News and Resources

Transfer Pricing Times: Volume VI Issue 9
Talbots Decision Emphasizes Economic Substance in the Transfer of Intangibles
In the decision reached on September 29, 2009 in Talbots, Inc. v. Commissioner of Revenue, the Massachusetts tax commissioner disallowed deductions that Talbots claimed for royalties paid to a wholly-owned intangible holding company (“IHC”) for use of its trademarks, trade names and services marks ("marks"). Deductions were disallowed because the transfer and license-back transaction involving the marks lacked economic substance and a valid non-tax business purpose. The Massachusetts Appellate Tax Board also found that the tax commissioner properly adjusted Talbots income by re-attributing to Talbots all of the royalty and interest income earned by the IHC, eliminating interest and dividend income received by Talbots from the IHC, and allowing Talbots a deduction for amortization and other expenses related to the marks.

This ruling is consistent with precedent in Massachusetts and other states where “naked” royalties paid to holding companies, viewed by taxing authorities as purely tax driven, have been disallowed. Talbots lost a similar case in the Maryland Tax Court, Classics Chicago Inc. v. Comptroller and the Talbots Inc. v. Comptroller (Apr. 11, 2008), which ruled that deductions on transactions between a parent company with Maryland nexus and a subsidiary can be revoked if the subsidiary does not have sufficient economic substance.

States have typically attacked the IHC structure on three grounds: First, they have argued that IHCs have no valid business purpose other than that of reducing the company’s tax liability; consequently, the economic substance of intercompany royalty payments is not supportable. Second, they have argued that royalty payments are higher than those that would have been paid in arm’s length transactions between unrelated corporate entities. Finally, they have argued that even though the IHC may be based in another state and has no physical presence in the state making the claim, by collecting a royalty from a parent company or sibling operating unit that does operate within the state, the IHC has taxable nexus with respect to the state making the tax claim.

Conversely, state court rulings have also demonstrated how companies can be successful in establishing and maintaining an IHC. The key is showing that the IHC, in the words of the Supreme Judicial Court of Massachusetts in Sherwin-Williams Co. v. Commissioner of Revenue (Sept. 10, 2001 to Oct. 31, 2002), is “a viable business entity . . . formed for a substantial business purpose or actually engaged in substantive business activity.” Good documentation also helps; in Hallmark Marketing Corporation v. Division of Tax Appeals, New York, Hallmark Marketing relied on a transfer pricing report that was sound, thoroughly prepared, and contemporaneous. In that case, the New York Tax Tribunal affirmed that Hallmark Marketing had implemented arm’s length intercompany pricing.

The predominant recent trend, however, is that states are simply combining and not recognizing intercompany transactions at all. Massachusetts has passed legislation for go-forward years, as have other states, to require combination of substantial intercompany transactions, making transfer pricing planning at the state level less important. However, since audits and litigation lag by several years, cases like the Talbots decision will continue to come up in the foreseeable future.

Obama Administration Rethinking International Tax Reforms
The Obama administration’s plans to reform certain international tax rules, originally announced last Spring as part of an outline for the proposed fiscal year 2010 budget, have fallen off the radar screen for now. Taken together, the proposals were expected to result in higher tax bills for many US multinationals.

The reforms impacted many key areas, including some with direct and indirect implications for transfer pricing. The measure would have likely limited the ability of US companies to defer taxation on foreign earnings. In addition, the “check the box” rules would be reined in, as would the ability to claim foreign tax credits.

There were also some proposed changes more directly impacting transfer pricing practice. First, certain assets that are now eligible to be transferred tax-free to a related party (e.g., goodwill, workforce) would be treated as intangibles, and therefore subject to a tax charge upon transfer. Further, intangible transfers would be valued at their “highest and best use”, as between a willing buyer and seller acting freely and with symmetric information. In addition, the statute of limitations for the IRS to examine requested taxpayer information on related-party transactions would be doubled, from three to six years, after a taxpayer provides the information. Finally, the IRS indicated its intention to clarify the “economic substance” doctrine, by which transfer pricing policies should reflect economic, not tax, considerations. There are also proposals aimed at curbing tax havens, reforming the qualified intermediary program, and limiting certain deductions for intercompany interest.

Many of these proposals have been subjected to intense criticism as business groups and tax practitioners worried about their impact on US competitiveness. Since the release of the proposed tax reforms, business leaders have been meeting with Obama administration officials to express their concerns. While the Obama administration denies that these criticisms led to shelving the proposals at this time, it is likely that this was a fight they wanted to avoid while other issues, such as health insurance reform, take center stage. However, the need to finance that and other administration initiatives may yet make a tempting target of international tax and transfer pricing rules.

Advance Pricing Agreement (APA) Fourth Quarter 2009 Statistics Released
The Advance Pricing Agreement (APA) Program Director at the IRS recently released statistics for the quarter ended September 30, 2009. The statistics include quarterly results of new APA matters received (as well as APAs completed and cases remaining in inventory) as of the end of the quarter. The number of new APA matters received in the fourth fiscal quarter of 2009 was 45, consisting of 27 bilateral APAs and 18 multilateral APAs. Comparing these results to the fourth quarter in prior years, the 45 APA matters represent the highest number of filings for that quarter in the last three years (2007-2009).

The total number of new APAs received for the year ended September 30, 2009 was 125, which is also the highest number of annual filings received over the last three fiscal years (2007-2009).

Along with quarterly statistics, the IRS publishes a full report detailing the performance of the APA program for the previous year. The Annual APA Statutory Reports are typically released in March following the year under review and include additional details and commentary on the full year which are not provided in the quarterly statistics. Copies of previous years’ annual reports can be found at http://www.irs.gov/businesses/international/index.html under “Advanced Pricing Agreement Program”.
 
Print Print This Page
E-mail E-mail This Page

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it for more information products, services, or resources.
Search
Transfer Pricing Times
Subscribe to our complimentary monthly email newsletter and receive the latest transfer pricing global news in your inbox.
Go