Treatment of Services Under Section 482; Allocation of Income and Deductions From Intangibles; Stewardship Expense, 44466-44519 [06-6497]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 71, Number 150 (Friday, August 4, 2006)]
[Rules and Regulations]
[Pages 44466-44519]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-6497]



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Part V





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1 and 31



Treatment of Services Under Section 482; Allocation of Income and 
Deductions From Intangibles; Stewardship Expense; Final Rule

Federal Register / Vol. 71, No. 150 / Friday, August 4, 2006 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 31

[TD 9278]
RIN 1545-BB31, 1545-AY38, 1545-BC52


Treatment of Services Under Section 482; Allocation of Income and 
Deductions From Intangibles; Stewardship Expense

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations that 
provide guidance regarding the treatment of controlled services 
transactions under section 482 and the allocation of income from 
intangibles, in particular with respect to contributions by a 
controlled party to the value of an intangible owned by another 
controlled party. This document also contains final and temporary 
regulations that modify the regulations under section 861 concerning 
stewardship expenses to be consistent with the changes made to the 
regulations under section 482. These final and temporary regulations 
potentially affect controlled taxpayers within the meaning of section 
482. They provide updated guidance necessary to reflect economic and 
legal developments since the issuance of the current guidance.

DATES: Effective Date: These regulations are effective on January 1, 
2007.
    Applicability Dates: These regulations apply to taxable years 
beginning after December 31, 2006.

FOR FURTHER INFORMATION CONTACT: Thomas A. Vidano, (202) 435-5265, or 
Carol B. Tan, (202) 435-5265 for matters relating to section 482, or 
David Bergkuist (202) 622-3850 for matters relating to stewardship 
expenses (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    Section 482 of the Internal Revenue Code generally provides that 
the Secretary may allocate gross income, deductions and credits between 
or among two or more taxpayers owned or controlled by the same 
interests in order to prevent evasion of taxes or to clearly reflect 
income of a controlled taxpayer. Regulations under section 482 
published in the Federal Register (33 FR 5849) on April 16, 1968, 
provided guidance with respect to a wide range of controlled 
transactions, including transfers of tangible and intangible property 
and the provision of services. Revised and updated transfer pricing 
regulations were published in the Federal Register (59 FR 34971, 60 FR 
65553 and 61 FR 21955) on July 8, 1994, December 20, 1995, and May 13, 
1996. A notice of proposed rulemaking and notice of public hearing were 
published in the Federal Register (68 FR 53448) on September 10, 2003. 
A correction to the notice of proposed rulemaking and notice of public 
hearing was published in the Federal Register (68 FR 70214) on December 
17, 2003. A public hearing was held on January 14, 2004.
    The Treasury Department and the IRS received a substantial volume 
of comments on a wide range of issues addressed in the 2003 proposed 
regulations. These comments were very helpful and substantial changes 
have been incorporated in response. In order to achieve the goal of 
updating the 1968 regulations, while facilitating consideration of 
further public input in refining final rules, these regulations are 
issued in temporary form with a delayed effective date for taxable 
years beginning after December 31, 2006.
    These regulations are issued a significant amount of time after 
proposed revisions to the regulations pertaining to cost sharing 
arrangements were issued. Commentators suggested that this type of 
timing sequence was important so that each regulation could be assessed 
properly. Commentators also suggested, among other things, that the 
services regulations be reissued in temporary and proposed form. By 
issuing these regulations in temporary and proposed form, the Treasury 
Department and the IRS provide taxpayers an opportunity to submit 
additional comments prior to the time these regulations become 
effective, allowing commentators to consider the potential interaction 
between these regulations and the cost sharing regulations.

