Transfer Pricing Ruling A Deterrent To Over-Zealous Tax Departments

by Mike Godfrey, Tax-News.com, Washington

13 May 2009

A recent transfer pricing ruling by the Massachusetts Apellate Tax Board could help to curb the over-zealousness of tax departments in making transfer-pricing adjustments to boost tax revenues without due regard to best practice.

The Appellant was International Data Group (IDG), a company headquartered in Massachusetts with 50 US and 62 overseas affiliates to which IDG provides accounting, marketing and management services. IDG successfully fought off a tax assessment that deemed they had undercharged their USD48m service charges to affiliates by more than USD22m for tax years 1992-94. A 6-year tax audit that led to an upwards assessment for tax and interest was thrown out in its entirety in a judgement of April 17, 2009.

It was ruled that IDG received fair compensation for its administrative services, there being ample, credible evidence that it acted at arm's-length with its subsidiaries in arriving at its fees.

The income adjustments made were fundamentally flawed - nearly all of IDG's expenses were attributed incorrectly to the provision of services to its subsidiaries. The extent to which IDG undertook work for its own benefit in identifying new marketing opportunities was barely taken into account and it had made an assumption that the directors' expenses in attending board meetings of subsidiaries was an expense that should be invoiced to the subsidiaries whereas it was established in the proceedings that the board meetings were primarily for the benefit of IDG in its stewardship of the subsidiaries.

The appellants' expert witness, Dr. Irving Plotkin, highlighted the flaws in the tax assessment. Dr. Plotkin stated that: "the threshold concern is if there's been a transaction between A and B, has that been properly priced. If there was no activity or if A did something which didn't benefit B, there is no question of pricing. Once it has been determined that a corporation has engaged in an activity which benefited a related corporation, the next step in the analysis is to determine how much it would cost the beneficiary of the activity to perform the activity itself or to procure the same services from a third party."

"This so-called make or buy analysis," explained Dr. Plotkin, "is premised on the idea that in an arm's-length transaction, a corporation would never pay more for services from an affiliate than it would pay to an unrelated party or than it would cost to perform the services itself."

No such analysis had been made. Instead, the assessment was based on IDG's own overall expenses. IDG's overall expenses were not an appropriate basis for determining arm's-length charges because many of the activities in which IDG engaged were not performed for the benefit of its subsidiaries.

The evidence included testimony and documents showing that other service providers offered lower fees than IDG for providing the same administrative services as well as the fact that IDG's subsidiaries had, at times, declined to contract with IDG for the administrative services, opting instead to perform the services for themselves or procure them from another provider.

Thus the methodology was not in accordance with Section 482 of the Massachusetts tax code.

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