GERMAN-AMERICAN CHAMBER OF COMMERCE COMMENTS ON TRANSFER-PRICING REGS.

We are pleased to enclose comens relating to the Proposed Section 482 regulations which we have prepared in conjunction with the German-American Chamber of Commerce, Inc.

Sincerely,

The German American Chamber of Commerce, Inc. is a membership organization based on over 800 American companies with subsidiaries in Germany and over 1,200 U.S. subsidiaries owned by German shareholders.

The following comments are respectfully submitted because the proposed regulations, if adopted in the published form, would i) impose new standards for transfer pricing not in conformity with traditional arm's length concepts and internationally accepted principles, ii) create an undue burden upon foreign-owned corporations and their shareholders, and iii) create an impediment to foreign investment in the United States.

The Proposed regulations require that the Comparable Profit Interval (CPI) be used to test intercompany pricing for tangibles and intangibles wherever any of the Proposed price determination methods other than the Matching Transaction Method (MTM) or the Comparable Uncontrolled Price (CUP) method is applicable. Since the applicability of the MTM and CPU methods has been restricted to uncontrolled third party transactions involving identical intangibles or goods under substantially the same terms, the effect of the new regulations will be to apply the objective statistically determined third party profitability CPI test to the overwhelming majority of intercompany prices.

(2) EXPANSION OF THE SUPERROYALTY PROVISION IS BEYOND THE STATUTORY AUTHORITY

The proposed revisions to the Regulations which were issued in response to the amendment to Section 482 under the Tax Reform Act of 1986 require that the income with respect to a transfer or license of an intangible shall be commensurate with the income attributable to such intangible. The Committee Reports which explain this amendment refer to the "profit or income stream generated by or associated with intangible property". This language cannot be interpreted to authorize the use of statistically determined profits of third parties which may not even be using the tested intangible. Moreover, the language clearly applies only to intangibles and not to intercompany pricing of tangible assets.

In applying the superroyalty rules to intangibles, the statute was intended to refer to the income of the taxpayer, not to a statistically determined industry standard. This intention is confirmed by the use of the term "income stream" in the Committee Reports. In that connection, the following comment contained in the Conference Committee Report should be given consideration: "In view of the fact that the objective of these provisions -- that the division of income between related parties reasonably reflect the relative economic activities undertaken by each." This comment demonstrates an intent that the income of both parties to the transaction be considered and allocated based on functional analysis.

(3) POTENTIAL FOR DOUBLE TAXATION

The four methods for determining the appropriateness of intercompany prices which are contained in the original Regulations have been adopted by the OECD and are given recognition in many European countries. Thus, double taxation can be avoided because a uniform method is generally applied. By introducing a totally different approach which tests only the price of one of the parties to a transaction without measuring the effects on the other party in the second country, the Regulations would expose taxpayers to a significant risk of double taxation.

(4) THE CPI RESULTS IN ARTIFICIAL PRICING.

The proposed method of determining the CPI requires retroactive adjustment of pricing based on information which can be determined only after the end of the year subsequent to the year in which the transactions take place. The adjustment in effect results in a fictitious price designed only to reach a statistically determined level of profitability solely for tax purposes which has no relationship to competitive factors, the cost of manufacture of the item or creation of the intangible or the effect on the other party to the transaction. Pricing thus determined would be irrelevant for customs duty purposes and could violate anti-dumping laws.

RECOMMENDATIONS

In order to avoid the problems inherent in the proposed method for testing intercompany prices, the following recommendations are respectfully submitted:

a. EXPANSION OF AVAILABILITY OF COMPARABLE UNCONTROLLED ("CUP") AND MATCHING TRANSACTION METHODS ("MTM").

The availability of these two methods is too restrictive under certain circumstances. In particular, the methods should be available when the same property is being transferred at the same or similar price even though the contractual terms of the transaction are less favorable to the related party buyer.

The Matching Transaction Method for determining arm's length pricing of intangibles and the Comparable Uncontrolled Price method of determining pricing of tangibles should continue to apply wherever differences from uncontrolled third party transactions are reasonably measurable.

Under these circumstances, there is no reason why uncontrolled third party pricing cannot be adjusted for such differences and the CPI should not be relevant or applicable.

b. IMPLEMENTATION OF CERTAIN SUBJECTIVE FACTORS WHEN UTILIZING THE PROFITABILITY STANDARD.

Where the Matching Transaction Method or Comparable Uncontrolled Price method are inapplicable, subjective methods of allocation of actual income relating to the transactions under examination would produce a more accurate and predictable result.

The proposed process, which recognizes intercompany pricing as the sole element of profit ability of a taxpayer, disregards the numerous other factors which distinguish a financially successful company from a less profitable one, such as management, general cost structure, differences in product quality that cannot be reflected in resale prices, standing in the market place, etc. The practical result of giving the CPI such a prominent role in intercompany pricing would be distortive and unfair to many taxpayers.