Explanation of Provisions

A. Controlled Services

1. Services Cost Method--Temp. Treas. Reg. Sec.  1.482-9T(b)
a. The Simplified Cost Based Method and Public Comments
    The 2003 proposed regulations set forth a simplified cost based 
method (SCBM). The SCBM was intended to preserve the salutary aspects 
of the current Sec.  1.482-2(b) cost safe harbor that provide 
appropriately reduced administrative and compliance burdens for low 
margin services. At the same time, the existing rules would be brought 
more in line with the arm's length standard, and various problematic 
features of those rules would be eliminated. The goal was to provide 
certainty concerning the pricing of low margin services, thus allowing 
the compliance efforts of both taxpayers and the IRS to concentrate on 
those services for which a robust transfer pricing analysis is 
particularly appropriate. The preamble to the 2003 proposed regulations 
also indicated that in certain cases, the allocation or sharing among 
group members of expenses or charges relating to corporate headquarters 
or other centralized service activities may be consistent with the 
proposed regulations, but no further guidance was provided on such 
service sharing arrangements.
    A number of commentators argued that the SCBM was actually 
counterproductive to its stated goals. These commentators contended 
that to apply the SCBM, taxpayers would potentially need to expend 
substantial sums to prepare comparability studies, perhaps separately 
for each of the numerous categories of back office services. They 
contended that, although taxpayers have in-depth knowledge concerning 
their businesses and the relative value added by their back offices, 
the SCBM called for quantitative judgments that business people are not 
qualified to make by themselves, especially in the prevailing 
compliance environment. As a matter of proper accountability, taxpayers 
would be required as a practical matter to devote significant 
compliance resources to enlist outside consultants or otherwise to 
develop support for those judgments.
    Commentators suggested a range of proposed alternatives to the SCBM 
regime. One such proposal was simply to return to the approach in the 
existing regulations under Sec.  1.482-2(b). The 1968 regulations are 
fairly rudimentary in nature, particularly, in today's tax compliance 
environment. In addition, those regulations were open to substantial 
manipulation by taxpayers (both inbound and outbound). Moreover, there 
have been extensive and far-reaching developments in the services 
economy since the existing regulations were published in 1968, with 
real prospects that many intragroup services have values significantly 
in excess of their cost. As a result, in the course of considering 
comments on the 2003 proposed regulations, the Treasury Department and 
the IRS have concluded that it would not be appropriate simply to 
readopt the standard in the 1968 regulations. Additional proposals by 
commentators included development of

[[Page 44467]]

