 Hello and welcome to this session. This is Professor Farhad and this session we would look at US transfer pricing roles and specifically we're going to be looking at sale of tangible property. This topic is covered in international accounting or taxation. As always, I would like to remind you to connect with me only then YouTube is what you would need to subscribe. I have 1500 plus accounting, audit, finance and tax lectures. This is a list of all the courses that I cover, including CPA questions on my website. I do have additional resources such as PowerPoints, Notes, True Faults, Multiple Choice, as well as 2000 plus CPA questions and hundreds of quasi-CPA simulations. If you are looking to learn about any prerequisite for this session, you could look in the description and you will find the playlist for the international transfer pricing. So we're going to start by looking at the sale of tangible property and specifically we're going to be looking at the Treasury regulation. The Treasury regulation in the US required the use of one of five specified methods to determine the arm length price in a sale of tangible property, whether it's inventory or fixed asset. Remember, the transaction has to be an arm length transaction. What is arm length transaction? How much would you charge a party that's not related to you? This is an arm length transaction. Here are the five methods, comparable uncontrolled price method, resale price method, cost plus method, comparable profit methods and profit split method. In this session, I'm going to be covering method one and method two. In the next session, I will cover the remaining three sessions. So let's start to talk about comparable uncontrolled price method. Think of this method, the closest thing I can tell you, you're looking at the market value, how much it's market. Comparable means you could compare it to something else. Uncontrolled means somebody else, someone you don't control. What would they charge? That's what we're looking at. So what would they charge if it's not controlled? It's the market value. And this method is generally considered the most reliable measure of an arm length price when comparable uncontrolled transaction exists. So basically, you are looking at something comparable to what you are doing. Assume a US-based parent company P makes a sale of tangible property to a subsidiary. Under this method, the price for tax purposes is determined by reference to sales by P to the same or similar product to unrelated customers. So one way to see how much we can charge S is to see how much we will charge someone else other than our subsidiary subcode. How much we will charge them, we will charge subcode. Or the purchases by subcode of the same or similar product for unrelated party. Or we could look at the subsidiary. How much with our subsidiary would have to buy the product if they did not buy it from us? Well, that's comparable uncontrolled price method. Also, the sale of the same product between the two unrelated parties could be used to determine the transfer price. Also, we could use at the sale between two unrelated parties. So to determine whether the comparable uncontrollable price result in the most reliable arm length price, a company must consider each of the factors of the Treasury regulation indicates specific factors that may be particularly relevant in determining whether an uncontrolled transaction is comparable. So simply put, that's not the only thing we look at. We look at other factors and we look at the US Treasury factors in a prior session. But here are some some factors that are considered important in comparability. The quality of the product, the contractual terms, the level of the market, geographical market in which the transaction takes place. The date of the transaction might make a difference. Intangible property associated with the sale, foreign currency risk, and alternative realistically available to the buyer and the seller. So simply put, when you are determining this comparable uncontrolled price, don't look only at the price. Well, if the price is being sold in Europe, it might be different than a price that's being sold in North Africa or Southern Europe versus Northern Europe or the Italian market versus the French market. The quality of the product, is it exactly the same or is it a little bit different? The date of the transaction, maybe during peak time, you can charge more. So there are many factors that that determine that comparable uncontrolled price method. This is the point. Okay. If the uncontrolled transaction is not exactly comparable, some adjustments to the uncontrolled price is permitted in order to make the transaction more comparable. So if you have to make some adjustments, you are allowed to do so. For example, let's assume S company, which is the parent company, a US manufacturer sell the same product to both controlled and uncontrolled distributor in Mexico. They sell some to their subsidiaries and some to somebody else. The price to the uncontrolled distributor is $40 per unit for the foreign, for the company that's not related to us, we're charging them $40. However, the parent company affixes its trademark to the product sold to a Mexican subsidiary. They put their trademark, but not to the product sold to the uncontrolled distributor. Now, the trademark is considered and considered to add approximately $10 value to the product because we add the trademark. That's what that's that's worth $10 more. The transaction are not strictly comparable anymore because the products sold to the controlled and uncontrolled parties are different. What's different about them? The trademark. In that situation, if the trademark is worth more than the adjusting, adjusting the uncontrolled price of $40 by $10 would result in a more comparable in 50 would be an acceptable transfer price under the comparable, comparable uncontrolled price price method. So this is an example where you're selling the same product except to your distributor. You're adding your trademark while your trademark is worth more. Therefore, you can charge your subsidiary more. So the value of the trademark could not be reasonably determined. The comparable uncontrolled price method may not result in the most reliable arm length price in the scenario. So we are assuming here that the trademark is worth $10. Otherwise, we cannot do so. Okay. Another method is called the resale price method. When you think of the resale price method, think of working back backward, backwards. So taking the final price and trying to factor something in it, trying to factor a profit margin, and you're selling and you're selling activity. So the resale price method determined the transfer price by subtracting an appropriate gross profit from the price at which the