The IRS released its most recent annual advance pricing agreement
(APA) report on April 2 2012 for the year 2011. The report shows a lull
in APA activity during 2011, perhaps due to an administrative
realignment of the programme. The number of completed APAs from the year
before decreased by 38%. New APA applications filed during 2011 reflect
a decrease of 33% from the year before, and a decrease of 27% from the
The APA programme recently merged with the office of the US Competent
Authority (USCA). As a successor to the APA programme the new Advance
Pricing and Mutual Agreement (APMA) office prepared the new APA report.
The report states that, during the fall of 2011, the USCA hired
additional managers and staff for the APMA office, representing a 50%
increase in total headcount.
The report states that, in part because of these transitional issues,
during 2011, the APA office completed 43 APAs and 47 recommended
negotiating positions, down from totals of 69 APAs and 58 recommended
negotiating positions in 2010. The average time to complete an APA
increased from 37 months in 2010 to 40.7 months in 2011.
Two APAs were cancelled or revoked during 2011. The most interesting revocation is discussed further below.
The inventory of pending APA requests totals 445, with 258 of those
requests consisting of requests for new APAs. The remainder consists of
requests for APA renewals. The majority of the requests are for
bilateral APAs, although 20% are for unilateral APAs.
Eaton Corporation v. Commissioner, T.C. Dkt. No. 5576-12,
involves a terminated APA. As set forth in the Tax Court petition, Eaton
had an APA and a renewal APA on the same subject. Despite those two
APAs, the Service made an adjustment increasing Eaton's income with
respect to the APA-covered transactions by nearly $400 million for the
two years in issue. It would seem unlikely that two separate IRS APA
teams could have been that wrong. Despite the APAs, the Service also
asserted transfer pricing penalties. Interestingly, the Service's
outside expert in the case is the same expert the Service relied on in
the Veritas case.
The Service has also asserted that an alternative § 367(d) income
adjustment should be made in an amount exceeding $200 million. This
relates to a § 936 restructuring transaction and would seem similar to
the § 367(d) arguments the Service has made in certain other cases
Eaton's APA was terminated December 16 2011, three days before the
Service issued its statutory notice of deficiency, which led to the Tax
Court filing. It will be interesting to see whether this surprising
development has an effect on the future popularity of the IRS's APA
New cost sharing regulations
Treasury and the IRS finalised the temporary § 482 cost sharing
regulations that were issued in 2008. The preamble contains a lengthy
discussion of the Treasury's and the IRS's views on cost sharing.
The preamble states that the arm's-length analysis under § 482 begins
with the factual and functional analysis of the actual transaction or
transactions among the controlled taxpayers. In a cost sharing agreement
(CSA), the controlled participants make economic contributions of two
types, namely, mutual commitments to prospectively share intangible
development costs in proportion to their reasonable anticipated benefits
from exploitation of the cost-shared intangibles (cost contributions)
and to provide any existing resources, capabilities, or rights that are
reasonably anticipated to contribute to developing cost-shared
intangibles (platform contributions). CSAs may also involve economic
contributions by the controlled participants of other existing
resources, capabilities, or rights related to the exploitation of the
cost-shared intangibles (operating contributions). Other prospective
economic contributions consist of costs incurred to develop or acquire
resources, capabilities, and rights that facilitate the exploitation of
cost-shared intangibles (operating cost contributions).
The combined effect of multiple contributions, potentially including
controlled transactions outside of the CSA (for example, make-or-sell
licenses, or intangible transfers governed by § 367(d)), may need to be
evaluated on an aggregate basis, where that approach provides the most
reliable measure of an arm's-length result, states the preamble. For
example, if a taxpayer transfers intangibles in a transaction governed
by § 367(d) in connection with contributions related to those same
intangibles in connection with a CSA, then the pricing of the
intangibles under § 367(d) may need to be evaluated along with the
pricing of all contributions in connection with the CSA on an aggregate
The preamble states the duration of the CSA activity may, or may not,
correspond to the conventional concept of useful life with respect to
any of the underlying economic contributions. It represents the period
over which the controlled participants reasonably anticipate returns
from the CSA activity. This would seem an effort on the part of Treasury
and the IRS to distance themselves from the holding in Veritas v. Commissioner with respect to useful life.