a list of activities that would qualify to be priced at cost or 
detailed provisions regarding cost sharing arrangements for low value 
services performed on a centralized basis, and other options.
    The Treasury Department and the IRS may have decided not to return 
to the 1968 regulations, but have nonetheless taken the full range of 
comments on the 2003 proposed regulations seriously. Therefore, in 
light of the extensive comments on these issues, the Treasury 
Department and the IRS have substantially redesigned the relevant 
provisions. The Treasury Department and the IRS recognize that the 
section 482 services regulations potentially affect a large volume of 
intragroup back office services that are common across many industries. 
It is in the interest of good tax administration to minimize the 
compliance burdens applicable to such services, especially to the 
extent that the arm's length markups are low and the activities do not 
significantly contribute to business success or failure.
    Accordingly, based on the comments, these temporary regulations 
eliminate the SCBM and replace it with the services cost method (SCM), 
as set forth in Sec.  1.482-9T(b). The SCM evaluates whether the price 
for covered services, as defined, is arm's length by reference to the 
total services costs with no markup. Where the conditions on 
application of the method are met, the SCM will be considered the best 
method for purposes of Sec.  1.482-1(c).
b. Services Cost Method: Identification of Covered Services and Other 
Eligibility Criteria
    Section 1.482-9T(b)(4) provides for two categories of covered 
services that are eligible for the SCM if the other conditions on 
application of the method are met. If the conditions are satisfied, 
covered services in each category may be charged at cost with no 
markup. The first category consists of specified covered services 
identified in a revenue procedure published by the IRS. This revenue 
procedure approach is consistent with taxpayer comments. Services will 
be identified in such revenue procedure based upon the determination of 
the Treasury Department and the IRS that they constitute support 
services of a type common across industry sectors and generally do not 
involve a significant arm's length markup on total services costs. 
Because the government performs the analysis necessary to determine the 
eligibility of specified covered services, the compliance burden that 
was previously imposed by the SCBM is eliminated for a broad class of 
commonly provided services.
    An initial proposed list of specified covered services is contained 
in an Announcement being published contemporaneously with these 
temporary regulations. This Announcement will be published in the 
Internal Revenue Bulletin. For copies of the Internal Revenue Bulletin, 
see Sec.  601.601(d)(2)(ii)(b). The Treasury Department and the IRS 
solicit public input on whether the list of services sufficiently 
covers the full range of back office services typical within 
multinational groups, on the descriptions provided for these covered 
services, and on other matters related to the Announcement. It is 
contemplated that a final revenue procedure, reflecting appropriate 
comments, will be issued to coincide with the effective date of the 
temporary regulations for taxable years beginning after December 31, 
2006. In the future, particular services may be added to, clarified in, 
or deleted from the list, depending on ongoing developments.
    The second category of covered services is certain low margin 
covered services. Taxpayers objected to the requirement under the SCBM 
that all services qualify for that method based on a quantitative 
analysis, but based on comments the Treasury Department and the IRS 
believe that controlled taxpayers might nonetheless want the discretion 
