IRS Seeks Public Comments Regarding the Development of a Model Memorandum of Understanding Between U.S. Tax Treaty Partners Outlining Transfer Pricing Safe Harbors for Routine Distribution Services

SUMMARY

On March 15, 2013, the Internal Revenue Service announced that it is seeking comments from the public regarding the development of a model memorandum of understanding between Competent Authorities relating to transfer pricing safe harbors for routine distribution functions. The IRS’s announcement follows the June 6, 2012, issuance of a discussion draft on transfer pricing safe harbors by the Organisation For Economic Co-operation and Development (the “OECD”). The OECD discussion draft included draft sample memoranda of understanding on a number of “low-risk” functions, including the distribution function.  

The pricing of routine distribution services frequently presents transfer pricing issues, for example, where a product is manufactured in one jurisdiction but distributed through affiliated distributors in a second jurisdiction. Global companies must commission costly transfer pricing studies to show that the charges for the distribution services reflect arm’s-length compensation given the services provided, and the risks borne, by the distributor. Additionally, because the transfer pricing rules in different countries differ, global companies may be subject to double taxation as a result of a transfer pricing adjustment in one jurisdiction that does not include a corresponding offset in a second jurisdiction. To avoid double taxation, companies that are subject to a transfer pricing adjustment in the United States may request Competent Authority assistance under the mutual agreement process if that second jurisdiction is a U.S. tax treaty partner, but the process is lengthy and there is no guarantee that the United States and the second jurisdiction will reach an agreement.  

A bilateral safe harbor would provide global companies with comfort that a transfer pricing policy consistent with the safe harbor will be respected, thereby obviating the need for costly transfer pricing studies and mitigating the risk that a later adjustment in one jurisdiction could result in double taxation. The IRS has recognized that the development of such a bilateral safe harbor for common distribution services supports sound tax administration.  

The IRS’s request for comments provides a unique opportunity to influence the development of a safe harbor that is applicable to a large number of routine cross-border transactions, and, as the first of its kind, will serve as a template for future bilateral safe harbors relating to other cross-border controlled transactions.

The IRS has requested comments that are highly specific, to the point of proposing text for draft model agreements. Comments should be submitted electronically by May 1, 2013, to lbi.apmacomments@irs.gov. Clients that have transfer pricing questions or are interested in submitting comments to the IRS on this matter are encouraged to contact any of the lawyers listed on the following page.