The preamble states that long-term licenses or R&D service
contracts may provide comparable uncontrolled transactions, provided and
to the extent that they involve the same or similar scope and
contractual terms, uncertainty of outcomes, profit potential, allocation
of intangible development and exploitation risks, including allocation
of the risks of existing contributions and the risks of developing
future contributions, consistent with the actual allocation of risks
under the CSA and through related controlled transactions. (This may be
an effort by Treasury and the IRS to distance themselves from Xilinx.)
A CSA may benefit from, and contribute to, the control group's unique
competitive advantages. Therefore, there may be no uncontrolled
transactions that reliably reflect the same contributions by the
parties, over a similar period of commitment, and with the same risk
profile and profit potential. Where comparable uncontrolled transactions
are unavailable, the CSA regulations, like other regulations under §
482, allow for reference to the results the controlled taxpayers could
have realised by choosing a realistic alternative. The CSA regulations
adopt the 2008 regulations' use of a constructed licensing alternative
to the CSA that closely aligns with the economics of the CSA, but takes
account of the licensors' commitment to bear the entire risk of the
intangible development that would otherwise have been shared.
Several commentators requested clarification concerning how and when
to update reasonably anticipated benefit shares, and whether these
updates may be made retroactively or only prospectively. Treasury and
the IRS added several sentences to Treas. Reg. § 1.482-7(e)(1)(i) to
clarify that RAB shares determined for a particular purpose should not
be further updated for that purpose based on information not available
at the time that determination needed to be made.
A sentence was added to Treas. Reg. § 1.482-7(g)(1) to clarify that
each method used for evaluating the arm's-length amount charged in a PCT
must yield results consistent with measuring the value of a platform
contribution by reference to the future income anticipated to be
generated by the resulting cost-shared intangibles.
Several commentors requested further guidance on the relationship
between the discount rate that is appropriate for discounting the
operating income associated with the cost-sharing alternative and the
discount that is appropriate for discounting the operating income
associated with the licensing alternative. In response, the final
regulations provide that the difference in risk between the two
scenarios solely reflects (1) the incremental risk, if any, associated
with the cost contributions taken on by the PCT payer in developing the
cost-shared intangible under the cost-sharing alternative, and (2) the
difference in risk, if any, associated with the particular payment forms
of the licensing payments and the PCT payments, in light of the fact
that the licensing payments in the licensing alterative are partially
replaced by cost contributions and partially replaced by PCT payments in
the cost-sharing alternative, each with its own payment form.
The preamble states that controlled taxpayers have flexibility to
choose a form of payment with respect to an arm's-length charge,
provided that the form of payment may be reasonably expected to yield a
value consistent with the arm's-length charge determined as of the date
of the PCT.
Several commentators suggested that the final regulations should
expressly permit the use of methods in Treas. Reg. § 1.482-9,
particularly the cost of services plus method, for valuing and
determining the form of payment of PCT payments for services provided,
for example, by a research team. As noted above, the final regulations
clarify the flexibility taxpayers have to adopt a form of payment
consistent with the arm's-length charge determined for a PCT. Thus, the
arm's-length charge for a platform contribution of services of a
research team might be converted into a cost-of-services-plus form of
payment, provided that, among other conditions, the method and form of
payment, treating the platform value of that research team separately
from the arm's-length charge, for any other platform contributions,
provide the most reliable measures of the arm's-length charges. The
experience of the IRS is that the arm's-length charges for platform
contributions of the services of a research team along with other
platform contributions (for example, base technology) are most often
reliably determined in the aggregate, states the preamble.
The preamble also states that controlled participants have
flexibility in agreeing to contingent payment terms, and thus, in
allocating upside or downside risk among the parties. In doing so, the
parties can tie their prices to the income actually earned with respect
to the subject of the buy-in or PCT. These price terms must be
determined on an upfront basis and must be coordinated and consistent
with the arm's-length charge. Several examples were added to Treas. Reg.
§ 1.482-7(h)(2)(iii)(C) to illustrate the treatment of certain types of
contingent price terms under the regulations.
Treasury and the IRS are considering issuing a revenue procedure
providing an exception to the periodic adjustment rules in the context
of an APA. They are also considering guidance addressing whether
taxpayers with CSAs covered by APAs should be relieved from the
administrative requirements of Treas. Reg. § 1.482-7(k)(2)-(4).
Intangibles: §§ 482 and 367(d)
Following or during the § 936 phase out period, US companies that
manufactured in Puerto Rico through a § 936 corporation typically
reorganised their operations so that the manufacturing thereafter was
conducted by a CFC.
