TEI's follow-up comments on section 482 services regulations: on November 27, 2007, TEI submitted the following comments on temporary and proposed regulations relating to the treatment of services under section 482 (T.D. 9278) and revenue procedure 2007-13.

• Position: Tax Executives Institute

Background

On July 31, 2006, the Internal Revenue Service and the U.S. Department of Treasury issued temporary and proposed regulations on the treatment of controlled services transactions and the allocation of income from intangibles. The regulations significantly revise the proposed regulations issued in 2003, and make material changes to the regulations issued in 1968.

The temporary regulations were originally to become effective for taxable years beginning after December 31, 2006. In Notice 2007-5, however, the IRS modified the effective date for a major portion of the regulations and clarified several issues. Subject to some exceptions, the effective date for identifying controlled services eligible to be priced at cost was deferred one year. In addition, the IRS issued Revenue Procedure 2007-13, which listed low-margin services that automatically qualify for use of the services cost method (SCM) of valuation.

Comments on the Temporary Regulations

The Low Margin Covered Services Test. Under Temp. Reg. [section][section] 1.482-9T(b)(4)(i) and (ii), two categories of covered services--"specified covered services" and "low margin covered services"--qualify for being billed at cost under SCM. Specified covered services are those listed in Rev. Proc 2007-13; low-margin covered services are those for which the median comparable mark-up does not exceed seven percent.

Apropos the test for low margin covered services, TEI recommends that any comparable study commissioned to comply with this regulation be valid for at least three years. In our view, it is unlikely that year-to-year variations will cause a low margin service in one year to fail to qualify in a future year. Thus, taxpayers should not be required to commission a comparable study every year to determine whether a service is low margin. Such an approach will lessen the compliance burden for taxpayers.

It would also be consistent with recent comments by IRS officials that IRS examiners should concentrate on high-value services and look for upfront documentation of these services. At a recent American Bar Association tax conference, John Breen of the IRS Office of Chief Counsel stated that the IRS has "gotten a very clear direction from our enforcement side of the house" that auditors need to work "smarter and more efficiently." In the context of SCM exams, he said, that means ignoring routine services. "If services are truly the back-office-type service--the routine bookkeeping, or [human resources], or record keeping--frankly those are not areas where we want to see people in the IRS spending their attention," he said. "We really want to focus on [the] moderate to sometimes very high value services." D. Stamper, IRS Looking for Upfront Documentation in Services Audits, Official Says, 2007 TNT 214-2 (Nov. 5, 2007) [insert in original].

Moreover, as a practical matter, because comparable mark-ups charged by third parties in a particular year will not be known until the following year, the best...