G L O B A L T R A N S F E R P R I C I N G S E R V I C E S T A X The New Services Regulations under IRC Section 482

G L O B A L T R A N S F E R P R I C I N G S E R V I C E S

T A X

The New Services Regulations under IRC The New Services Regulations under IRC Section 482Section 482

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ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BY USED, BY A CLIENT

OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii)

PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

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Overview of Temporary Services Regulations

4© 2007 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved.

Overview of Temporary Services RegulationsOverview of Temporary Services Regulations

Scope of Regulations Beneficial Services and Cost Base Services Cost Method (“SCM”) Shared Service Arrangements (“SSA”) Other Specified Methods for Services Intangibles and Risk Contracts and Documentation


Temporary Services Regulations (cont.)Temporary Services Regulations (cont.)

The regulations are relevant to “activities”, broadly defined– “includes the performance of functions, assumption of

risks, or use by a renderer of tangible or intangible property or other resources, capabilities or knowledge”

Overlap with other §482 rules: Test transactions under rules that provide the most reliable measure of an arm’s-length result– Need to test or corroborate material Intangible Property

(“IP”) transfers under intangible property rules in all cases

Global Dealing and Parent Guarantees carved out


Temporary Services Regulations: Beneficial Services and Cost BaseTemporary Services Regulations: Beneficial Services and Cost Base

A service renderer must charge for activities that provide, or are reasonably anticipated to provide, a direct benefit to a controlled party

Beneficial services do not include:

– “Duplicative activities”—unless recipient receives additional value

– Activities that only provide an indirect or remote benefit

– Benefits considered to result from taxpayer’s status as a member of a controlled group (“passive association”)

– Shareholder activities


Duplicative ActivitiesDuplicative Activities

If a headquarters activity duplicates an activity that is performed by a recipient on or for its own account, the activity is generally not considered to provide a benefit.

However, a benefit is provided if the duplicative activity itself provides an additional benefit

– Example: A company retains outside counsel to review transaction documents; in-house legal staff also review the documents. The duplication reduces the commercial risk of the transaction.


Indirect or Remote BenefitsIndirect or Remote Benefits

An activity does not provide a benefit to a recipient if the benefit is so indirect or remote that the recipient would not be willing either:

– To pay an uncontrolled party to perform the activity, or

– To perform the activity itself

Example: If the headquarters implements changes to increase its own management efficiency, the benefit to its subsidiaries is likely indirect or remote.


Passive AssociationPassive Association

A taxpayer is not considered to receive a benefit where that benefit results from the recipient’s status as a member of a controlled group.

– Obtaining a contract a subsidiary might not otherwise have gotten if not for membership in group

– A volume discount from membership in group

– However, if headquarters negotiates a contract on behalf of a subsidiary, or provides a financial or performance guarantee, those activities do provide benefits to the subsidiary


Shareholder ActivitiesShareholder Activities

An activity is not considered to provide a benefit if the sole effect of that activity is either:

– To protect the renderer’s capital investment in the recipient or in other members of the controlled group; or

– To facilitate compliance by the renderer with reporting, legal, or regulatory requirements

Day-to-day management activities generally do not relate to the renderer’s capital investment


Shareholder Activities – Example 1Shareholder Activities – Example 1

Company X is publicly-held and is required to prepare and file periodic financial statements.

Company X, Company Y, and other subsidiaries each maintain their own separate accounting departments that record transactions and prepare financial statements in accordance with local accounting practices.

Subsidiaries forward their financial results to Company X, which compiles data into reports in accordance with U.S. laws and regulations.

Does Company X’s activity provide a benefit to Company Y? Why or why not?

Company X(U.S.)

Company Y (Country B)



Same facts as Example 1, except Company Y’s accounting department maintains a general ledger recording individual transactions, but does not prepare any financial statements.

Company Y forwards general ledger data to Company X, who analyzes and compiles financial statements for Company Y, as well as for Company X’s reporting requirements.

