Proposed regulations relating to the treatment of services under section 482.

July 2, 2004

On July 2, 2004, Tax Executives Institute filed the following comments with the Internal Revenue Service and the U.S. Department of Treasury concerning the development of a per se list of low-margin and non-integral services that should qualify for a cost safe harbor under the proposed regulations relating to the treatment of services under Code Section 482. The comments took the form of a letter from TEI President Raymond G. Rossi to Treasury's International tax Counsel Barbara Angus. The letter was prepared under the aegis of TEI's International Tax Committee, whose chair is Bruce R. Maggin of IBM Corporation. Janice L. Lucchesi of Akzo Nobel Inc. materially contributed to the development of the letter.

Tax Executives Institute is pleased to submit the following comments concerning the development of a per se list of low-margin and non-integral services that should qualify for a cost safe harbor under the section 482 services regulations.

As discussed in our December 23, 2003, comments on the proposed regulations and at the January 14, 2004, public hearing, we are concerned about the proposed elimination of the cost safe harbor and its replacement with the simplified cost-based method (SCBM). The treatment of non-integral services under current Treas. Reg. [section] 1.482-2(b)(3)--which permits a taxpayer to charge services at cost where they are not an integral part of the business activity of either the member rendering the services or the member receiving the benefit of the services--has served taxpayers and (we believe) the government well for nearly four decades.

Thus, TEI believes that the current cost safe harbor should be retained. Accordingly, we appreciate Treasury's willingness to consider an alternative to SCBM that would permit charges to be made at cost for certain low-margin and non-integral services. The vast majority of back-office services--including finance, treasury, controller, accounting, legal, tax, human resources, and procurement--are routine, low-margin services for which charging cost is reasonable. These charges would not be deductible in many foreign jurisdictions and requiring a mark-up would raise serious concerns about double taxation. Thus, we commend the Treasury Department and IRS for seeking a more administrable solution.

Controlled Services Transactions

The proposed regulations apply to "controlled services transactions," which are broadly defined under Prop. Reg. [section] 1.482-9(1) as any activity by a controlled taxpayer that results in a benefit to one or more controlled taxpayers. The term "activity" is defined to include the use by the renderer (or the making available to the renderer) of any property or other resources of the renderer. An activity provides a benefit if it results in a reasonably identifiable increment of economic or commercial value that enhances the recipient's commercial position (or is reasonably anticipated to do so). An activity confers a benefit if an uncontrolled taxpayer in circumstances comparable to those of the recipient would be willing to pay an uncontrolled party to perform the same or similar activity.

Prop. Reg. [section] 1.482-9(1)(3)(iv) provides that certain stewardship or shareholder expenses do not provide a benefit that requires a charge to be made. Thus, an activity does not provide a benefit under the proposed regulations if its primary effect is to protect the renderer's capital investment in the recipient or other members of the controlled group, or if the activity relates primarily to compliance by the renderer with reporting, legal, or regulatory requirements specifically applicable to the renderer (when the renderer is the parent of the controlled group). (1)

The proposed regulations make a distinction, however, between shareholder expenses and activities in the day-to-day management of a controlled group. The latter expenses are not viewed as protecting the renderer's capital investment. TEI believes that certain low-margin and non-integral services that fall within the definition of a "controlled services transaction" (because they are perceived as providing a "benefit") should nonetheless be charged at cost under the final regulations.

For sound business reasons, many multinational taxpayers choose to consolidate the performance of certain services that benefit all, or nearly all, group members. These "headquarters" or centralized services may include accounting, financial, legal, management, marketing, internal audit, and computer or information technology activities. (2) We believe that charging these services out at cost is reasonable and consistent with the policy expressed in the Preamble to the proposed regulations concerning the SCBM method to--</p> <pre> serve the same purpose as the current regulations relating to the pricing on non-integral

services by providing reduced compliance and administrative burdens with respect to the transfer pricing of low-margin services.

Such reduced burdens allow both taxpayers and the IRS to direct their resources appropriately to other issues. (3) </pre> <p>To further this goal of simplification and to reduce taxpayer burdens, TEI recommends that the cost safe harbor be retained, at least with respect to certain enumerated services. The final regulations should provide for the development of a list of low-margin and non-integral services that could be charged at cost. Most back-office services are typically routine, low-margin services for which charging cost is reasonable and appropriate. In the case of non-integral services, neither the service provider nor recipient is normally in a position to develop comparable uncontrolled transaction data. By definition, the non-integral services are outside the companies' principal area of business and thus outside their area of expertise in determining appropriate pricing. The OECD guidelines acknowledge that there are circumstances under which the value of services might not be greater than the associated costs: "This could occur where, for example, the service is not an ordinary or recurrent activity of the service provider but is offered incidentally as a convenience to the [multinational] group." (4) Thus, the guidelines appear to accommodate a cost safe harbor for low-margin or non-integral services.

