Proposed regulations relating to the treatment of services under section 482.

July 2, 2004

On July 2, 2004, Tax Executives Institute filed the following comments with the Internal Revenue Service and the U.S. Department of Treasury concerning the development of a per se list of low-margin and non-integral services that should qualify for a cost safe harbor under the proposed regulations relating to the treatment of services under Code Section 482. The comments took the form of a letter from TEI President Raymond G. Rossi to Treasury's International tax Counsel Barbara Angus. The letter was prepared under the aegis of TEI's International Tax Committee, whose chair is Bruce R. Maggin of IBM Corporation. Janice L. Lucchesi of Akzo Nobel Inc. materially contributed to the development of the letter.

Tax Executives Institute is pleased to submit the following comments concerning the development of a per se list of low-margin and non-integral services that should qualify for a cost safe harbor under the section 482 services regulations.

As discussed in our December 23, 2003, comments on the proposed regulations and at the January 14, 2004, public hearing, we are concerned about the proposed elimination of the cost safe harbor and its replacement with the simplified cost-based method (SCBM). The treatment of non-integral services under current Treas. Reg. [section] 1.482-2(b)(3)--which permits a taxpayer to charge services at cost where they are not an integral part of the business activity of either the member rendering the services or the member receiving the benefit of the services--has served taxpayers and (we believe) the government well for nearly four decades.

Thus, TEI believes that the current cost safe harbor should be retained. Accordingly, we appreciate Treasury's willingness to consider an alternative to SCBM that would permit charges to be made at cost for certain low-margin and non-integral services. The vast majority of back-office services--including finance, treasury, controller, accounting, legal, tax, human resources, and procurement--are routine, low-margin services for which charging cost is reasonable. These charges would not be deductible in many foreign jurisdictions and requiring a mark-up would raise serious concerns about double taxation. Thus, we commend the Treasury Department and IRS for seeking a more administrable solution.

Controlled Services Transactions

The proposed regulations apply to "controlled services transactions," which are broadly defined under Prop. Reg. [section] 1.482-9(1) as any activity by a controlled taxpayer that results in a benefit to one or more controlled taxpayers. The term "activity" is defined to include the use by the renderer (or the making available to the renderer) of any property or other resources of the renderer. An activity provides a benefit if it results in a reasonably identifiable increment of economic or commercial value that enhances the recipient's commercial position (or is reasonably anticipated to do so). An activity confers a benefit if an uncontrolled taxpayer in circumstances comparable to those of the recipient would be willing to pay an uncontrolled party to perform the same or similar activity.

Prop. Reg. [section] 1.482-9(1)(3)(iv) provides that certain stewardship or shareholder expenses do not provide a benefit that requires a charge to be made. Thus, an activity does not provide a benefit under the proposed regulations if its primary effect is to protect the renderer's capital investment in the recipient or other members of the controlled group, or if the activity relates primarily to compliance by the renderer with reporting, legal, or regulatory requirements specifically applicable to the renderer (when the renderer is the parent of the controlled group). (1)

The proposed regulations make a distinction, however, between shareholder expenses and activities in the day-to-day management of a controlled group. The latter expenses are not viewed as protecting the renderer's capital investment. TEI believes that certain low-margin and non-integral services that fall within the definition of a "controlled services transaction" (because they are perceived as providing a "benefit") should nonetheless be charged at cost under the final regulations.

For sound business reasons, many multinational taxpayers choose to consolidate the performance of certain services that...