Transfer Pricing 2022 Comparisons

In the United States, the rules of transfer pricing are established statutorily in Section 482 of the Internal Revenue Code (the "Code") and regulatorily in the Treasury regulations beginning with Section 1.482-0.

The statute itself is brief, merely one paragraph in length with no subsections. Its role is to establish the government’s authority to reallocate income “in order to prevent evasion of taxes or clearly to reflect the income” among related parties.

The US Department of Treasury ("Treasury") regulations, on the other hand, are extraordinarily detailed and extensive (beginning with Treasury Regulation Section 1.482-0 through 1.482-9), establishing the various valuation methods and transfer pricing rules to be applied in multiple circumstances, such as the provision of loans or advances, the transfer of tangible or intangible goods, or the rendering of services among related parties.

The US Internal Revenue Service (IRS) also regularly issues revenue rulings, revenue procedures, agency directives and any number of other “informal” pronouncements (neither statutes nor regulations) that attempt to address questions of interpretation or enforcement of the transfer pricing provisions.

Finally, there is a long line of federal court decisions that have interpreted Section 482 and the applicable regulations and pronouncements that must be consulted when considering transfer pricing issues.

The government’s authority to regulate the allocation of income between related parties stretches back to regulations that were enacted in 1917. The current Section 482 has its origins in Section 45 of the 1928 Code, which was largely unchanged until revisions in 1986. In 1986, Section 482 was amended to incorporate the “commensurate with income standard” with respect to the transfer of intangible property. More recently, in 2017, Section 482 was amended as part of the Tax Cuts and Jobs Act to capture concepts that previously had been embodied solely in the Treasury regulations, namely with respect to the “aggregation” of transactions among related parties in certain circumstances and the consideration of “realistically available alternatives” when valuing intangible property transfers.

The “lingua franca” of transfer pricing jurisprudence, the “arm’s-length standard”, is not part of Section 482, though, and has never been. However, it has been embodied in US transfer pricing law since the 1920s as part of the Treasury regulations. The Treasury regulations, likewise, have been through multiple revisions and refinements over the years, the most significant being revisions that followed the “1988 White Paper” that had been commissioned by the US Congress to study and evaluate US transfer pricing. That led, in 1994, to the most extensive revisions to the transfer pricing regulations since their inception.

Among the most significant changes that arose out of those 1994 changes was to make clear that in performing transfer pricing valuation, there is no “hierarchy of methods”, which had been a major area of dispute for many years. In other words, in considering all of the various methods available to determine the “best method” that ensures that related parties are pricing their transactions in accordance with arm’s-length standards, there is no method that is preferred over any other.

Moreover, because perhaps the most contentious transfer pricing area in the last 25 years has been related to “cost sharing agreements” with respect to the transfer and development of intangibles, there have been many significant revisions to the regulations on that issue as well in the past 10–15 years. Indeed, in the 1968 version of the regulations, cost sharing consisted of one paragraph. Today, Treasury Regulation Section 1.482-7 (sharing of costs) is arguably among the most detailed and complex provisions of the Treasury regulations related to transfer pricing.

The US transfer pricing rules apply to so-called controlled transactions. The rules do not require technical control (ie, they do not require that one party to the transaction own any specified percentage of another party to the transaction). Instead, the test for determining whether a controlled transaction exists (and therefore whether the IRS can apply the transfer pricing rules to reallocate income) is a flexible test that allows the IRS to apply the transfer pricing rules in cases of common ownership (direct or indirect) but also where there is no technical ownership if the parties to the transaction are “acting in concert” with a common goal of shifting income.

US laws list a number of specific transfer pricing methods that taxpayers can use depending on whether the transfers among related parties relate to tangible property, intangible property (including cost sharing transactions) or services.

With respect to the transfer of tangible property, the methods are:

• the comparable uncontrolled price (CUP) method;
• the resale price method;
• the cost plus method; and
• unspecified methods.

With respect to the transfer of intangible property, the methods are:

• the comparable uncontrolled transaction (CUT) method; and
• unspecified methods.

Transactions involving the transfer of tangible or intangible property are both also subject to evaluation under:

• the comparable profits method; and
• the profit split method, which includes the:
1. comparable profit split method; and
2. residual profit split method.

With respect to cost sharing arrangements specifically, the methods for valuing any platform contribution of intangibles to such an arrangement are:

• the CUT method;
• the income method;
• the acquisition price method;
• the market capitalisation method;
• the residual profits split method; and
• unspecified methods.

With respect to the transfer of services, the methods are:

• the services cost method;
• the comparable uncontrolled services price (CUSP) method;
• the gross services margin method;
• the cost of services plus method;
• the comparable profits method;
• the profit split method; and
• unspecified methods.

Transactions among related parties with respect to loans or advances or cost sharing agreements also have detailed regulatory requirements that must be satisfied to determine whether those transactions are in accordance with arm’s-length principles.