controlled buyer resells the tangible property. Let me give you a simple example. Let's assume we're selling something to another party and we know that other parties are going to sell it for $100. Okay. So if they're going to sell it, this is the final sale. If they're going to sell it for $100 and we think they should make a 10% profit, approximately 10%. Well, we can sell it to them for $90 because we know they're going to sell it for $100. Well, that's not exactly 10%. Let's assume $10. They're going to make $10 profit. Okay. For every $100, they make $10 profit. We can sell it to them at $90. So simply put, we find the final sale price, we find the gross margin, and we cut the gross margin out for that seller, and that's our selling transfer price. In order to use this method, the company must know the final selling price to the uncontrolled parties and be able to determine the appropriate gross margin for the reseller. So I have to know what's the final price, and I have to know how much profit they should be making. Okay. The resale price method is typically used when the buyer or reseller is merely a distributor of the finished goods, a so-called sales subsidiary. So this method is used, again, when the final party is basically selling the product. So it's basically a distributor. The method is acceptable only when the buyer and the reseller does not add substantial amount of value to the product. In other words, I'm selling you the product, but you are not adding any value to it. All what you're doing is you're selling it at an additional profit. So the resale price method is not feasible in cases where the reseller adds substantial value to the goods, or where the goods become part of a larger product. So that method cannot be used in those circumstances. Okay. For example, if the product that you are selling, it goes into a different product and basically the new product is being sold as the final product, then you cannot use the resale price method. The resale price method is used when the product that you sold, you sold product A and the final sales product A. If you sold product A, if you sold batteries and those batteries go into the car, well, guess what? The distributor is not selling the batteries, they're selling the car, which is the batteries only part of it. Okay. Or the goods become part of a larger product because there's no final selling price to the uncontrolled parties for the goods that were transferred. So that's why we can't use this method. Take a look at an example. Okay. Let's assume an appropriate gross profit is determined by reference to the gross margin earned in comparable uncontrolled transaction. Okay. So this is how we can, this is how we figure out the gross profit. Let's assume that O company manufactures and sells automobile batteries, I'm using this example, that it's Canadian affiliates, which in turn sells the battery to local retailers for $50. So the final price is $50. Okay. Other Canadian distributor of automobile batteries earn an average of 25% on similar sales. So we know the final selling price, and we're selling batteries and the batteries are being sold directly to the consumer. And we know other competitors, other competitors, uncontrolled comparable prices, they make a profit of 25%. Applying the resale method. Now O company would establish an arm length price of $37.50, which is 25% less than the $50 or 75% of $50 per unit of its sale of batteries to its Canadian affiliate. So basically, resale price is $50 less an appropriate gross margin gross margin is 25%. So this is how we determine the price. Now bear in mind, if we continue with our example, if all companies, Canadian affiliates operate an automobile assembly plant and places the batteries purchased from the from automobile that are sold for $20,000 per unit, the company cannot use the resale price method for determining an appropriate transfer price, because now they're not selling the battery for $50. The battery is a is a small section of a new product, which is the car itself. So we cannot use this method. Okay. So in determining an appropriate gross margin, the degree of comparability between the sale made by the Canadian affiliate and the sale made by uncontrollable Canadian distributor need not to be as great as under the comparable uncontrolled price method. So one word when you when we're using this method, the degree of comparability, it doesn't have to be exactly the same. So we're not really concerned like under the compare comparable uncontrolled price method, you don't have to be concerned with comparability that much. So the decisive factor is similarity of functions performed by the affiliate. So we need to see if the both affiliates are using the same function using it for the same function. Okay. For example, if the functions performed by the Canadian affiliate and selling batteries are similar to the functions performed by the Canadian distributor of automobile parts in general, the company could use the gross profit margin earned by the uncontrolled sellers of automobile parts in Canada and determining an acceptable transfer price. So notice, it doesn't have to be 100% the same as long as the functions are comparable. We're good enough. Similar functions were good enough. Okay. And we could look at other factors when we are using this method such as inventory level and turn over rate. What's your inventory level? Well, guess what? If you have too much inventory, you're gonna have to worry about your prices, you can, you know, if you don't, if you're if your turnover is high, then you can increase your prices because you're selling your product quickly. Other factors could be contractual terms after you sell this product, do you have any warranty, the sales volume affect the price, the credit term, the transport term, there are many other factors. Okay, in determining this resale price method, sales, marketing, advertising, programs, services including promotional programs and rebate. That's this would also affect the price level of the market. Is it wholesale market or a retail market? Simply put, it's never Apple to Apple. You always have to make those additional adjustments. Now all these adjustments, all these factors, when the company determined the price, they have to document it properly and show evidence in case they were audited. Now in the next session, we're gonna keep looking at sale of tangible property. But specifically, we're gonna be looking at the other three methods that I did not cover, which is the cost plus comparable profit methods and the profit split method. As always, I would like to remind you or invite you to visit my website, where I do have additional resources, and I strongly suggest you subscribe, it's an investment in your career. Good luck and study hard.