THE IMPACT OF COST PRINCIPLES AND STANDARDS FOR THE OPERATION OF TRANSFER PRICING - Scientific conference
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THE IMPACT OF COST PRINCIPLES AND STANDARDS FOR THE OPERATION OF TRANSFER PRICING

14.05.2019 13:38

[Section 4. Accounting, analysis and audit]

Author: Grinenko Julia Igorivna, postgraduated student, audit department of Kyiv National Economics University named after Vadym Hetman


The analysis can rely on several different standards of value depending on the purpose of a valuation assignment. The purpose of a valuation, and the standard of value that is applied, can have significant effects on the subject property value conclusion. In other words, valuations performed for different purposes, using different standards of value, can result in different value conclusions. These different value conclusions can be attributed to differences in the definition (and intent) of the standard of value. The appropriateness of the standard of value depends on the context and purpose of the valuation.

Fair market value, the standard of value used in valuations prepared for certain federal tax matters, is generally considered by courts and other income tax practitioners to be consistent with the arm’s- length price standard, the standard of value used in transfer pricing analyses.

Not far removed from the two aforementioned standards of value is fair value. Fair value is the standard of value used for U.S. GAAP financial reporting purposes [1].

In general, each of these standards of value attempts to estimate the price of a property that would be agreed to by independent parties. If all three standards attempt to estimate a price that would be agreed to by independent parties, one may conclude that they should yield equivalent results. However, this is not always the case. This is because these three standards of value diverge from each other in subtle yet significant aspects.

This discussion examines and compares three valuation standards, fair value, fair market value, and arm’s-length price. It also addresses why analysis performed under these three seemingly equivalent standards will not always equate.

In the United States, the standard of value used for financial accounting is fair value. Fair value is defined by the Financial Accounting Standards Board (FASB) in Accounting Codification Standards topic 820 (ASC 820), as follows [2]:

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction in the principal (or most advantageous) market at the measurement date under current market conditions (that is, an exit price) regardless of whether that price is directly observable or estimated using another valuation technique.

In addition to the fair value standard used in financial reporting, there is also fair value derived from state shareholder rights statutes. This statutory fair value standard of value is typically the standard applied in valuations related to dissenting shareholders or minority oppression actions. The definition of fair value in this context can vary from state-to-state, and sometimes even among courts within the same state. Fair value is also the standard used by some states for marital dissolution matters.

For this reason, analysts work closely with client legal counsel to understand the statutes and relevant standards of value applicable to the subject analysis.

Under U.S. income tax law [3], fair market value is the relevant standard of value for income tax purposes. Fair market value is not explicitly defined in the Internal Revenue Code, but it is defined in the Treasury regulations (the “regulations”). The regulations generally carry the full force of law in the United States [4].

The Treasury regulations define fair market value as follows: the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts [5, p. 157].

Despite fair market value being considered the relevant standard of value under U.S. tax law, the arm’s-length price standard may also be applicable in certain income tax matters, such as for intercompany transfer pricing purposes.

The arm’s-length price standard states that the amount charged by one related party to another for a given product should be the same as if the parties were not related. The definition of arm’s-length price as it applies in the United States is presented in the Section 482 regulations [3].

According to the Section 482 regulations:

A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result). 

Although the arm’s-length price standard is the relevant standard of value for intercompany transfer pricing purposes in the United States, other standards may be applied by international tax authorities. For example, the OECD provides the authoritative international definition of the arm’s-length principle. This standard of value is applicable for intercompany transfer pricing purposes in many other (non-U.S.) countries.

According to the OECD: where conditions are made or imposed between the two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. 

For purposes of this discussion, it is important to recognize the differences between the Treasury regulation definition and interpretation of the arm’s- length price standard and the OECD definition and interpretation of the arm’s-length principle.

Fair value and arm’s-length price are not directly compared to each other in the Internal Revenue Code, the regulations, or in ASC 820. However, the definitions can be compared by analyzing certain key attributes of value that are identified in each definition.

Table 1 is reproduced (with minor editorial changes) 1 article in Tax Notes International [3]. The table presents a comparison of the following specific attributes of arm’s-length price and the fair value standard of value, based on the current definitions of each standard: the controlled transaction, the application context, the comparable transaction, the valuation




As stated above, arm’s-length price and the fair value standard are similar in regards to the subject transaction. For both, the subject transaction is recognized as it is actually structured.

Arm’s-length price standard and fair market value have subtle differences. However, for purposes of this discussion, these differences will also be omitted and we will assume them to be equivalent. This assumption comports with the general position taken by many practitioners.

In general, however, these two definitions and standards are largely equivalent, and an in-depth analysis comparing and contrasting the subtle differences between these definitions is beyond the scope of this discussion. For this discussion, we rely on the Treasury regulation definition of the arm’s- length price standard.

REFERENCES

1. U.S. GAAP Accounting Standards Codification Topic 820: Fair Value Measurements and Disclosure [Electronic resourse]: [Website]. – Electronic data. – Mode of access: http://www.fasb.org/

2. The International Financial Reporting Standards. [Electronic resourse]: [Website]. – Electronic data. – Mode of access: http://www.ifrs.org/

3. Electronic Tax Code, Regulations and Official Guidance [Electronic resourse]: [Website]. – Electronic data. – USA : IRS. – Mode of access: World Wide Web: mode:https://www.irs.gov/Tax-Professionals/Tax-Code, Regulations and Official Guidance 

4. United Nations Practical Manual on Transfer Pricing for Developing Countries. – New York, United Nations, 2013. – 485 p. [Electronic resourse]: [Website]. – Electronic data. – Mode of access: World Wide Web: mode:https://www.irs.gov

5. Венгер С.А. Трансфертне ціноутворення у міжнародному бізнесі // Академічний огляд. – 2011. – № 2(35). – С. 156-163.



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