The IRS has taken the position that any goodwill, going concern value
and workforce-in-place that was transferred can be taxed to the US
company under § 367(d). The § 367(d) regulations, however, exempt
foreign goodwill and going concern value from these rules. Moreover, the
specific intangibles that are covered under § 367(d) are defined by
reference to § 936(h). Those rules also do not include
A number of cases have now been docketed in this dispute, two of which have adjustments in excess of $1 billion. Medtronics, Inc. v. Commissioner, T.C. Dkt. No. 6944-11; Guidant LLC (formerly Guidant Corp.) v. Commissioner, T.C. Dkt. Nos. 5989-11 and 5990-11 and 10985-11; Boston Scientific Corporation v. Commissioner, T.C. Dkt. No. 26876-11; and Eaton Corporation v. Commissioner, T.C. Dkt. No. 5576-12.
In its notices of deficiency, the IRS asserts transfer pricing
adjustments with respect to the respective taxpayer's CFC manufacturing
operations, and, as an alternative argument, asserts that certain
intangibles were transferred subject to § 367(d).
The issue is an important issue not just for companies that were
involved in § 936 conversions. If these intangibles can be included
under § 367(d), then any incorporation of a foreign branch could become
subject to taxation under § 367(d).
The Obama Administration's Budgets propose to make this change in the
law, that is, to include goodwill, going concern value and
work-in-place as intangibles for purposes of both §§ 482 and 367(d),
calling the change a "clarification". Following the Tax Court's holding
in Veritas v. Commissioner, 133 T.C. No. 14 (2009), that this
would constitute a change in the law, not a clarification, the IRS
issued an Action on Decision vehemently disagreeing.
Related to this issue (but different), First Data v. Commissioner,
T.C. Dkt. No. 7042-09 (March 2009), was settled. The transfers of agent
network, software and IP valued at $900 million was subject to tax
under § 367(d). (Settlement announced Dec. 15, 2011). See also TAM 200907024.
Refund claim barred under treas. Reg. § 1.482-1(a)(3)
The Court of Federal Claims granted the government summary judgment
in the context of a corporation's claim for tax refunds based on
restructuring expenses of its foreign corporate parent, finding that the
refunds were prohibited by Treas. Reg. § 1.482-1(a)(3) because the
expenses were not claimed on a timely filed return. Intersport Fashions West Inc. v. United States, ___ Ct. Cl. ____ (2012).
In 2005, the IRS examined the taxpayer's tax returns for 2001, 2002
and 2003. As a result of the audit, the taxpayer received additional
assessments. The taxpayer then filed amended returns for the 2001 and
2002 tax years claiming deductions in excess of $1 million in expenses
allocated from its foreign parent company.
The IRS successfully disallowed the deductions claimed on the amended
returns on the grounds that they were prohibited under Treas. Reg. §
1.482-1(a)(3) because the taxpayer had not claimed them on a timely
filed tax return.
The court stated that subject to a limited right to a controlled
taxpayer to report allocable income after the year in issue, a
controlled taxpayer may not affirmatively use § 482 or compel the
Service to make an allocation or other adjustment. The fact that the
original filing many have been the result of a mistake did not excuse
the filing of an untimely tax return. The taxpayer also was unsuccessful
in contending that it was entitled to relief on the basis of
The DeCoro case
In re DeCoro USA, Ltd (US Bankruptcy Court, MD NC 2012),
involved sales of furniture made to customers located in the US. The
furniture in issue was manufactured in China and shipped to the US by
DeCoro (Hong Kong), a Hong Kong company. DeCoro USA (USA is a North
Carolina corporation and a wholly owned subsidiary of Hong Kong). The
furniture sales to customers in the US were procured by USA either
through employees of USA or independent sales representatives engaged by
During 2008 or early 2009, the IRS began an examination of the US tax
liability of Hong Kong and USA. The primary question during the
examination was: Which company should pay the income tax due from the
furniture sales to customers located in the US? Which was dependent upon
which company should be regarded as the seller of the furniture.
If USA were a dependent agent of Hong Kong, then the sales would be
treated as having been made by Hong Kong and Hong Kong would be taxed as
a foreign corporation making sales in the US. This was the primary
position of the IRS during the pre-petition period. Conversely, if USA
were an independent distributor, then the sales would be treated as
having been made by USA and USA would be liable for any income tax due
as a result of the domestic sales. This was the position of USA during
the audit. Both Hong Kong and USA filed for bankruptcy protection before
the IRS made an assessment.
