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January 6, 2014
Transfer Pricing Is Still Dead . . .: But It Is Feeling Much Better Every Day!
by Ajay Gupta

Full Text Published by Tax Analysts®

Ajay Gupta (Tax Analysts/Derek Squires)Ajay Gupta is editor of Tax Notes International. E-mail:

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Edward Kleinbard, then chief of staff of the Joint Committee on Taxation, conceded in late February 2008 that "transfer pricing enforcement is dead."1 Following that frank admission, diagnoses of transfer pricing rules' inability to distinguish tax sophistry from financial sophistication have acquired a melancholy air of finality. And prognoses have been couched in dire, almost funereal, tones. In fact, the approaching demise of transfer pricing has become a continuing staple of most international tax discussions. This recurrent refrain of the imminent collapse of the existing transfer pricing regime evokes memories of the long-awaited and even longer-lamented death of Spain's Generalissimo Francisco Franco, which provided the theme for a running Saturday Night Live sketch during the show's inaugural season in 1975.

Our Top Story Tonight

Those of us old enough to have watched the original broadcasts, or idle enough to have watched YouTube videos of them, may recall the following "Weekend Update" by Chevy Chase, accompanied by Garrett Morris, posing as "Headmaster of the New York School for the Hard of Hearing," and appearing "as a public service to those of our viewers who have difficulty with their hearing."

    Chevy Chase: Our top story tonight . . .

    Garrett Morris: [screaming] Our top story tonight . . .!

    Chevy Chase: . . . Generalissimo Francisco Franco . . .

    Garrett Morris: [screaming] . . . Generalissimo Francisco Franco . . . !

    Chevy Chase: . . . is still dead.

    Garrett Morris: [screaming] . . . is still dead!2

Francisco Franco (ASSOCIATED PRESS)2013 was a banner year for heralding transfer pricing's death. Many high-profile events reconfirmed fatal flaws in the worldwide system of pricing goods and services transferred between commonly controlled entities. Among the more notable: Apple CEO Tim Cook's testimony before the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations in May, acknowledging without apology the tech sector's voracious appetite for the double Irish with a Dutch sandwich, and claiming without credulity that indulgence to be consistent "with the spirit of the laws" (prior coverage: Tax Notes Int'l, May 27, 2013, p. 866); Starbucks's payment to HM Revenue & Customs of £5 million in June and an equal amount at year's end, following through on its declared belief "that our customers should not have to wait for us to become profitable before we started paying UK corporation tax" -- a belief precipitated by a prolonged roasting at the U.K. Public Accounts Committee (prior coverage: Tax Notes Int'l, July 1, 2013, p. 22); and the OECD's base erosion and profit-shifting action plan, together with a discussion draft on transfer pricing of intangibles and a white paper on transfer pricing documentation, published in July and discussed at a public consultation in November, during which few, if any, heads surfaced above the sand (prior coverage: Tax Notes Int'l, Dec. 2, 2013, p. 823). In light of these multiple demonstrations of dysfunction and decay, we have selected the persisting vegetative state of global transfer pricing enforcement as the international tax development of the year.

Fake Sign Language Interpreter

In the following pages, three influential experts air their views on the subject: two noted academics from both sides of the Atlantic, who have written extensively in the area; and a prominent activist from the U.K., who has led the charge for greater transparency in tax reporting by multinational enterprises. As with most requiems, some of the orators come to bury transfer pricing, others to praise it.

Before you get to this memorial service for transfer pricing, let me add a few words of my own. I wasn't sure what role this introduction should play. I was tempted to mimic Garrett Morris and merely amplify the featured performers' remarks. But then another role model presented itself -- the fake sign language interpreter from Nelson Mandela's memorial, standing next to some very famous personalities, pretending to translate their words of wisdom, but in actuality moving his hands in made-up gestures that often amounted to "no more than gibberish." Here we go then -- alongside the considered comments of our contributors, these are my very own hand gestures on the abiding morbidity surrounding transfer pricing.

Emigration From Eden

The first-ever transfer of a good between entities under common control appears to have been recorded in Genesis:

    When the woman saw that the fruit of the tree was good for food and pleasing to the eye, and also desirable for gaining wisdom, she took some and ate it. She also gave some to her husband, who was with her, and he ate it.3

And we have been busy calculating the price to impute to that intragroup transfer ever since! I bring up the "Emigration From Eden" to point out that entities under common control transfer goods and services not so much to do business with each other as to do business together -- to venture beyond their native terrain, to expand the frontiers of their existence and activity. Thus, an MNE's constituent corporations transact with one another to develop new markets, to explore new worlds, to boldly go where no other professionally managed for-profit corporation has gone before -- developing countries, Socialist states, even Vermont.

That exploratory zeal underlying most intragroup MNE transactions is lost on the transfer pricing regime, which forsakes all other deities of tax law to worship with single-minded devotion at the altar of the arm's-length standard. Consequently, transfer pricing treats an MNE's scale-transforming exertions as humdrum everyday exercises. To paraphrase Adam Smith, whereas a typical MNE is inspired by the vision of founding "a great empire for the sole purpose of raising up a people of customers," transfer pricing considers its operations "a project undertaken by shopkeepers."4

Let a Hundred Flowers Bloom

An MNE's constituent corporations are by no means the only self-dealing entities that our tax system confronts. Domestic corporations do it -- with their directors, officers, and large shareholders. Partners do it -- with each other, and with their partnerships. Heck, even husbands and wives do it. In these and other cases, when analyzing the dealings at issue, and characterizing them for tax purposes, where appropriate, we step together transactions. We refuse to be satisfied by the form in front of us and instead go looking for the substance lurking behind it. Often, we insist that the sought-after substance be economic in character. All of these approaches, in some sense, could be reconciled with a hunt for an arm's-length transaction. But neither their scope nor their sweep is restricted to such a stylized search. To the contrary, we look, dissect, attack, and defend in many different ways, from many different perspectives, and with many different methods.