Under US law, all transactions among related parties may utilise an “unspecified” method if it is the “best method” to determine arm’s-length results.

Since 1994, there is no “hierarchy” of methods set forth in the transfer pricing laws of Section 482 of the Code or Section 1.482-0, et seq of the Treasury regulations. However, US courts historically have shown a preference for transactional-based methods, such as the CUT or CUP methods, in appropriate circumstances.

The US has no direct “statistical measure” requirement, other than to the extent that statistics are used as tools within the various specified or unspecified methods.

The “arm’s-length range” acknowledges that often the arm’s-length price of a good or service or profits of an enterprise will be within a range of results and will not be a single point. So long as taxpayers can demonstrate that their results are within that range, then the government will not adjust the prices or profits determined. If, however, the government determines that the taxpayer’s price or resulting profits are outside the taxpayer’s range or a range determined by the government by a same or different method, then the government will adjust the taxpayer’s results accordingly. When a taxpayer’s or the IRS’s analysis produces a range of results rather than a single point, the Treasury regulations generally support use of the interquartile range of those results to evaluate arm’s-length pricing, rather than the full range of results, unless all the data points in the range are of sufficiently high reliability as to warrant use of the full range.

The US requires comparability adjustments. In determining whether transactions are “comparable” in the first instance for purposes of determining whether the taxpayer’s related-party transactions have been conducted in accordance with the arm’s-length standard, there are a number of factors that are to be considered. And, to the extent that there are differences between the related-party transaction and the third-party transaction, adjustments for these comparability factors should be considered as well. These factors for determining (and adjusting for) comparability include, in summary:

• functions performed;
• contractual terms;
• risks assumed;
• economic and financial conditions;
• nature of property or services transferred; and
• special circumstances, such as:
1. market share strategy; and
2. different geographical markets (eg, location savings).

Transfer pricing under US law is governed primarily by Section 482 of the Code and its implementing Treasury regulations, together with the “Associated Enterprises” Article (usually Article 9) of US tax treaties (if a transfer pricing issue involves an associated enterprise in a treaty jurisdiction). The second sentence of Section 482, from which the IRS gets authority to make transfer pricing adjustments, provides: "In the case of any transfer (or license) of intangible property (within the meaning of [section 367(d)(4)]), the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible."

This is called the “commensurate with income” (CWI) standard. When the CWI standard was added to the Code in 1986, “intangible property” was defined in Section 936(h)(3)(B), but in 2017 the definition was expanded to include “goodwill, going concern value, or workforce in place (including its composition and terms and conditions (contractual or otherwise) of its employment)”. The prior version had a residual category, “any similar item, which has substantial value independent of the services of any individual”.  This was revised in 2017 to read “other item the value or potential value of which is not attributable to tangible property or the services of any individual”.

Treasury Regulation Section 1.482-4 governs transfer pricing of intangibles. It points to three specified methods for determining the arm’s-length consideration for the transfer of an intangible – the CUT method (in Section 1.482-4(c)), the comparable profits method (in Section 1.482-5) and the profit split method (in Section 1.482-6) – and to a residual “unspecified method” (in Section 1.482-4(d)), which must satisfy certain criteria.

Section 1.482-4 also provides – in addition to two of the possible methods for determining the arm’s-length pricing in an intangibles transfer – special rules for transfers of intangibles. These include rules implementing the CWI standard (Section 1.482-4(f)(2) – “Periodic adjustments”), rules for determining the owner of intangible property (Section 1.482-4(f)(3)), and rules for determining contributions to the value of intangible property owned by another.

Section 1.482-4 provides the specific methods to be used to determine arm’s-length results of a transfer of intangible property, including in an arrangement for sharing the costs and risks of developing intangibles other than a cost sharing arrangement covered by Section 1.482-7. Section 1.482-7 provides very detailed rules for cost sharing arrangements.

Treasury regulations addressing controlled transactions involving intangible property pre-date and differ slightly from Organisation for Economic Co-operation and Development (OECD) guidance on hard-to-value intangibles (HTVI), which are a subset of intangibles. 

Base erosion and profit shifting (BEPS) Actions 8–10 reports treat the HTVI approach as part of the arm’s-length principle. HTVI are intangibles for which, (i) at the time of their transfer, no sufficiently reliable comparables exist; and (ii) at the time the transaction was entered into (a) the projections of future cash flows/income expected to be derived from the transferred intangibles, or (b) the assumptions used in valuing the intangibles are highly uncertain. If HTVI requirements are met, in evaluating the ex ante pricing arrangements, a tax administration is entitled to use the ex post evidence about financial outcomes to inform the determination of the arm’s-length pricing arrangements.

The HTVI approach will not apply if any one of four exemptions applies.