to show that particular services--not otherwise covered by the revenue 
procedure--qualify for the SCM, using a modified quantitative approach. 
Low margin covered services consist of services for which the median 
comparable arm's length markup on total services costs is less than or 
equal to seven percent. As under the SCBM, the median comparable arm's 
length markup on total services costs means the excess of the arm's 
length price of the controlled services transaction over total services 
costs, expressed as a percentage of total services costs. For this 
purpose, the arm's length price is determined under the general 
transfer pricing rules without regard to the SCM, using the 
interquartile range (including any adjustment to the median in the case 
of results outside such range). Again, if the markup on costs for 
eligible services is seven percent or less, this category of services 
can be charged out at cost with no markup.
    Under Sec.  1.482-9T(b)(2), specified covered services or low 
margin covered services otherwise eligible for the SCM will qualify for 
the method if the taxpayer reasonably concludes in its business 
judgment that the services do not contribute significantly to key 
competitive advantages, core capabilities, or fundamental chances of 
success or failure in one or more trades or businesses of the renderer, 
the recipient, or both. Unlike the quantitative judgment called for 
under the SCBM, this is a business judgment preeminently within the 
business person's own expertise. Exact precision is not needed and it 
is expected that the taxpayer's judgment will be accepted in most 
cases. This condition is intended to focus transfer pricing compliance 
resources of both taxpayers and the IRS principally on significant 
valuation issues. Thus, it is anticipated that in most cases the 
examination of relevant services will focus only on verification of 
total services costs and their appropriate allocation. These are issues 
even under the 1968 regulations. There will be little need in all but 
the most unusual cases to challenge the taxpayer's reasonable business 
judgment in concluding that such typical back office services do not 
contribute significantly to fundamental risks of success or failure. 
The condition effectively is reserved to allow the IRS to reject any 
attempt to claim that a core competency of the taxpayer's business 
qualifies as a mere back office service. For illustrations of the role 
performed by this condition, see the contrasting pairs of Example 1 and 
Example 2, Example 3 and Example 4, Example 5 and Example 6, Example 8 
and Example 9, Example 10 and Example 11, and Example 12 and Example 13 
in Sec.  1.482-9T(b)(6).
    As indicated in this preamble, it is expected that in all but 
unusual cases, the taxpayer's business judgment will be respected. In 
evaluating the reasonableness of the taxpayer's conclusion, the 
Commissioner will consider all the relevant facts and circumstances. 
This provision avoids the need to exclude from the SCM certain back 
office services that as a general matter and across a range of industry 
sectors are low margin, but that in the context of a particular 
business nonetheless constitute high margin services. That is, it 
permits the Treasury Department and the IRS to include a greater range 
of service categories under the SCM, even though in specific 
circumstances an otherwise covered service of a particular taxpayer 
will be ineligible.
    In addition, under Sec.  1.482-9T(b)(3)(i), a single procedural 
requirement applies under the SCM. The taxpayer must maintain 
documentation of covered services costs and their allocation. The 
documentation must include a statement evidencing the taxpayer's 
intention to apply the SCM.
    In Sec.  1.482-9T(b)(3)(ii), the SCM preserves the same list of 
categories of