Thus, under section 704(b), allocations made in accordance with a partnership agreement are respected only if they have "substantial economic effect." An allocation has economic effect if it is "consistent with the underlying economic arrangement of the partners."5 An allocation's economic effect is substantial if there is a reasonable possibility that the allocation "will affect substantially the dollar amounts to be received by the partners from the partnership, independent of tax consequences."6 An arm's-length yardstick may very well serve as a backstop measure -- available to catch a partner's distributive share that might otherwise fall through a crack in subchapter K.

Section 482 and its regulations, authorizing the use of the arm's-length standard to "make allocations between or among the members of a controlled group,"7 seem broad enough to encompass a partnership of partners under common control. For its part, the IRS remains convinced that it has license to invoke the arm's-length standard "to reallocate a partner's distributive share of any partnership item despite the validity of the allocation under section 704(b), provided that the requirements of section 482 are met."8 But in testing partnership allocations, arm's length is neither where we typically begin nor where we usually end.

Similarly, when it comes to families made of flesh and blood instead of paper and ink, we deploy multiple devices to disentangle related parties. For transfer taxes, we look for "a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts."9 That requires, but is not necessarily satisfied by, an arm's-length distance. With income taxes, however, we dispense with the niceties of hypotheticals and resort to the crudity of gross approximations. The "kiddie tax" of section 1(g) taxes the unearned income of a child at the parent's highest applicable marginal rate.

In sum, the tax landscape is dotted with self-dealing entities at every nook, and by every brook, to which tax law generally responds by letting a hundred doctrinal flowers bloom. Much like the many posies of Through the Looking Glass that Alice encountered at the "Garden of Live Flowers," these multiple blossoms of tax jurisprudence talk "when there's anybody worth talking to."10 By comparison, the straitjacketed doctrine of transfer pricing, quite like the dying protagonist of Citizen Kane, is fixated on a solitary rosebud -- the arm's-length standard in one case and a childhood sled in the other. Both embody a yearning to recapture a moment that never was. For transfer pricing, just as much as it did for Orson Welles's character, that unremitting preoccupation stultifies thought and stifles reasoning.

Clipping Coupons and Parking Intangibles

Consider the debate over the propriety of a tech giant, such as Google, parking its intangibles in a tax haven subsidiary, which then claims to earn royalties on them. Are intangibles parked at Google Ireland any different from the clipped bond coupons placed in his son's pocket by Paul R.G. Horst, who came up second best to Commissioner Guy T. Helvering in Helvering v. Horst?11 "The power to dispose of income is the equivalent of ownership of it."12 So too here: The power to dispose of a royalty stream should be the equivalent of ownership of the underlying intangibles. Further, "the rationale of Horst applies fully to a contingent-fee contract. . . . That the amount of income the asset would produce was uncertain at the moment of assignment is of no consequence."13 Therefore, a contingent fee arrangement constitutes an anticipatory assignment of income notwithstanding the contingency in any ultimate recovery. So too here: Moving to an offshore entity, intangibles capable of generating a stream of royalties, should comprise an anticipatory assignment of income notwithstanding any asserted vagaries in the ebb and flow of that stream. A cost-sharing agreement purporting to apply to those intangibles should then amount to little more than the "attenuated subtleties" so effortlessly dismissed in Horst and its progenitor, Lucas v. Earl.14 An artificial arm's-length distance between the transacting parties, be they Messrs. Horst, Sr. and Jr., or Corps. Google, U.S. and Ireland, only serves to obscure their true intent -- an "arrangement by which the fruits are attributed to a different tree from that on which they grew."15

Paradise Regained?

Justice Oliver Wendell Holmes Jr.'s admonition to keep in mind the tree that bore the fruit in question prompts a revisit to the Genesis story with which I began. Had Adam held back at arm's length Eve's proffered apple from the forbidden tree, paradise would not have been lost. But he did not, resulting in the messy, turbulent, lively world we now inhabit. Given that reality, assessing the original sin of self-dealing by seeking to reconstruct life in Eden would surely, and rightly, be deemed, and doomed as, a fool's errand. Yet transfer pricing marches on -- to "the paradise of fools, to few unknown."16

If transfer pricing, as a category immune from the applicability of general principles of tax law, were to hurry up and die, its resurrection, as a common-sense method of assigning prices to goods and services transferred between an MNE's constituent corporations, can finally get underway.


1 Jon Almeras, "Tax Revenue Sets Sail for Foreign Shores," Tax Notes, Mar. 10, 2008, p. 1061.

2 SNL, Season 1, Episode 7, transcript available at

3 Genesis 3:6.

4 Adam Smith, The Wealth of Nations, Book IV, Ch. 7.149 (1776).

5 Reg. section 1.704-1(b)(2)(ii)(a).

6 Reg. section 1.704-1(b)(2)(iii)(a).

7 Reg. section 1.482-1(a)(2); -1(i)(1), (3), (5).

8 FSA, Sept. 10, 1993.

9 Reg. section 20.2031-1(b).

10 Lewis Carroll, Through the Looking Glass, Ch. 2 (1896).

11 311 U.S. 112 (1940).

12 Id. at 118.

13 Comm'r v. Banks, 543 U.S. 426, 435 (2005).

14 281 U.S. 111 (1930).

15 Id. at 115.

16 John Milton, Paradise Lost, Book III, Line 495 (1674).


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