By contrast, US federal law takes a slightly different approach, applicable not to a special class of intangibles, but rather to all intangibles. In 1986, Section 482 of the Code was augmented with the CWI standard. In 1988, Treasury and the IRS agreed to interpret and apply the CWI standard consistently with the arm’s-length standard (Notice 88-123, 1988-2 C.B. 458, 475). The Tax Court explained that Congress never intended the CWI standard to override the arm’s-length standard (Xilinx, Inc. v Commissioner, 125 T.C. 37, 56–58, aff’d 598 F.3d 1191 (9th Cir. 2010)).

Subparagraph 1.482-4(f)(2)(i) (the “periodic adjustment rule”) implements the CWI standard, providing that if an intangible is transferred under an arrangement that covers more than one year, the consideration charged in each year may be adjusted to ensure that it is commensurate with the income attributable to the intangible. Furthermore, in determining whether to make such adjustments in a taxable year under examination, the IRS may consider all relevant facts and circumstances throughout the period the intangible is used.

Subparagraph 1.482-4(f)(2)(ii) gives five exceptions from application of the periodic adjustment rule. These exceptions to some extent mirror the four exceptions from application of the HTVI rule, but there are differences.  For example, Section 1.482-4(f)(2)(ii)(A) provides that if pricing is based on an exact comparable uncontrolled transaction, then no period adjustment can be made. If a CUT exists, however, then the intangibles, by definition, are not HTVI.

The US recognises research and development cost sharing arrangements. Major versions of Treasury regulations addressing cost sharing arrangements were issued in 1968 (one paragraph), 1995 (15 pages), 2009 (61 pages) and 2011 (77 pages), with amendments along the way. The 1995 cost sharing regulations have been the subject of three large Tax Court cases:

• Veritas Software Corp. v Commissioner, 133 T.C. 297 (2009) (buy-in issue), nonacq. 2010-49 I.R.B.;
• Altera Corp. & Subs. v Commissioner, 145 T.C. 91 (2015), rev’d, 926 F.3d 1061 (9th Cir. 2019), en banc rehearing petition denied, 941 F.3d 1200 (9th Cir. 2019) (validity upheld of requirement to share stock-based compensation costs of intangibles); and
• Amazon.com, Inc. v Commissioner, 148 T.C. 108 (2017), aff’d, 934 F.3d 976 (9th Cir. 2019) (buy-in issue, and pool of intangible development costs).

Currently, there is one docketed Tax Court case addressing the 2009 Temporary regulations’ determination of the “PCT Payment” (the successor of the “buy-in” payment provision under the 1995 regulations).

Treasury regulations under Section 482 do not allow a taxpayer to make an affirmative transfer pricing adjustment after filing a tax return. Section 1.482-1(a)(3) – entitled “Taxpayer’s use of section 482” – provides: "If necessary to reflect an arm’s length result, a controlled taxpayer may report on a timely filed U.S. income tax return (including extensions) the results of its controlled transactions based upon prices different from those actually charged. Except as provided in this paragraph, section 482 grants no other right to a controlled taxpayer to apply the provisions of section 482 at will or to compel the district director to apply such provisions. Therefore, no untimely or amended returns will be permitted to decrease taxable income based on allocations or other adjustments with respect to controlled transactions."

Notwithstanding Section 1.482-1(a)(3), there are at least two established exceptions – one regulatory and one judicial.

The regulatory exception addresses set-offs under Treasury Regulation Section 1.482-1(g)(4). Suppose, for example, that in a taxable year, B pays A an above-arm’s-length price in a controlled transaction. If, with respect to another controlled transaction between A and B, in the same taxable year, the IRS makes a Section 482 adjustment increasing A’s income, then A can use as a set-off against (ie, reduction of) the IRS adjustment the overpayment (ie, excess above arm’s-length amount) A received from B in the different controlled transaction.

The judicial exception ties to a line of cases supporting the proposition that if the IRS makes an adjustment with respect to a taxpayer’s controlled transaction, courts have authority to determine the arm’s-length transfer pricing for the transaction, even if that results in a refund for the taxpayer (see, eg, Pikeville Coal Co. v U.S., 37 Fed. Cl. 304 (1997), motion for reconsideration denied, 37 Fed. Cl. 304 (1997); Ciba-Geigy Corp. v. Commissioner, 85 T.C. 172 (1985)).

Finally, the CWI standard was originally added in 1986 (tweaked slightly in 2017), after the progenitor of Section 1.482-1(a)(3) arose. The language of the CWI standard (“shall be commensurate with the income attributable to the intangible”) nominally applies both to the IRS and to taxpayers. Accordingly, it may be possible for a taxpayer to assert that the CWI standard gives it the right – for example, in the case of a transfer of intangible property – to override Section 1.482-1(a)(3), thereby prohibiting IRS adjustments with respect to the transfer that exceed the actual income attributable to the intangible. This assertion would assuredly be challenged by the IRS; this issue has never been addressed by a court.

