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Transfer Pricing: Current Problems and Solutions

Ronald Wu Claremont McKenna College

Chapter I


The current problems and possible solutions surrounding United States transfer pricing regulations are discussed and studied. The schemes large multinational companies are implementing to legally evade taxes are uncovered as the financial effects to the United States Treasury and government are becoming material. The benefits for these schemes are financially advantageous for corporations as they are able to report larger profits and higher returns for investors.

This is being done at the expense of US government. Corporations are finding ways to escape the high U.S. corporate tax rate and lower their global tax liabilities by allocating income to lower tax jurisdictions.

Introduction (Cont.)
Tax havens like Ireland or Bermuda are popular to have subsidiaries which hold a corporations intangible property. Five United States Tax Court cases concerning transfer pricing are studied and the outcomes are analyzed.

The current problems studied from these cases are, shifting intangible property, valuing intangible property, the arms length standard.
The possible solutions to these currents problems are by no means easy to solve and no one revision can relieve all the problems.

The arms length standard is the corner stone to the current problems and if the government can find a way to better enforce the standard or replace it, it will be a large step in the right direction.



Current Situation
Transfer pricing is defined as the price charged between related parties for goods, services, or use of property. Transfer pricing is globally used by a large amount of companies and related enterprises to replicate cost allocations. It is a significant part for both the tax payers and tax administrators because cost allocations have a large impact on income, which ultimately determines a corporations taxable income.

Legally shifting profits out of U.S.

Shifted to tax havens like Bermuda, Switzerland, Ireland, Singapore, and the Cayman Islands. These nations have
Lower corporate tax rates compared to the United States 35 percent. Have special tax exemptions for operating businesses in their country which pose large financial benefits for U.S. based companies.

By taking advantage of these foreign tax rates and exemptions, multinational corporations are lowering their international tax rates and reporting higher profits

The process
A corporation is comprised of a United States parent company, a foreign principal and other foreign subsidiaries.

The foreign subsidiaries distribute and/or manufacture products The foreign principal holds the responsibility of making executive and investment business decisions. In addition, the foreign principal holds the intangible property which is the trademark, patent or property the business profits on. The U.S. parent company supplies marketing knowledge, supporting services and sometimes engages in domestic and foreign distribution.

The process (Cont)

The foreign subsidiaries and the U.S parent company run limited risk operations which are considered low profit in transfer pricing analysis The high profit activities occur at the foreign principal because it holds the intangible property. The corporation will allocate or transfer a majority of their income to the foreign principal located in a country with a tax exemption or low tax rates. The intangible property is developed using American technology and research, both of which are subsidized by U.S tax incentives. Just before the product, containing the intangible property, is produced or released, it is transferred to a foreign principal located in a tax haven using cost sharing agreement.

This process leads to lower overall taxes and increased returns for the corporations investors. the U.S. Treasury is left with little return on their investments

Causes of Dispute
All transfer pricing disputes arise over the arms length standard principal. In court, corporations support related party transfer prices and allocations with unrelated transactions, believed to be within arms length Conversely, IRS argues that the unrelated transaction is not arms length because of a difference in quantity, market price, type of customer, packaging and other non-monetary factors. As certain transactions are unique and no comparable unrelated transaction exists Especially with transactions concerning intangible property. If the arms length standard is ruled violated by the Tax Court authorizes the IRS to adjust the income, deductions, credits, or allowances of commonly controlled taxpayers to prevent evasion of taxes or to clearly reflect their income.



Google Case
Google has legally evaded $3.1 billion taxes through a process called Double Irish or or Dutch Sandwich. Google has dropped its foreign tax rate from 35% to a shocking 2.4% by shifting profits through Ireland, the Netherlands and Bermuda to take advantage of each countrys corporate tax laws.. Google entered into an Advanced Pricing Agreement with the IRS in connection with certain intercompany transfer pricing arrangements. The IRS has not charged Google with any wrong doing at this time and many other multinational corporations are engaging in similar activities.

The intangible property


Advanced Pricing Agreement



Ad. & Sales Google Netherlands Google Ireland Ltd. Holdings


Google Barmuda


An unlimited co.

Foreign Principal

Chapter 4


Chapter 5


Chapter 6


National Semiconductor Corporation Case

The dispute issue was the arms length pricing and comparable transactions NSC manufactures semiconductors as well as specializes in analogue equipment and subsystem It had 6 subsidiaries and they purchased semiconductor material from NSC, packaged them and sold a majority of their finished products back to NSC. It claimed that it measured transfer price under the comparable uncontrolled transaction method. Under the transfer pricing system NSC US sustained operating losses from the sale of semiconductor dies and material to its subsidiaries, while the subsidiaries recorded a profit.

NSC Case(Cont.)
The issue presented to the United States Tax Court, IRS indicated one of the comparable transactions contained packaging terms that were materially different. The court decided that it is unrealistic that the transfer prices used would result in operating losses for the parent company while the subsidiaries incur high profits. The court made appropriate adjustments to bring the pricing closer to reasonable arms length standards. The court increased NSCs taxable income by $6.96 million, $2.54 million, $8.05 million, $13.54 million, and $9.51 million for the years 1978, 1979, 1980, 1981, and 1982.

DHL corporation Case

The topic of discussion concerns the allocation of a trademark sale and the arms length standard.

DHL is a package delivery company. In 1979 DHLI was created in Hong Kong. DHL ran the United States business and DHLI/MNV ran the international business. In 1990, DHL granted DHLI to purchase the DHL trademark for $20 million, though, other firms had interest in purchasing DHLI/MNV. In previous offers the value of the trademark had been $50 million and $100 million. The IRS issued a deficiency notice trademark valuation.

DHL corporation Case(Cont....)

DHL argues to the US Court that this case dealt with a transaction between two related parties and one unrelated party as opposed to just related parties. However, the Court doesnt find the existence of unrelated party to alter DHLs compliance with the arms length standard. Thus the court has reason to believe that the trademark value in the in the deal had significant related party influence. The court confirms the non-arms length pricing and upholds the $100 million price for the transaction.

Compaq computer corporation Case

The dispute is whether the income from printed circuit assemblies or PCAs from Compaqs Singapore subsidiary was allocated at arms length. Compaq computer manufactures personal computers (PCs). Compaq had three sources of PCAs (a part of the central processing unit within the PC): PCAs manufactured by Compaq USA, PCAs purchased from its subsidiary in Singapore, and PCAs purchased from unrelated subcontractors located in the United States. The IRS filed a notice of deficiency for taxes payable of $42.4 million for 1991 and $33.5 million for 1992 questioning the transfer pricing used.

CCC Case (Case.)

The prices for PCAs were determined by Compaq US using turnkey pricing (a variation of cost plus pricing, where a firm accounts for fixed costs by adding the amount paid to the manufacturer to the mark up of the good or service. Because of the competition between unrelated subcontractors, prices were set at market levels in the United States. But Compaq Singapore sold PCAs to Compaq US with 6.1 per cent less than standard production cost. The IRS investigation discovered that the comparable transaction used by Compaq US did not satisfy as arms length comparable for the purchases of PCAs from Compaq Singapore.

CCC Case (Case.)

The IRS determined that Compaq US paid less than arms length prices to its subsidiaries using the CUP method. Compaq US argues that the transaction with unrelated subcontractors are consignment purchase and cannot be used as comparable. Compaq Singapores costs were less than other comparable companies; as a result, the transfer prices should be less than prices paid to unrelated subcontractors. The prices paid to Compaq Singapore are consistent with the arms length standard because it would yield a similar net profit margin. The court affirms Compaq US claims.