The development of a per se list of services would address concerns about the administrative burden imposed by the SCBM method. (5) The cost of obtaining comparable information about these services would often exceed any benefit to the fisc. Again, the use of a per se list is consistent with the OECD guidelines, which provide that in some circumstances, "the additional tax revenue that would be collected does not justify the costs and administrative burdens of determining what an appropriate arm's length price might be in some cases." (6)

Attached in Appendix A is a proposed list of typical low margin and non-integral services. We believe this list is consistent with the examples in the proposed regulations of what the Treasury Department and IRS perceive to be routine, low-margin services. (7) The list is representative of the types of services companies may charge at cost and is not intended to be all-inclusive. While common functions may generally be found at many multinational companies, a specific taxpayer's facts and circumstances must be taken into account. For example, warehousing or inventory management may be non-integral to one business and integral to another. For this reason, we recommend that the list create a presumption that these services may be charged at cost, unless the IRS can clearly demonstrate that an intangible within the meaning of Treas. Reg. [section] 1.482-4(b) is being transferred.

Form of Guidance

TEI recommends that the list be issued in the form of a revenue procedure that could be updated annually. Such an approach will guarantee flexibility. It will also permit the IRS to add, clarify, or even delete services (on a prospective basis), based on its audit experience. The procedure should specify that the list of services is not exclusive and that other low-margin services may qualify for the cost alternative, based on a taxpayer's particular facts and circumstances.

Conclusion

Tax Executives Institute appreciates this opportunity to present its views on the development of a list of low-margin and non-integral services under the proposed section 482 regulations. If you have any questions, please do not hesitate to call Bruce R. Maggin, chair of TEI's International Tax Committee, at 914.765.4083, or Mary L. Fahey of the Institute's professional staff at 202.638.5601.

(1) Under Prop. Reg. [section] 1.482-9(1)(3), other exceptions include indirect or remote benefits, duplicative services, and passive association. TEI recommends that the definition of shareholder expenses be broadened to include members of a controlled group that provide these services to a sister corporation.

(2) These services are not always performed at the corporate headquarters, but may be performed at a regional headquarters or a shared services center. Thus, these headquarters expenses may well be performed in an entity other than a parent.

(3) Preamble, 68 FED. REG. 53449, 53452 (Sept. 10, 2003).

(4) Organisation for Economic Cooperation and Development, TRANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES AND Tax ADMINISTRATIONS, Ch. VII, [paragraph] 7.34 (March 1996) (hereinafter cited as "OECD Guidelines").

(5) Unlike the cost safe harbor, a taxpayer using SCBM will face significant administrative burdens to comply with its requirements. Because of its subjective nature, the work necessary for a taxpayer to comply with this method (and for the IRS to audit it) will be substantially higher than the cost safe harbor. Moreover, the new method will produce substantial uncertainty. For example, to use SCBM, a taxpayer must determine an arm'slength markup for each service it offers by gathering comparability information from uncontrolled entities. These comparables will be difficult, if not impossible, to find.

(6) OECD Guidelines [paragraph] 7.37.

(7) See Prop. Reg. [sub section] 1.482-9(f)(5), Ex. 1 (accounting); Ex. 3 (administrative); Ex. 6 (custodial); Ex. 7 (logistics-coordination); 1.482-9(1)(4), Ex. 9 (compliance review), Ex. 10 (use of outside advisers).

20th Annual High Technology Tax Institute

(co-sponsored by San Jose State University's College of Business Tax Policy Institute and TEI)

November 8-9, 2004 Crowne Plaza Cabana Hotel Palo Alto, CA

* International High Technology Tax Current Developments

* California High Tech Tax Current Developments including Waters Edge, Apportionment, Farmer Brothers

* Emerging Forms of U.S. and International Equity Awards: What Does One Do After Financial Statement Stock Option Expensing?

* Best Tax Practices After Sarbanes-Oxley or How to Protect your CEO and CFO 

* Permanent Establishment: When Does It Exist and How Is Income Allocated?

* High Tech Federal Tax Update including Legislative and Regulatory Developments, R&D, and Capitalization

* IRS Audit Issues: Cost Sharing Buy-ins, Prefiling Agreements, Fast Track, Tax Shelters 

* M&A Trends and Techniques: Section 382 Maximization, BIGs, Public-Private Acquisitions, Investing/Disinvesting, Loss Disallowance, Section 355

* Global Leveraged Financing: Hybrids, Thin Capitalization, Double and Triple Dipping, EU Tax Law Changes

* AS 109/5/23/Reserves/Contingencies and M-3, Listed Transactions, Reportable

Appendix A

The "Per Se" List of Services To Be Charged At Cost

The following services are often performed by corporate centers. These services may be provided by a central department that sets policies for the worldwide company or by a country organization in order to comply with local law. These services are either routine and low-margin or not integral to the operations of a typical business.