The United States is a party to a vast tax treaty network that allows for extensive “exchange of information” (EOI) among countries. EOI agreements generally authorise the IRS to assist and share tax information with non-US countries to enable that state to administer its own tax system and, of course, vice versa. These EOI agreements are memorialised in various forms, including bilateral tax treaties, tax information exchange agreements and multilateral treaties, such as the OECD/Council of Europe Convention on Mutual Administrative Assistance in Tax Matters (the "Multilateral Convention") and the Hague Convention on the Taking of Evidence Abroad in Civil or Commercial Matters (the "Hague Convention").

There are few limits on the types of taxes (income, estate, etc) that may be the subject of EOI requests, although each agreement has particular limits on, or exceptions to, the type of information that may be exchanged or how that information may be used among the “competent authorities” of each state. The US tax treaties in general, however, follow the US Model Treaty, which provides in Article 26(1) that: "The competent authorities of the Contracting States shall exchange such information as may be relevant for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes of every kind imposed by a Contracting State to the extent that the taxation thereunder is not contrary to the Convention, including information relating to the assessment or collection of, the enforcement or prosecution in respect of, or the determination of appeals in relation to, such taxes. The exchange of information is not restricted by paragraph 1 of Article 1 (General Scope) or Article 2 (Taxes Covered)."

Under most EOI agreements with the US, there are few types of information that may not be exchanged. Under many EOI agreements, however, the US is not obligated to exchange information that it deems contrary to public policy or that would disclose trade or business secrets, under the “Business Secret Exemption”. Also, the US, like many European countries specifically, has various “data privacy” laws that likewise may restrict or prevent the taxing authorities from exchanging certain types of information across borders as well.

The United States has a robust, well-developed advance pricing agreement (APA) programme. The programme dates back to the early 1990s, with the first APA completed in 1991. The APA programme used to be located in the IRS’s Office of Chief Counsel, but now is located in the IRS’s Large Business and International Division. In 2012, the APA programme merged with the portion of the US Competent Authority office charged with resolving transfer pricing disputes under the United States’ bilateral income tax treaty network to create the Advance Pricing and Mutual Agreement Program (APMA).

In late 2020, APMA expanded to also include the Treaty Assistance and Interpretation Team (TAIT). TAIT seeks to resolve competent authority issues arising under all other articles of US tax treaties. Since its inception, the United States’ APA programme has executed approximately 2,000 APAs.

APMA administers the APA programme. According to APMA’s most recently published APA annual report, published in March 2021 and covering January through December 2020, at the end of 2019 “the APMA Program comprised 64 team leaders, 21 economists, 9 managers and 3 assistant directors” in addition to the programme’s director. Individual teams include both team leaders and economists. APMA’s primary office is in Washington, DC, but it also has offices in California, Illinois and New York.

Both the APA process and mutual agreement procedures (MAPs) fall under the jurisdiction of APMA, such that the same APMA teams and personnel have responsibility for transfer pricing matters regardless of whether they arise in an APA context or a MAP proceeding.

Generally, APAs are available to any US person (which includes domestic corporations and partnerships) and any non-US person that is expected to file one or more US tax returns during the years that address the issues to be covered by the proposed APA. As stated in Revenue Procedure 2015-41, which governs APAs in the United States, APAs generally “may resolve transfer pricing issues and issues for which transfer pricing principles may be relevant...”  As the Revenue Procedure also states, “APMA may also need to consider additional, interrelated issues, additional taxable years... or additional treaty countries... in order to reach a resolution that is in the interest of principled, effective, and efficient tax administration.”

There are limits on APA access for issues that are, have been, or are designated to be subject to litigation.

APAs can include both prospective (future) years and, where applicable, “rollback” (prior) years. Rollback years are addressed in 7.8 Retroactive Effect for APAs. Designation of the first prospective year of an APA application ties to the timing of the filings of the taxpayer’s tax return for the year and the taxpayer’s APA request. Generally, the first prospective year is the year in which the taxpayer files a complete or sufficiently complete APA request by the “applicable return date”, which is the later of the date the taxpayer actually files its US tax return for the year or the statutory deadline for filing the return without extensions. All proposed APA years ending before the first prospective year will be considered rollback years. For bilateral or multilateral APAs, APMA requires that the taxpayer file its completed APA request within 60 days of having filed its request with the foreign competent authority (bilateral) or authorities (multilateral).

There are user fees associated with seeking an APA. For APA requests filed after 31 December 2018, the fees are USD113,500 for new APAs, USD62,000 for renewal APAs, USD54,000 for small case APAs and USD23,000 for amendments. User fees can be mitigated if multiple APA applications are filed by the same controlled taxpayer group within 60 days.

There is no prescribed limit on the number of years that can be covered by an APA. An APA application should propose to cover at least five prospective years, and APMA seeks to have at least three prospective years remaining at the time the APA is executed. Rollback years, if any, will add to the aggregate APA term. According to APMA’s most recently published APA annual report, the average term length of APAs executed in 2019 was six years, but the full range of terms spanned from one to 15 years.