The IRS claim in bankruptcy was based on an income tax liability of
USA (an understandable switch of its position during the audit due to
the bankruptcy filings). The IRS argued that under § 482, USA's markup
should have been substantially higher due to the arm's-length results of
similarly situated independent distributors. The IRS also asserted that
USA should have withheld 30% on a deemed dividend paid to Hong Kong.
USA contended that any tax due was owing by Hong Kong. The parties
disagreed as to whether Hong Kong engaged in that trade or business in
the US. USA asserted that it was acting as an agent of Hong Kong in
selling furniture in the US and that through the attribution of those
activities to Hong Kong, Hong Kong was engaged in business in the US.
The IRS disputed that contention, arguing that USA acted as an
independent distributor and not as an agent of Hong Kong.
The court stated that there is apparently no agreement regarding by
whom the sales were made, and when and where the purchase and sale of
the furniture took place, for tax purposes. In denying USA's motion for
summary judgment, the court stated that the IRS adjustment to USA's
income pursuant to § 482 does not purport to change the source or amount
of the sales as reported by USA in its tax returns. USA's objection did
not focus on the propriety of this § 482 adjustment, nor the amount of
The court observed that "some of the most difficult questions as to
what constitutes a US trade or business arise when a foreign corporation
uses the services of another person in the US in order to conduct
business, thereby raising the specter of agency attribution."
The court stated that most courts that have considered the issue have
concluded that in determining whether a nonresident has engaged in a
trade or business in the US for tax purposes, the activities of an agent
of the nonresident in the US will be attributed to the nonresident and
treated the same as if the nonresident had performed the activities. The
court, citing the restatement of agency, stated that the status of the
parties depends upon the substance of the contracting parties'
The IRS argued that the distribution agreement showed that USA was an
independent distributor and not an agent. USA pointed out that under
the distribution agreement the price that USA was required to pay to
Hong Kong was essentially the same as the price at which USA sold the
furniture, which precluded USA from realising any profit from the sale
of the furniture. Thus, USA stated that it did not stand to make a
profit from the sales of the furniture and that this is indicative of a
dependent agent rather than an independent distributor.
The court stated that it is required to view the evidence in a light
most favorable to the IRS, since USA is the moving party. Given this
prescription, together with the limited scope of the evidence, the court
stated that it was satisfied that USA had failed to establish that it
was the agent of Hong Kong with respect to the furniture sales in issue.
Fenwick & West
Tel: +1 650.335.7205
Jim Fuller is a partner in the Tax Group at Fenwick & West in
Mountain View, California. Fuller is the only US tax adviser to receive a
coveted Chambers star performer rating, Chambers USA (2012). He is
included as one of the world's top 25 tax advisers in Euromoney's Best of the Best (2012).
Fuller has been included in Euromoney's World's Leading Transfer Pricing Advisors, and also has been involved as counsel in many large-corporate IRS Appeals proceedings and tax court cases.
Fenwick & West has represented more than 50 of the Fortune 100
and more than 100 of the Fortune 500 companies in federal tax matters.
International Tax Review named Fenwick in 2012 as one of only two US law
firms in the first tier in both planning and transactional.
Four times in the past six years, International Tax Review gave Fenwick & West its San Francisco Tax Firm of the Year Award. Three times in the past six years, International Tax Review gave Fenwick & West its National Tax Litigation Firm of the Year Award.
Fenwick & West
Tel: +1 650.335.7254
David Forst is the practice group leader of the tax group of Fenwick
& West. Forst was named one of the top tax advisers in the western
US by the International Tax Review and is listed in Chambers USA
America's Leading Lawyers for Business (2011).
Forst's practice focuses on international corporate and partnership
taxation. He is a lecturer at Stanford Law School on international
taxation. He is an editor of, and regular contributor to, the Journal of
Taxation, where his publications have included articles on
international joint ventures, international tax aspects of mergers and
acquisitions, the dual consolidated loss regulations, and foreign
currency issues. He is an editor of the Journal of Passthrough Entities,
where he writes a regular column on international issues. Forst is a
frequent chairman and speaker at tax conferences, including the NYU Tax
Institute, the Tax Executives Institute, and the International Fiscal