Sec. 482 foreign exchange considerations for U.S. distributor subsidiaries buying in foreign currency.

• Author: Bitler, Robert

One of the more common inbound situations under Sec. 482 is a U.S. distributor subsidiary that buys tangible products from a foreign related party, such as a foreign parent. Since such purchases constitute related party, transactions, Sec. 482 requires that the prices on those purchases be at arm's length. Acceptable methods for determining arm's length prices are detailed within the Sec. 482 regulations, and have been updated under the proposed Sec. 482 regulations issued at the beginning of 1992.

The determination of arm's length transfer prices for tangible goods in inbound situations can be exceedingly complex, and may depend on any one or a combination of the following factors: the volume of products sold by the parent to related and/or unrelated parties; the different types of products sold; the contractual terms under which such sales are made; the levels of the market at which related and/or unrelated buyers operate; the amounts of advertising undertaken by the related and/or unrelated buyers; the incorporation of intangible property (such as trade names and trademarks) in the sales; physical differences in the sales; differences in the geographic markets to which sales are made; the profit margins earned by unrelated parties on the resale of similar property, the profit margins earned by the manufacturers of the products sold. In addition, foreign exchange considerations may be crucial in determining a correct arm's-length transfer price, and in certain situations may play a very large role in that determination.

More than ever, both U.S. and foreign multinational corporations are taking a proactive stance in managing their foreign exchange exposure. Such exposure includes not only that of a transactional nature, such as when accounts payable for inventory purchases are in a foreign currency, or of a translational nature, such as when foreign assets change in value due to foreign exchange fluctuations, but also those of a structural (or economic) nature. Structural foreign exchange exposure occurs when transactional and translational exposures have been accounted for, but profitability nevertheless continues to be influenced by changing foreign exchange rates. In general terms, structural foreign exchange exposure typically arises when a company's sales or purchases are made in different currencies than those of competitors. A good example would be a U.S. computer chip manufacturer that purchases all of its raw materials from U.S. suppliers (and thus in U.S. dollars) and sells all of its products to U.S. buyers (and thus in U.S. dollars), but all of whose U.S. competitors sell products manufactured in and purchased from Japan and Korea. Should the dollar rise against the Japanese yen and the Korean won, such...