An APA can cover not only future years, but also prior (or “rollback”) years. Rollback years are the years of an APA term that precede the first prospective year (see 7.5 APA Application Deadlines). A taxpayer seeking rollback coverage should include the rollback request in its APA application, and APMA can suggest, or even require, the addition of rollback coverage when the taxpayer does not request it where the facts and circumstances are sufficiently similar across the proposed prospective and rollback periods. 

Specific US Transfer Pricing Penalties

Transfer pricing penalties under the Code and Treasury regulations

Section 6662 of the Code – entitled “Imposition of Accuracy-Related Penalty on Underpayments” – imposes two specific types of transfer pricing penalties, in addition to other penalties. The penalty regime is somewhat complex, and uses a variety of overlapping terms. The penalties are sometimes formally called “additions to tax”. Subsection 6662(a) provides that if any portion of an underpayment of tax required to be shown on a tax return is attributable to one or more of the causes described in Section 6662(b), there shall be added to the tax an amount equal to 20% of the portion of the underpayment attributable to such cause(s). The “accuracy-related penalties” arising from the causes listed in Section 6662(b) are further named in regulations. Penalties cannot be “stacked” – only one penalty can apply to a given underpayment of tax.

The two transfer pricing penalties are part of the trio of penalties in the “substantial valuation misstatement” penalty under Chapter 1 of the Code (Normal taxes and surtaxes), introduced in Section 6662(b)(3) and described in Section 6662(e) and in Treasury Regulation Sections 1.6662-5 & -6. The 20% penalty is imposed under Section 6662(a) if tax underpayments exceed certain thresholds (described below). Subsection 6662(h) doubles the penalty (to 40%, called a “gross valuation misstatement penalty”) if the tax underpayments exceed doubled upper, or halved lower, thresholds (described below).

The transactional penalty

The first transfer pricing penalty (the “transactional penalty” described in Section 6662(e)(1)(B)(i)) applies if the tax return-reported price for any property or services, on a transaction-by-transaction basis, is 200% or more, or 50% or less, than the correct Section 482 price. For the corresponding gross valuation misstatement penalty, replace 200% by 400%, and 50% by 25%.

The net Section 482 transfer pricing adjustment penalty

The second transfer pricing penalty (called either the “net Section 482 transfer pricing adjustment penalty” or the “net adjustment penalty” described in Section 6662(e)(1)(B)(ii)) turns on the amount of the “net section 482 transfer price adjustment” – in essence, the aggregate of all Section 482 adjustments for a given taxable year – defined in Section 6662(e)(3)(A) as “the net increase in taxable income for the taxable year (determined without regard to any amount carried to such taxable year from another taxable year) resulting from adjustments under section 482 in the price for any property or services (or for the use of property)”. The net Section 482 transfer pricing adjustment penalty applies if the net Section 482 transfer price adjustment exceeds the lesser of USD5 million or 10% of the taxpayer’s gross receipts. For the corresponding gross valuation misstatement penalty, replace USD5 million by USD20 million, and 10% with 20%.

Defending against transfer pricing penalties

Code Section 6664(c)(1) provides in general that no penalty shall be imposed under Section 6662 with respect to any portion of an underpayment of tax if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion (the Reasonable Cause & Good Faith Exception). A substantial body of case law addresses the Reasonable Cause & Good Faith Exception, but almost none in the context of transfer pricing penalties.

Subparagraph 6662(e)(3)(B) excludes from the penalty threshold determinations, for the net Section 482 transfer pricing adjustment penalty, any portion of the increase in taxable income attributable to any redetermination of price if the taxpayer meets three requirements, which depend on whether or not the taxpayer used a specific transfer pricing method. If the taxpayer used a specific transfer pricing method, then Section 6662(e)(3)(B)(i) requires that:

• the taxpayer’s use of the method was reasonable;
• the taxpayer has documentation on its application of the method; and
• the taxpayer gives the documentation to the IRS within 30 days of a request.

Treasury Regulation Subsection 1.6662-6(d) greatly expands on the documentation needed to demonstrate compliance with Section 6662(e)(3)(B). Subparagraph 6662(e)(3)(D) overrides application of the Reasonable Cause & Good Faith Exception to imposition of a net Section 482 transfer pricing adjustment penalty unless the taxpayer meets the requirements of Section 6662(e)(3)(B) with respect to such portion.

The Reasonable Cause & Good Faith Exception applies to prevent imposition of the transactional penalty. Treasury Regulation Section 1.6662-6(b)(3) provides, however, that if a taxpayer meets the Section 1.6662-6(d) requirements with respect to a Section 482 allocation, the taxpayer is deemed to have established reasonable cause and good faith with respect to the item for penalty protection purposes. Thus a taxpayer meeting the requirements of Section 1.6662-6(d) has protection against imposition of either transfer pricing penalty.

Treasury Regulation Section 1.6038-4 – entitled “Information returns required of certain United States persons with respect to such person’s U.S. multinational enterprise group” – provides that certain US persons that are the ultimate parent entity of a US multinational enterprise (US MNE) group with annual revenue for the preceding reporting period of USD850 million or more are required to file Form 8975.