Company Y takes the data prepared by Company X, adjusts for minor differences in local accounting practices, and uses the data for reports it files in Country B.


Company X(U.S.)




Members of Company X’s internal audit staff visit Company Y on a semiannual basis in order to review the following:

– Adherence to internal operating procedures issued by Company X

– Compliance with U.S. anti-bribery laws, which apply to Company Y on account of its ownership by a U.S. corporation


Company X(U.S.)




Company X concludes that it may benefit from new currency-control legislation in Country B if it changes the capital structure of Company Y.

Company X engages an investment banking firm and a law firm to review Country B legislation and to propose possible changes to the capital structure of Company Y.


What if Company Y bears the full cost of retaining the firms?

Company X(U.S.)




Facts are the same as in Example 4 except the new legislation relates solely to corporate governance in Country B.

Company X retains the law firm and the investment banking firm to evaluate whether restructuring would do the following:

– Increase Company Y’s profitability

– Reduce the number of legal entities in Country B

– Increase Company Y’s ability to introduce new products more quickly in Country B


Company X(U.S.)




Company X conducts the following activities for Company Y :

– Establishes detailed personnel policies;

– Reviews and approves performance appraisals of Company Y’s executives;

– Monitors compensation paid to all Company Y personnel;

– Is involved with hiring and firing decisions regarding senior executives of Company y.


Company X(U.S.)




Company X conducts a retreat for senior executives at which it produces a strategy statement for increasing the profitability of the company as a whole.

The strategy statement is made available to Company Y; Company Y independently evaluates whether to implement some, all, or none of the initiatives contained in the strategy statement.


Company X(U.S.)



Charging out headquarters costsCharging out headquarters costs

The area of identifying shareholder expense is often one of the more contentious areas of a tax audit of headquarters expenses.

“Stewardship haircut”: Many audits are ultimately settled on arbitrary lines, such as reducing all allocated expenses by x%.

Determine allocation key for headquarters costs that are not shareholder activities

Determine whether or not to mark-up headquarters costs


Present and FuturePresent and Future

Countries such as the U.S. and Japan have enacted, or are enacting, new rules that narrow the category of expenses that do not have to be charged out, pushing headquarters to increase charges and possibly require a markup.

At the same time, many non-OECD countries, such as China and India, are deeply skeptical of charged emanating from offshore headquarters and often challenge the deductibility of these charges.


Temporary Services Regulations: Beneficial Services and Cost Base (cont.)Temporary Services Regulations: Beneficial Services and Cost Base (cont.)

Total Services Costs include all costs—direct and indirect—of rendering a service

– Indirect costs can be allocated using “any reasonable method”

Stock option costs are expressly included

– Regulations are silent on selection of valuation methods

– If comparability is important, grant date is generally the more logical approach

Issues regarding non-U.S. deductibility


Temporary Services Regulations: Services Cost Method (“SCM”)Temporary Services Regulations: Services Cost Method (“SCM”)

Under the SCM, services are charged at “total services cost” Elective method Services qualify for the SCM (i.e., are “covered services”) if three

requirements are satisfied:

– The services are not specifically excluded services

– The renderer determines that they are not “core” services

– Either— The IRS identifies the services as in a revenue procedure

(“specified covered services”) or The median net cost plus markup on the services is 7% or less

(“low margin covered services”)


Temporary Services Regulations: Shared Services Arrangements (“SSA”) under the SCMTemporary Services Regulations: Shared Services Arrangements (“SSA”) under the SCM

Participants share covered services costs based on shares of the reasonably anticipated benefits

Requirements for SSA include:

– Two or more covered participants

– Inclusion of all controlled participants that reasonably anticipate a benefit from one or more covered services specified in the SSA

– Each covered service must confer a benefit on at least one participant in the SSA

– Taxpayer must maintain certain documentation


Temporary Services Regulations: SSAs (cont.)Temporary Services Regulations: SSAs (cont.)

