the Sub-Chapter Name Here] Income Shifting Outbound N/A N/A N/A Issue Associated UIL(s) References Embedded Services and Embedded Intangibles 9411.02 IPS Unit to be developed Provision of High Value Services 9422.05 IPS Unit to be developed Sale of Tangible Goods 9411.05 IPS Unit: ISO/9411.05_01(2013) Sale of Tangible Goods from a CFC to a USP CUP Method Overview of IRC Section 482 9411.07 IPS Unit: ISO/9411.07_01(2013) Overview of IRC Section 482 Comparable Profits Method 9422.07 IPS Unit: ISI/9422.07_07(2013) CPM Simple Distributor Inbound Resale Price Method 9422.07 IPS Unit: ISI/9422.07_08(2013) Inbound Resale Price Method Routine Distributor Purchases of Tangible Goods 9422.07 IPS Unit: ISI/9422.07_05(2013) Purchase of Tangible Goods from a FP - CUP Method Best Method 9422.09 IPS Unit: ISI/9422.09_04(2013) Best Method Determination for an Inbound Distributor Arm’s Length Standard 9422.09 IPS Unit: ISI/9422.09_06(2013) Arms Length Standard Back to Table Of Contents Index of Related Issues