Form 8975 and Schedule A are used by filers to annually report certain information with respect to the filer’s US MNE group on a country-by-country basis. The filer must list the US MNE group’s constituent entities, indicating each entity’s tax jurisdiction (if any), country of organisation and main business activity, and provide financial and employee information for each tax jurisdiction in which the US MNE does business. The financial information includes revenues, profits, income taxes paid and accrued, stated capital, accumulated earnings and tangible assets other than cash.

There is broad alignment of US transfer pricing rules under Code Section 482 with the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (TPG). In 2007 informal guidance, the IRS signalled its belief that Section 482 and its associated Treasury regulations were “wholly consistent with... the OECD Transfer Pricing Guidelines”.  Given US involvement with the creation of the 2017 TPG, that sentiment is likely stronger now.

Both the Section 482 Treasury regulations and the TPG have subdivisions broadly dealing with the arm’s-length standard/principle, transfer pricing methods, comparability, intangibles transfers, services and cost sharing arrangements/cost contribution arrangements. The TPG go further in certain respects, however, such as by including subdivisions addressing administrative approaches to avoiding and resolving transfer pricing disputes (Chapter IV); documentation, including the three-tiered approach (master file, local file and country-by-country reporting) (Chapter V); and transfer pricing aspects of business restructurings (Chapter IX).

It is challenging to answer the question of whether there are any circumstances under which US transfer pricing rules depart from the arm’s-length principle. US transfer pricing rules use the concept of the “arm’s-length standard” rather than the “arm’s-length principle”. The standard is not found in Code Section 482, but cases addressing the statute and its predecessor have held the standard to be fundamental in the application of the statute. Section 1.482-1 of the Treasury regulations provides that, in determining the true taxable income of a controlled taxpayer, “the standard to be applied in every case is that of a taxpayer dealing at arm’s length with a controlled taxpayer”. The regulation continues that “[e]valuation of whether a controlled transaction produces an arm’s length result is made pursuant to a method selected under the best method rule described in section 1.482-1(c)”.

US transfer pricing rules provide a range of specified methods for determining arm’s-length consideration in controlled transactions. While there is no formal hierarchy, the CUT method is paramount in the sense that pricing determined using such method is immune from adjustment under the CWI standard. The transfer pricing rules do not nominally depart from the arm’s-length principle, but they do depart from it in the case of cost sharing arrangements, governed by Treasury Regulation Section 1.482-7. There, whether or not such an arrangement is considered arm’s length is determined solely by whether the arrangement meets the requirements of the regulation; ie, Section 1.482-7 redefines the arm’s-length standard.

See 9.4 Impact of BEPS 2.0.

The IRS believes the transfer pricing rules under Code Section 482 and its implementing Treasury regulations are consistent with the TPG but there is a belief among tax practitioners that differences exist. Any such differences are likely to manifest themselves in APA or MAP proceedings under US tax treaties with countries whose transfer pricing rules follow the TPG.

In a controlled party situation, one entity can bear the risk of another entity’s operations by guaranteeing the other entity a return, but the risk-bearing entity must be appropriately compensated for the risk bearing. US regulations require that contractual risk allocation will be respected if the terms are consistent with the economic substance of the underlying transactions. Comparison of risk bearing is also important in determining the degree of comparability between controlled and uncontrolled transactions.

The UN Practical Manual on Transfer Pricing does not have a significant impact on transfer pricing practice or enforcement in the United States. While the Manual may be a reference point for US transfer pricing matters in which the counterparty country relies on the Manual more substantially, Code Section 482, its implementing Treasury regulations, US case law and, where relevant, the TPG provide the primary authorities for US transfer pricing practice and enforcement.

The United States transfer pricing rules do not have safe harbours for transactions deemed immaterial or for taxpayers of a certain size. But the rules do contain isolated safe harbours that apply to certain types of transactions. Chief among them is the services cost method (SCM), a specified transfer pricing method that permits (but does not require) a taxpayer to charge out certain “covered services” at cost (ie, with no mark-up/profit element).

Covered services eligible for the SCM include specified covered services (ie, those on a list published by the IRS, which includes services such as IT, HR and finance) and low-margin services (those for which the median comparable mark-up on total costs is 7% or less). A service is not eligible for the SCM if it is on a list of excluded activities contained in a regulation (eg, manufacturing, research and development, and distribution). In addition, to qualify for the SCM, a taxpayer must reasonably conclude in its business judgement that the activity does not contribute significantly to key competitive advantages or fundamental risks of success or failure.

Another isolated safe harbour relates to loans. The applicable rules provide for safe harbour interest rates for bona fide debts denominated in US dollars where certain other requirements are met.

