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Effective date of section 482 services regulations should be delayed.

The following comments were filed with U.S. Department of Treasury and Internal Revenue Service on October 6, 2006. The comments were prepared under the aegis of TEI's International Tax Committee, whose Chair is Janice L. Lucchesi of Akzo Nobel Inc. TEI's detailed comments on the services regulations will be reprinted In the January-February 2007 issue.

On behalf of Tax Executives Institute, I am writing to recommend that the effective date of the revised section 482 regulations, relating to the treatment of services and the allocation of income and deductions from intangibles, be delayed from January 1, 2007, to at least January 1, 2008.

The revised effective date is necessary to permit taxpayers to make the necessary changes to their data collection systems and otherwise to ensure compliance with the new rules.


On July 31, 2006, the Internal Revenue Service and the U.S. Department of Treasury issued temporary and proposed regulations that provide guidance on the treatment of controlled services transactions and the allocation of income from intangibles. The regulations significantly revise the proposed regulations that were issued in 2003, and make material changes to the regulations now in effect, which were issued in 1968.

For example, under the new rules, certain services that are either specified in a revenue procedure or are low-margin services with an arm's-length mark-up of 7 percent or less may qualify for pricing under the Service Cost Method (SCM) and may be charged out with no mark-up. In addition, the proposed regulations adopt a direct benefit test that will require taxpayers to determine at the inception of any service-offering component the precise identity of the affiliates that will consume that component. As promulgated, the revised section 482 services regulations would generally be effective for taxable years beginning after December 31, 2006.


TEI commends the Treasury Department and IRS for responding to taxpayers' concerns about the 2003 proposed regulations by making the revised rules less burdensome. The Institute is preparing comments on the revised rules, but wanted to voice our concerns about the effective date of the regulations immediately.

Specifically, we believe the January 1, 2007, effective date is impractical because it will take many taxpayers longer than that to implement the regulations and to make the necessary modifications to their data processing systems to capture the information necessary to comply. The functional and economic analyses required to determine both the services that qualify for SCM--including whether the service contributes "significantly to fundamental risks of business success or failure"--and the arm's-length price for other services cannot be properly done by January 1, 2007.

1. The Required Systems Changes Are Significant and Will Take Time to Implement. The five-month period between promulgation of the temporary regulations and the effective date in T.D. 9278 is insufficient in light of the information technology and internal control issues raised by the new rules. Consider the following:

* Many corporations have regionalized their computing systems to provide faster data transmission. Charge-outs and adjustments may flow from affiliate, to region, to affiliate (or from affiliate, to region, to region, to affiliate). These systems will have to be modified to ensure the traceability of transaction components and related mark-ups; moreover, the conversion of extant processes and systems must be done on a global scale and must be performed sequentially.

* Modifications will also have to be made to the systems used by foreign affiliates that provide services on a sub-contractor basis to U.S. service providers. Such foreign assistance charges must be tracked separately because, depending on the results of the taxpayer's comparability studies, the taxpayer may be required to mark-up the costs when they are charged out of the United States.

* The direct benefit test in the revised regulations will further complicate taxpayers' intercompany billing processes. Taxpayers must determine at the inception of any service-offering component the precise identity of the affiliates that will consume that component.

For example, many corporations have global purchasing programs where affiliates may purchase a variety of goods and services at a group discount. Certain affiliates may determine, however, that they can negotiate lower prices at a local level. The regulations will require that those affiliates not be charged for the purchasing program. For corporations with numerous affiliates, the process of determining which entity will participate in the program could be very lengthy.

* Additional billing and systems modifications will be required where intangibles used in the provision of intercompany services are jointly developed by several affiliates. Many taxpayers have interpreted the existing regulations as permitting joint, beneficial ownership of intangibles where such characterization reflected the economic substance of the arrangement. The revised regulations' "one owner" rule requires affiliates to pay royalties to the "owners" of the intangibles--which must be identified--based on the intangibles' notional values. Systems must be modified to describe these payments and accommodate any withholding taxes that may be imposed by foreign jurisdictions. Royalty characterization must also be reflected in each system through which the payments will pass. Moreover, contracts among affiliates or joint venturers must be renegotiated to comply with the rules; in some cases, government approval may be required for these agreements.

* Because of the IRS's electronic filing mandate, companies had to direct the attention of their IT staffs to ensuring their ability to file their 2005 Forms 1120 electronically by the extended due date (September 15). The e-filing mandate delayed companies from turning to implementing the revised section 482 regulations. In TEI's view, it will take a minimum of one year for multinational corporations to design, build, test, and implement the systems modifications needed to comply with the revised regulations. (1)

2. Correlative Changes to the Financial Accounting Procedures Require Time to Implement. Adding to the systems challenges are internal control and financial reporting procedures that may require corporations to freeze changes to their systems for the six-to-eight weeks that straddle a year end to ensure systems integrity during the year-end close and financial summary periods. The internal controls requirements of the Sarbanes-Oxley Act of 2002, combined with the Financial Accounting Standards Board's (FASB's) new guidance in respect of the accounting for income taxes, fundamentally alter the environment for public company tax and accounting functions. (2)

Before the FASB issued Financial Accounting Interpretation 48 - Accounting for Uncertainty in Income Taxes in June 2006, companies generally booked their tax expense for financial reporting purposes on the basis of the return "as filed" or to be filed for a tax period. The new guidance takes a two-prong approach for recognizing and measuring tax benefits. It requires a company to make a hypothetical assumption, based upon a new recognition standard for tax benefits of "more likely than not": For each tax position, is it more likely than not that the position would be sustained, based on the technical merits of the position, if the issue is examined by the taxing authority and litigated to the court of last resort? If yes, the company must determine how much of the tax benefit is to be recognized in the financial statements, taking into account the facts and circumstances of each tax position; detection risk is not taken into account. In addition, companies must predict the likelihood of events happening in the next 12-month period that affect the amount of tax benefits for uncertain tax positions.

The requirements of FIN 48 place increased pressures on public companies to analyze and estimate how potential disputes--including transfer pricing issues in respect to all open years--will ultimately be determined by the beginning of the 2007 tax year. To ensure proper reporting of financial results in the first quarter of 2007, affected taxpayers must have the substance of their analyses completed--and their systems in place--by the end of 2006. Moreover--in addition to analyzing all their open tax year positions under the revised financial reporting standards--if the regulations become effective as planned, companies must also take into account the revised services regulations for financial reporting purposes in the first quarter of 2007. (3)

With the July 31, 2006, issuance date of the revised section 482 regulations, calendar-year companies will have barely five months to read and understand nearly 200 pages of regulations, analyze how those regulations may affect intercompany relationships, conduct transfer pricing studies to determine what useful information about comparable third-party transactions may be available, and then apply that combined analysis to determine not only what transfer prices may be supportable on their returns, but also how any transfer pricing disputes are like to be ultimately resolved with the IRS. Five months is simply not enough time to do these analyses properly.

For these reasons, TEI urges the government to defer the effective date of the temporary regulations no earlier than January 1, 2008.


Tax Executives Institute appreciates this opportunity to present its views on the effective date of the revised section 482 regulations relating to services. We would be pleased to meet with your to discuss this issue.

TEI will submit more detailed comments on the proposed and temporary regulations later this year. If you have any questions, please do not hesitate to call Janice L. Lucchesi, chair of TEI's International Tax Committee, at 312.544.7023, janice.lucchesi@, or Mary L. Fahey of the Institute's professional staff at 202.638.5601,
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Publication:Tax Executive
Date:Nov 1, 2006
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