The preamble to the proposed regulations states that activities undertaken to comply with the legal requirements applicable to shareholders or to safeguard shareholder's equity are properly viewed as a shareholder activity and need not be charged out. It may be appropriate to conclude that such activities provide no benefit to any member of the controlled group, but that conclusion would be based on a detailed analysis of the facts. To the extent these services are not otherwise exempt based on a taxpayer's circumstances (e.g., because they represent stewardship expenses), they may properly be billed at cost.

Human Resources

1. Developing and updating plans regarding career-development and succession;

2. Developing job evaluation process including procedures and forms;

3. Providing benchmarking studies for compensation and benefits;

4. Developing compensation and benefit structures that meet the requirement of internal and external equity;

5. Developing and administering a policy for employees;

6. Training and coaching the human resource function throughout the company;

7. Developing company-wide training courses;

8. Implementing and administering benefit plans (including medical, pension, insurance, cafeteria, and savings);

9. Providing company-wide job postings and referral services;

10. Providing employee assistance programs;

11. Administering (including compliance) employee stock option and stock purchase plans that are offered on a worldwide basis; and

12. Providing security services (e.g., executive protection or global headquarters security).

Accounting, Finance, and Treasury

1. Developing a company-wide accounting manual that prescribes accounting methods to be used;

2. Developing models to use for budgeting and investment evaluations;.

3. Consolidating legal entities per country for use in statutory financial statements and tax returns;

4. Consolidating worldwide results by business area for use in management accounting;

5. Performing operational and financial audits of material business areas;

6. Processing vendor invoices for payment;

7. Processing customer invoices;

8. Investigating customer creditworthiness;

9. Collecting customer invoices;

10. Processing warranty claims;

11. Establishing bank accounts and lockboxes for use by local companies, including overdraft facilities and lines of credit;

12. Providing currency hedging;

13. Developing and maintaining an automated payroll system that integrates benefit and payroll information, including--

i. Processing wage payments;

ii. Processing federal and state payroll taxes, unemployment insurance premiums, state disability insurance premiums, and workers' compensation premiums;

iii. Preparing payroll tax forms, including Forms 940, 941, and W-2;

15. Preparing government census and related forms;

16. Preparing reports required by escheat laws;

17. Developing financial operating records;

18. Providing internal audit functions; and

19. Preparing advice on the financial accounting treatment of unusual transactions.

Tax

1. Preparing federal, state and local income, property, sales/use, VAT, excise, and other tax returns;

2. Calculating and processing tax payments;

3. Overseeing audits conducted by tax authorities; and

4. Providing tax advice to businesses to ensure compliance with tax laws.

Information Technology

1. Implementing company-wide computer systems including those used for accounting, manufacturing, customer service, human resources, payroll, and e-mail;

2. Providing training to users;

3. Providing hands-on assistance to users (i.e., a help desk);

4. Formulating guidelines with respect to the use of IT systems;

5. Maintaining and repairing IT systems;

5. Providing telecommunications facilities; and

6. Developing global standards/architecture for infrastructure, information, and associated internal IT systems.

Purchasing

1. Developing a procurement program with key vendors in areas of travel, manufacturing, information technology, office facilities, computer equipment, and others to ensure continued supply at certain cost;

2. Drafting and negotiating purchasing agreements; and

3. Purchasing equipment pursuant to company standards.

Communication

1. Developing a corporate communications policy;

2. Developing a corporate identity;

3. Developing a public relations program;

4. Maintaining contacts with key stakeholders; and

5. Distributing internal and external corporate communications.

Risk Management

1. Providing insurance coverage for general, product, and worker's compensation liability; property loss; and business interruption; and

2. Administering policies and claims with respect to an insurance program.

Legal

1. Developing and implementing a corporate compliance program to ensure that affiliates are in compliance with applicable rules and regulations;

2. Drafting and reviewing contracts;

3. Preparing advice in respect of structuring and reorganization, acquisition, and divestment transactions; and

4. Maintaining corporate books and records.

Health Safety Environment and Regulatory Affairs 

1. Developing company health, safety, and environment standards;

2. Conducting reviews of production sites; and

3. Training production-site personnel.

Centralized Control and Coordination Activities

1. Coordinating production activities to ensure that specific products are not over--or under-produced on a regional or global basis; and

2. Providing centralized collection of sales and marketing data for use in product development and advertisements.

Business Development

1. Investigating expansion into new markets with existing products and services; and

2. Investigating expansion of product and service lines.

Logistical/Commercial Services

1. Arranging for the shipment and warehousing of goods;

2. Completing import/export documentation and arranging for customs payment;

3. Overseeing audits by customs authorities;

4. Drafting and negotiating distribution agreements; and

5. Providing travel-related services.