The proposed regulations, which have shifted the focus of transfer pricing from the actual price charged to the overall profitability of comparable unrelated third parties, must address the various factors unique to specific companies. For example, the company under audit may have significant management problems or may incur extraordinary profit or loss in a given year for reasons unique to it. In addition, many newly formed foreign-owned corporations will incur start-up losses in a totally unfamiliar marketplace. As a result, we suggest that subjective types of factors be allowed to be taken into account by taxpayers when they formulate their comparable profit intervals. Thus, subjective factors which affect the profitability of the taxpayer should be applied to permit adjustment of the results obtained on the basis of third party profitability.

c. THE THREE YEAR AVERAGING RULE SHOULD BE ELIMINATED IF SUBJECTIVE FACTORS CAN BE TAKEN INTO ACCOUNT.

The three year averaging rule contained in the CPI should be eliminated and, instead, each year should be reviewed on its own (taking into account extraordinary profit and loss items). If the three (3) year averaging rule remains in the final version of the regulations then adjustments will have to be made more than one year after they were initially set. No prudent businessman would wait such a long period of time to definitively set his prices. Moreover, taxpayers would have prices which would be fixed initially for purposes of customs, anti-dumping, etc., but not for tax purposes.

The method of determining the CPI should enable the taxpayer to calculate his prices in advance. This could be accomplished if the CPI were to be based an comparable methods for the prior year. If subjective factors, as recommended above, could be considered, the proposed three year averaging method would not be necessary since specific economic changes in a particular year would result in appropriate adjustments.

d. ADDITIONAL-CLARITY IS NEEDED TO DETERMINE THE CPI.

The proposed regulations do not provide sufficient detail to enable taxpayers to coherently calculate their CPI range. For example, the IRS must provide greater guidance as to how one determines (a) which party should be the tested party, (b) which unrelated parties should be used to locate comparable data and how to locate such data and (c) which ratios should be applied after the data is compiled. Unless these (and other) areas are clarified the dispute between taxpayers and the IRS will be just as fierce as in the past with the only difference being the dispute itself. In the past the dispute has focused on what the correct price should be and now the disputes will focus on how to calculate the CPI.

e. UNDULY BURDENSOME -- COMPLIANCE FOR MANY TAXPAYERS.

In order to make an attempt at complying with the proposed regulations, taxpayers will have to engage the services of an economist to help them develop a system for computing their CPI'S. While many large corporations may have the resources to take this necessary action the small companies cannot justify similar action. In fact, any such attempt might cause such companies to price themselves out of the marketplace. As a result, we recommend the adoption of a de minimis exception to the CPI rules.

Perhaps the IRS should make a study to determine at what point a company is large enough to merit undertaking the difficult job of compliance which the proposed regulations mandate. The complicated and expensive CPI calculations should be made applicable only where intercompany transactions reach a significant volume. Smaller taxpayers and those whose intercompany transactions are not sufficiently significant should be permitted to continue to use the present methods.

f. CPI SHOULD BE APPLIED ON ALL RELATED PARTIES INVOLVED IN THE TRANSACTION.

The proposed regulations should be modified to take into account whether an adjustment of one related company would significantly affect the application of the other related parties' CPI. For example, if a U.S. subsidiary of a foreign parent is audited in connection with its intercompany purchases of goods from the parent, any adjustment and reallocation of income made to the U.S. subsidiary should not prevail if it would render the parent as comparatively unprofitable in its own marketplace. As such, an exception from an adjustment should exist in the CPI rules if the taxpayer can demonstrate that such a reallocation of income would make the other related party unprofitable or clearly significantly less profitable then its competitors in its marketplace.

If the CPI is applied to adjust the price of the U.S. party to a transaction, the taxpayer should be able to show that the adjustment may not be appropriate because the effect of such a pricing adjustment on the foreign related party's profit would be distortive. In other words, an adjustment of intercompany prices must be economically justified for both parties to the transaction.

g. ACCESS TO DATA

The taxpayer should be given access to comparative profit statistics and information concerning the functions performed by the companies with which it is to be compared so that a true comparison and appropriate adjustments for differences in conditions can be made. The information currently published in SEC reports of publicly traded companies is not sufficiently specific in order to enable a company to isolate the profitability of a product line and the functions which are performed by the reporting company.

The new concepts developed by the IRS in the proposed regulations under I.R.C. section 482 are being reviewed with great concern internationally. The IRS is urged to re-evaluate these concepts to enable taxpayers to comply with them without exhausting an unreasonable amount of time and money. If such reasonable standards are not adopted then the rules are likely to act as a further impediment to U.S. international trade and investment and may lead to reciprocal measures by foreign tax authorities against U.S. business abroad.

Sincerely,