TXX5766 USAco, a domestic corporation, is a wholly-owned subsidiary of FORco, a
ID: 2593060 • Letter: T
Question
TXX5766
USAco, a domestic corporation, is a wholly-owned subsidiary of FORco, a foreign corporation. USAco purchases chemical supplies from FORco, and also pays FORco a royalty for the use of FORco's propriety pharmaceuticals. The only method USAco could use to determine the arm's length price for both of these related party transactions is:
a)the comparable profits method.
b)the cost plus method.
c)the resale price method.
d)the comparable uncontrolled price method.
a)the comparable profits method.
b)the cost plus method.
c)the resale price method.
d)the comparable uncontrolled price method.
Explanation / Answer
The comparable profits method looks to the profits of, uncontrolled entities, rather than the prices used in uncontrolled transactions, to determine an arm's-length allocation of profit between two related corporations. Under this method, the profitability of comparable uncontrolled entities is used as a benchmark for determining an arm's-length net profit for one of the controlled parties (the "tested party"), and then a transfer price is established which leaves the tested party with that amount of net profit.
In the cost plus method, product similarity is less important than under the comparable uncontrolled price method, while the similarity of the functions performed, risks borne, and contractual terms agreed to is relatively more important. Consistency between the accounting methods used to compute the gross profit markup for the controlled and uncontrolled transactions also is important.
As with the resale price method, in assessing the comparability of controlled and uncontrolled transactions for purposes of the cost plus method, product similarity is less important than under the comparable uncontrolled price method, while the similarity of the functions performed, risks borne, and contractual terms agreed to is relatively more important. Consistency between the accounting methods used to compute the gross profit markup for the controlled and uncontrolled transactions also is important.
In assessing the comparability of controlled and uncontrolled transactions for purposes of the comparable uncontrolled price method, the most important factor is product similarity. Other significant factors include the similarity of contractual terms and economic conditions. Because information regarding comparable uncontrolled transactions is usually not available, the comparable uncontrolled price method is usually difficult to apply in practice.
In the above case the only method that should be used is the Comparable profits method
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