The US transfer pricing rules address location savings under the regulations that deal with comparability. The location savings rule is not specific to savings that arise from operating in the United States – it applies generally to determine how to allocate location savings between a US company and an affiliate operating in a lower-cost locale. The rule looks to hypothetical bargaining power and provides that the affiliate in the lower-cost locale should keep a portion of the location savings if it is in a position to bargain for a share of the location savings (ie, if there is a dearth of suitable alternatives in the low-cost locale or similar low-cost locales).

The US does not have special rules that disallow marketing expenses by local licensees claiming local distribution intangibles. Rules that were once unique to the US, such as the commensurate with income rule that allows the IRS to make after-the-fact adjustments based on actual results in the case of an intangibles transfer lasting more than one year, are becoming more common as taxing authorities focus on hard-to-value intangibles. 

The US requires co-ordination between transfer pricing and customs valuation. Code Section 1059A and the Treasury regulations thereunder look to ensure that, when any property is imported into the United States in a related-party transaction, the importer cannot claim a higher tax basis in its imported merchandise than the value that it claimed for the purpose of its customs obligations. In other words, the related-party importer generally cannot claim that the value of the property for transfer pricing purposes under Section 482 is different from the value of the property for the purpose of paying customs duties in the United States.

The Code and Treasury regulations recognise, however, that there may be differences in value that are appropriate once specific factors are taken into account. Among those factors are freight charges; insurance charges; the construction, erection, assembly, or technical assistance provided with respect to the property after its importation into the United States; and any other amounts that are not taken into account in determining the customs value are not properly included in customs value, and are appropriately included in the cost basis or inventory cost for income tax purposes. This last factor (italicised) typically allows a taxpayer to demonstrate how its transfer price of the imported good accords with the arm’s-length standard required under Section 482 and why any difference between that arm’s-length value and the customs value is in accord with its obligations under Section 1059A.

This is an area, though, that continues to confound not only taxpayers but also the taxing and customs authorities, which are not as co-ordinated as they would prefer. These tax versus customs obligations therefore must be considered carefully.

The US transfer pricing controversy process comprises audit, administrative appeals and judicial phases.

• Audit – US transfer pricing audits can be long and intensive, involving hundreds of information requests and sometimes including interviews. In the event a taxpayer does not agree with an audit adjustment proposed by the IRS, the taxpayer has the right to pursue an administrative appeal. The examination team will issue a 30-day letter that gives the taxpayer 30 days to contest the adjustment by filing a protest to be considered by the IRS Independent Office of Appeals. Alternatively, a taxpayer can bypass the administrative appeal process and head straight to litigation if it desires.
• Administrative appeal – the IRS Independent Office of Appeals handles administrative appeals of audit adjustments in transfer pricing and other cases. Appeals officers will consider the examination file, the taxpayer’s protest and the IRS examination team’s response to it, and will conduct one or more hearings with the aim of settling the dispute. Appeals officers are instructed to account for the probable results in litigation and settle cases based on the “hazards of litigation”. A taxpayer unable to resolve its dispute on audit or before the IRS Independent Office of Appeals can proceed to court.
• Judicial process (trial and appeal) – a taxpayer can litigate a transfer pricing case in the US Tax Court, a federal district court or the Court of Federal Claims. The US Tax Court is the only prepayment forum (ie, the only court in which the taxpayer can litigate without first paying the disputed tax and suing the United States for a refund). The federal district courts and the Court of Federal Claims hear refund suits.

Taxpayers and the government can appeal trial court decisions to the federal appellate courts. US Tax Court and federal district court decisions are appealable to the 12 regional circuit courts of appeals. Court of Federal Claims decisions are appealable to the US Court of Appeals for the Federal Circuit. Appellate court decisions can be appealed to the US Supreme Court, which has discretion as to whether to entertain the appeal (and which, in fact, entertains very few appeals).

Judicial precedent on transfer pricing in the US is fairly well developed. But transfer pricing cases are facts-and-circumstances dependent, which renders it difficult to rely too heavily on precedent from one case to the next.

There have been a number of important transfer pricing court cases in the United States. Some of them are as follows.