Only services eligible for the SCM may be the subject of an SSA

A single SSA may include multiple covered services If taxpayer reasonably concludes that the SSA’s

allocation method provides the “most reliable” measure of participant’s respective share of reasonably anticipated benefits, then Commissioner may not adjust such allocation basis


Temporary Services Regulations: Other Specified MethodsTemporary Services Regulations: Other Specified Methods

Comparable Uncontrolled Services Price Method (“CUSP”)

Gross Service Margin Method (“GSM”) Cost of Services Plus Method Comparable Profits Method (“CPM”) Profit Split Method Unspecified Methods


Temporary Services Regulations: Intangibles and Risk Temporary Services Regulations: Intangibles and Risk

Intangible owners and contributors

– Sole owner based on legal ownership or control

– Contributor compensation required for development or enhancement

– Potential for IRS to impute arrangements Contingent payment contracts for services allowed

– Must be documented by written contract in advance Amended definition of residual profit split

– “Routine” means susceptible of benchmarking


Temporary Services Regulations: Contracts and DocumentationTemporary Services Regulations: Contracts and Documentation

Enhanced importance of contracts

– Respect for form unless inconsistent with economic substance

– Ability to impute form in absence of contract Required documentation for penalty protection

– Generally same as other transactions

– Must document determination and allocation of costs

– Additional specified documentation for SCM, SSA, contingent services agreements


Notice 2007-5 and Rev. Proc. 2007-13Notice 2007-5 and Rev. Proc. 2007-13

Extends old cost safe harbor one year

– Adds “core capability” test Applies to entire group Judgment can be made by anyone with knowledge

SCM white list now includes “other similar activities”

– Makes white list more useful Cost plus services can be shared

– But not under flexible SSA rules


Notice 2007-5 and Rev. Proc. 2007-13 (cont.)Notice 2007-5 and Rev. Proc. 2007-13 (cont.)

Taxpayers may document contingent service arrangements for 2007 up to the date of tax return

– Will non-U.S. tax authorities accept contingent service fees?

IRS promises to “take it easy” on penalties for 2007


Temporary Services Regulations: Applicability to Corporate Finance FunctionTemporary Services Regulations: Applicability to Corporate Finance Function

Put intercompany agreements in place as soon as possible

Review and document costs– Document benefit or lack of benefit– Impact of stock-based compensation

Determine whether and when to apply the SCM Consider global or regional shared services centers Identify higher risk transactions

– Embedded services, embedded intangibles Consider contingent payment arrangements for

services to match business objectives

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Potential Triggers for a Transfer Pricing Examination


Transfer Pricing “Red Flags”Transfer Pricing “Red Flags”

Related operations in a low-tax jurisdiction Large or complex intercompany transactions reported

on U.S. tax forms 5471 or 5472 Persistent U.S. losses (three or more recent years) Persistently low U.S. profitability relative to industry

norms Different prices for goods or services in transactions

with related parties vs. unrelated parties


Transfer Pricing “Red Flags” (cont.)Transfer Pricing “Red Flags” (cont.)

Payment or receipt of management fees Multiple intercompany transactions that may have to

be considered jointly to establish meaningful transfer prices

Use of profit splits, lump sum payments, or unspecified methods

Royalties or license fees that total more than approx. 5% of net sales

Some of the above triggers may be more likely to have an impact on U.S. taxpayers with non-U.S. ownership

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Q & A

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Presenter’s contact detailsPresenter’s contact details

Thomas HerrThomas HerrKPMG LLPKPMG LLP(612) 305-5532(612) [email protected]@kpmg.com

© 2007 KPMG LLP, the U.S. member firm of KPMG International, a Swiss cooperative. All rights reserved.

All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

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G L O B A L T R A N S F E R P R I C I N G S E R V I C E S T A X The New Services Regulations under IRC Section 482