IRS Issues Proposals On Taxation Of Services Under Transfer-Pricing Rules

by Mike Godfrey, Tax-News.com, Washington

03 August 2006

The US Treasury Department and the Internal Revenue Service on Tuesday issued proposed and temporary regulations on the tax treatment of services transactions, including services transactions related to intangible property, under the related party transfer pricing rules.

The regulations update the existing rules regarding related party services transactions (which have not been revised since their issuance in 1968) to reflect an increasingly global economy, as well as the significance of cross-border services.

Key highlights of the Proposed and Temporary Regulations are:

• A reduction in administrative and compliance burdens for low-margin services.
• Ensuring that valuable intangibles cannot be transferred outside the United States for less than arm's length consideration.
• Updating guidance on the transfer pricing methods to determine the arm's length price in a services transaction.
• The transfer pricing methods provided are generally consistent with current regulations applicable to transfers of tangible and intangible property and are consistent with international standards in this area.
• In response to significant comments received on the 2003 proposed regulations, the Simplified-Cost Based Method for pricing low-margin services has been eliminated. In its place, the proposed and temporary regulations set forth the Services Cost Method, which provides two avenues for routine back-office services to be charged at cost with no markup.
• Coordination of the rules applicable to services related to intangibles with the transfer pricing rules applicable to transfers of intangible property.

"The proposed and temporary regulations respond appropriately to comments that the proposed regulations would not have achieved their intended purpose of simplifying transfer pricing for low-margin services," explained Treasury International Tax Counsel Hal Hicks.

He continued:

"The new guidance takes low-margin services off the table and makes administration of the rules more productive for both taxpayers and the IRS. The regulations are issued in proposed and temporary form with a delayed effective date in order to allow taxpayers sufficient time to implement any necessary internal procedural changes and to provide further comments before finalization."

"Along with the proposed cost sharing regulations issued last year and forthcoming re-proposed global dealing regulations, the proposed and temporary services regulations modernize our transfer pricing rules to keep them current with changing business practices."

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