• The Coca-Cola Co. v Commissioner (2020 (US Tax Court) – still active) – the Tax Court ruled that the IRS was not arbitrary and capricious in applying the comparable profits method with return on assets profit level indicator to allocate income from six foreign affiliates to the US parent. In so doing, the Tax Court did not allow the taxpayer to argue based on the substance of the controlled transactions. The Tax Court allowed the taxpayer to offset against its royalty obligations amounts paid historically as dividends in satisfaction of a pricing method agreed between the taxpayer and the IRS.
• Amazon.com, Inc. v Commissioner (2017 (U.S. Tax Court); 2019 (9th Circuit)) – the Tax Court ruled that the IRS’s application of the income method to price a cost sharing buy-in was arbitrary, capricious or unreasonable. The Tax Court agreed with the taxpayer that the IRS had wrongly included non-compensable goodwill and going concern value in its adjustment. The US Court of Appeals for the Ninth Circuit rejected the IRS’s argument that goodwill and going concern value were compensable under the then existing regulations (which have since been amended). 
• Altera Corp. v Commissioner (2015 (US Tax Court); 2018 (9th Circuit)) – the Tax Court invalidated a regulation that required parties to a cost sharing agreement to share the costs of stock-based compensation.  A divided US Court of Appeals for the Ninth Circuit reversed and upheld the regulation.
• Bausch and Lomb, Inc. v Commissioner, (1989 (US Tax Court); 1991 (2nd Circuit)) – the Tax Court rejected the IRS’s attempt to collapse a license of technology and subsequent sale of contact lenses and treat a licensee as a contract manufacturer. The US Court of Appeals for the Second Circuit affirmed. 
• Hospital Corporation of America v Commissioner (1983 (US Tax Court)) – the Tax Court held that a business opportunity is not property and respected a transaction in which a foreign affiliate entered into a contract that the US parent could have entered into itself.
• B. Forman Co. v Commissioner (1970 (US Tax Court); 2nd Circuit (1972)) – the Tax Court required technical control for the transfer pricing rules to apply. The US Court of Appeals for the Second Circuit reversed and endorsed a flexible “acting in concert” test.

With the potential exception of targeted economic sanctions programmes (ie, embargoes), the US does not restrict outbound payments relating to uncontrolled transactions.

The US does not restrict outbound payments relating to controlled transactions. But the US recently instituted a base erosion and anti-abuse tax (BEAT) targeting outbound payments in controlled transactions that strip earnings out of the US through deductible payments.

The US has a regulation regarding the effects of other countries’ legal restrictions. That regulation is currently being challenged in court. The regulation provides that the IRS will respect a foreign legal restriction only if certain requirements are met. Chief among those requirements is that the foreign legal restriction must be publicly promulgated and generally applicable to uncontrolled taxpayers in similar circumstances. The regulation also requires:

• that the taxpayer must exhaust all remedies provided by foreign law for obtaining a waiver;
• that the foreign legal restriction must expressly prevent payment of part or all of the arm’s-length amount; and
• that the related parties must not have circumscribed or violated the foreign legal restriction in any way (eg, by payment of a dividend).

The regulation provides another difficult-to-satisfy avenue for compelling the IRS to respect a foreign legal restriction – if a taxpayer can demonstrate that the foreign legal restriction affected an uncontrolled taxpayer under comparable circumstances for a comparable period of time.

Pursuant to the Ticket to Work and Work Incentives Improvement Act of 1999, Congress required the IRS to publish an annual report on its APA programme. The first report covered the period from the APA programme’s inception in 1991 through 1999, and the IRS has published annual reports every year since. The annual report provides substantial data and other information on APAs during the covered year, including:

• the number of APA applications filed in total and, for bilateral APAs, by foreign country;
• the number of APAs executed in total and, for bilateral APAs, by foreign country;
• the number of APA applications pending in total and, for bilateral APAs, by foreign country;
• the number of APAs revoked or cancelled, and APA applications withdrawn;
• the numbers and percentages of APAs executed by industry and certain sub-industries;
• the nature of the relationships between the controlled parties in executed APAs;
• the types of covered transactions in executed APAs;
• the types of tested parties in executed APAs;
• the transfer pricing methods used in executed APAs;
• the sources of comparables, comparable selection criteria and nature of adjustments to comparables or tested party data in executed APAs;
• the use of ranges, goals and adjustment mechanisms in executed APAs;
• the use of critical assumptions in executed APAs;
• the term lengths of executed APAs;
• the amount of time taken to complete new and renewal APAs; and
• post-execution efforts to ensure compliance with an APA and ensure the adequacy of required annual documentation under an APA.

There are no similar reports on IRS transfer pricing audit outcomes.

The United States is not known to rely on secret comparables for transfer pricing enforcement. Typically, at the end of a transfer pricing audit, if the IRS is going to assert a transfer pricing adjustment, then the IRS will provide the taxpayer with a written report in which it discloses any comparables on which it is relying to justify its adjustment. Similarly, in litigation, the IRS would provide one or more reports detailing the IRS’s transfer pricing analyses and the bases for them.

In the APA context, the annual report required by Congress (see 16.1 Publication of Information on APAs or Transfer Pricing Audit Outcomes) specifies the sources of comparable data on which APMA relies, with the list generally comprised of publicly available databases.

It is generally too soon to tell how COVID-19 may affect the transfer pricing landscape in the United States. It is certainly possible that COVID-19-related economic impacts may affect the value of intangibles, tangible goods, services transactions or any other market transactions that provide comparables for transfer pricing analyses. The impacts of COVID-19 should become more apparent in the years ahead.

As of yet, the IRS has not relieved payment obligations or otherwise relaxed standards.

IRS transfer pricing audits have continued during COVID-19. While some transfer pricing audits have slowed somewhat, in general existing transfer pricing audits have proceeded apace, certain transfer pricing audits have concluded, and new transfer pricing audits have commenced.