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Executive Summary

IRS/TREASURY INTERCOMPANY PRICING "DISCUSSION DRAFT" proposals regarding the administration of "arm's length" pricing rules depart from international standards and may result in double taxation of U.S. companies, the Pharmaceutical Manufacturers Association maintains in April 13 comments to the Internal Revenue Service. The comments respond to an IRS/Treasury Department "Study of Intercompany Pricing," published in the Federal Register on Oct. 18. Referring to the draft as a "white paper," PMA maintained that "the principal suggested innovations in the White Paper would represent unilateral action by the U.S. that departs from international standards for administering arm's length pricing rules." The association stated that "such a departure" would "place U.S. companies in conflict with their tax administrations resulting in uncertainty for the pricing of U.S. products and increased double taxation of U.S. companies." The IRS explains in its publication that the "discussion draft" is intended as a preliminary to new regulations on existing intercompany pricing. The document was published pursuant to a 1986 law amending section 482 of the Internal Revenue Code. The amendment provides that income from a transfer or license of intangible property, such as a drug patent, must be commensurate with the income attributable to the property. The study also addresses issues relating to cost-sharing agreements by section 936 companies. PMA urged that "no significant changes should be proposed in existing intercompany pricing regulations until there has been reconsideration of the narrow perspective of the White Paper." The association has also requested a meeting between Treasury Secretary Brady and drug company CEOs to discuss the contemplated changes. The association asserted that the IRS study methodology for basic arm's length rate of return is flawed because it assumes that foreign manufacturing subsidiaries are "mere contract manufacturers and that foreign marketing affiliates perform simple marketing functions." That assumption is "nothing more than the litigating position of the IRS that has in recent years been repeatedly rejected by the courts," PMA said. The association contended that "in third-party situations, it is very common for the licensee of a technology to bring its own valuable skills, marketing expertise and financial strength to the enterprise." The IRS' arguments in a case involving Bausch & Lomb and the allocation of income to its Irish subsidiary were rejected in a March 23 decision in U.S. Tax Court in Washington, D.C. ("The Pink Sheet" April 3, T&G-12). The basic arm's length rate of return methodology also runs counter to "the intent and statutory structure" of section 936(h) of the tax code, according to PMA. The methodology "appears to deny section 936 corporations the statutory right to a return on manufacturing intangibles when they elect the cost-sharing pricing method," the association stated. Since the study does not set out special rules for section 936 corporations that have elected the cost-sharing option, PMA said it is concerned that rules "might be employed to allocate to the section 936 company an amount of income equal to the estimated return on its production assets. This amount is said to be equivalent to a return on routine manufacturing intangibles." Remaining income, under the IRS proposal, would "all be attributed as a royalty to the U.S. parent of the section 936 corporation," PMA maintained.

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