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controlled transactions that are not eligible to be priced under the 
method as under the SCBM. The Treasury Department and the IRS continue 
to believe that these transactions tend to be high margin transactions, 
transactions for which total services costs constitute an inappropriate 
reference point, or other types of transactions that should be subject 
to a more robust arm's length analysis under the general section 482 
rules. Comments are requested in this regard in light of the other 
substantial changes made in the regulations.
    Consistent with the purpose of providing for appropriately reduced 
compliance burdens for services subject to the SCM, the temporary 
regulations retain provisions in Sec.  1.6662-6T(d)(2) similar to those 
associated with the SCBM.
c. Shared Services Arrangements
    Section 1.482-9T(b)(5) of the temporary regulations provides 
explicit guidance on shared services arrangements (SSAs). In general, 
an SSA must include two or more participants; must include as 
participants all controlled taxpayers that benefit from one or more 
covered services subject to the SSA; and must be structured such that 
each covered service (or group of covered services) confers a benefit 
on at least one participant. A participant is a controlled taxpayer 
that reasonably anticipates benefits from covered services subject to 
the SSA and that substantially complies with the SSA requirements.
    Under an SSA, the arm's length charge to each participant is the 
portion of the total costs of the services otherwise determined under 
the SCM that is properly allocated to such participant under the 
arrangement. For purposes of an SSA, two or more covered services may 
be aggregated, provided that the aggregation is reasonable based on the 
facts and circumstances, including whether it reasonably reflects the 
relative magnitude of the benefits that the participants reasonably 
anticipate from the services in question. Such aggregation may, but 
need not, correspond to the aggregation used in applying other 
provisions of the SCM. If the taxpayer reasonably concludes that the 
SSA (including any aggregation for purposes of the SSA) results in an 
allocation of the costs of covered services that provides the most 
reliable measure of the participants' respective shares of the 
reasonably anticipated benefits from those services, then the 
Commissioner may not adjust such allocation basis.
    In addition, as a procedural matter, the taxpayer must maintain 
documentation concerning the SSA, including a statement that it intends 
to apply the SCM under the SSA and information on the participants, the 
allocation basis, and grouping of services for purposes of the SSA. 
Guidance is also provided on the coordination of cost allocations under 
an SSA and cost allocations under a qualified cost sharing arrangement.
d. Deleted Provisions
    The SCM is considerably streamlined as compared to the SCBM. Upon 
further consideration, and in light of public comments, many of the 
conditions, contractual requirements, quantitative screens, and other 
technicalities associated with the SCBM have been eliminated. The 
Treasury Department and the IRS believe this streamlined approach 
serves the interests of both the government and taxpayers by reducing 
complexity and administrative burden.
2. Comparable Uncontrolled Services Price Method--Temp. Treas. Reg. 
Sec.  1.482-9T(c)
    The 2003 proposed regulations set forth the comparable uncontrolled 
services price (CUSP) method. This method evaluated whether the 
consideration in a controlled services transaction is arm's length by 
comparison to the price charged in a comparable uncontrolled services 
transaction. This method was closely analogous to the comparable 
uncontrolled price (CUP) method in existing Sec.  1.482-3(b).
    One commentator objected to the statement in Sec.  1.482-9(b)(1) of 
the 2003 proposed regulations that, to be evaluated under the CUSP 
method, a controlled service ordinarily needed to be ``identical to or 
have a high degree of similarity'' to the uncontrolled comparable 
transactions. The commentator viewed the comparability analysis in the 
examples in proposed Sec.  1.482-9(b)(4) as more consistent with the 
standard in existing Sec.  1.482-3(b)(2)(ii)(A). The Treasury 
Department and the IRS agree that the comparability standards under the 
CUSP method for services should run parallel to those under the CUP 
method for sales of tangible property. Indeed, the provisions are 
parallel. The commentator misconstrues the purpose of the quoted 
provision.
    Although the provision contains general guidance on situations in 
which the method ordinarily applies, it is not intended to and does not 
alter the substantive comparability standards. Just like the CUP 
method, the standards under the CUSP method emphasize the relative 
similarity of the controlled services to the uncontrolled transaction 
and the presence or absence of nonroutine intangibles. Section 1.482-
9T(c)(2)(ii) of the temporary regulations also provides, consistent 
with the best method rule, that the CUSP method generally provides the 
most direct and reliable measure of an arm's length result if the 
uncontrolled transaction either has no differences from the controlled 
services transaction or has only minor differences that have a definite 
and reasonably ascertainable effect on price, and appropriate 
adjustments may be made for such differences. If such adjustments 
cannot be made, or if there are more than minor differences between the 
controlled and uncontrolled transactions, the comparable uncontrolled 
services price method may be used, but the reliability of the results 
as a measure of the arm's length price will be reduced. Further, if 
there are material differences for which reliable adjustments cannot be 
made, this method ordinarily will not provide a reliable measure of an 
arm's length result.
    The CUSP provisions in these temporary regulations are 
substantially similar to the corresponding provisions in the 2003 
proposed regulations.
3. Gross Services Margin Method--Temp. Treas. Reg. Sec.  1.482-9T(d)
    The 2003 proposed regulations provided for a gross services margin 
method, which evaluated the amount charged in a controlled services 
transaction by reference to the gross services profit margin in 
uncontrolled transactions that involve similar services. The method was 
analogous to the resale price method for transfers of tangible property 
in existing Sec.  1.482-3(c).
    Under the 2003 proposed regulations, this method would ordinarily 
be used where a controlled taxpayer performs activities in connection 
with a ``related uncontrolled transaction'' between a member of the 
controlled group and an uncontrolled taxpayer. For example, the method 
may be used where a controlled taxpayer renders services to another 
member of the controlled group in connection with a transaction between 
that other member and an uncontrolled party (agent services), or where 
a controlled taxpayer contracts to provide services to an uncontrolled 
taxpayer and another member of the controlled group actually performs 
the services (intermediary function).
    The 2003 proposed regulations defined the terms ``related 
uncontrolled transaction,'' ``applicable uncontrolled

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price,'' and ``appropriate gross services profit''. A ``related 
uncontrolled transaction'' is a transaction between a member of the 
controlled group and an uncontrolled taxpayer for which a controlled 
taxpayer performs either agent services or an intermediary function. 
The ``applicable uncontrolled price'' is the sales price paid by the 
uncontrolled party in the related uncontrolled transaction. The 
``appropriate gross services profit'' is the product of the applicable 
uncontrolled price and the gross services profit margin in comparable 
uncontrolled services transactions. The gross services profit margin 
takes into account all functions performed by other members of the 
controlled group and any other relevant factors.
    One commentator mistakenly interpreted the term ``related 
uncontrolled transaction'' to suggest that the comparable transaction 
under this method is one that takes place between controlled parties. 
While this was not intended, the Treasury Department and the IRS agree 
that the nomenclature is potentially confusing, and as a result, these 
regulations substitute the term ``relevant uncontrolled transaction'' 
in lieu of ``related uncontrolled transaction'' wherever that appeared. 
In other respects, the gross services margin provisions in these 
temporary regulations are substantially similar to the provisions in 
the 2003 proposed regulations.
4. Cost of Services Plus Method--Temp. Treas. Reg. Sec.  1.482-9T(e)
    The 2003 proposed regulations set forth the cost of services plus 
method. This method evaluated the amount charged in a controlled 
services transaction by reference to the gross services profit markup 
in comparable uncontrolled services transactions. The gross services 
profit is determined by reference to the markup as a percentage of 
comparable transactional costs in comparable uncontrolled transactions. 
This method would ordinarily apply where the renderer of controlled 
services provides the same or similar services to both controlled and 
uncontrolled parties. In general, those are the only circumstances in 
which a controlled taxpayer would likely have the detailed information 
concerning comparable transactional costs necessary to apply this 
method reliably.
    The cost of services plus method in the 2003 proposed regulations 
was generally analogous to the cost plus method for transfers of 
tangible property in existing Sec.  1.482-3(d). The method implicitly 
recognized that financial accounting standards applicable to services 
have not developed to the same degree as the standards applicable to 
other categories of transactions, such as manufacturing or distribution 
of tangible property. For that reason, the method adopted the concept 
of ``comparable transactional costs,'' which the 2003 proposed 
regulations defined as all costs of providing the services taken into 
account in determining the gross services profit markup in comparable 
uncontrolled services transactions. In this context, comparable 
uncontrolled transactions could be either services transactions between 
the controlled taxpayer and uncontrolled parties (internal 
comparables), or services transactions between two uncontrolled parties 
(external comparables).
    The 2003 proposed regulations also recognized that comparable 
transactional costs could be a subset of total services costs. 
Generally accepted accounting principles (GAAP) or Federal income tax 
accounting rules (if income tax data for comparable uncontrolled 
transactions are available) could provide an appropriate platform for 
analysis under this provision, but neither is necessarily conclusive.
    Commentators objected that the concept of comparable transactional 
costs was imprecise, and they suggested that such costs should in any 
event include only the direct costs associated with providing a 
particular service, as determined under GAAP or Federal income tax 
accounting rules. As noted above, the financial accounting standards 
for services transactions are not as precise as the standards 
applicable to other types of transactions. The relative lack of 
uniformity in turn makes it impractical to derive a single definition 
of cost that would apply generally to controlled services transactions.
    Comparable transactional costs may potentially include direct and 
indirect costs, if such costs are included in the internal or external 
uncontrolled transactions that form the basis for comparison. Section 
1.482-9T(e)(4) Example 1 has been modified to clarify this concept.
    Several commentators objected to Sec.  1.482-9(d)(3)(ii)(A) of the 
2003 proposed regulations. In their view, this provision required the 
results obtained under the cost of services plus method to be confirmed 
by means of a separate analysis under the comparable profits method 
(CPM) for services. If a confirming analysis under the CPM for services 
were required in all cases, commentators reasoned, the cost of services 
plus method could not be viewed as a specified method in its own right.
    The Treasury Department and the IRS agree and clarify that the 
intent of the rules is not to require confirmation of the results under 
the cost of services plus method. In response to public comments, Sec.  
1.482-9T(e)(3)(ii)(A) of these temporary regulations incorporates 
several changes. First, restatement of the price under this method in 
the form of a markup on total costs of the controlled taxpayer is 
necessary only if the cost of services plus method utilizes external 
comparables. If internal comparables are used, this calculation need 
not be performed. Second, in situations where the price is restated, 
the sole purpose is to determine whether it is necessary to perform 
additional evaluation of functional comparability.
    For example, if the price under the cost of services plus method, 
when restated, indicates a markup on the renderer's total services 
costs that is either low or negative, this may indicate differences in 
functions that have not been accounted for under the traditional 
comparability factors. A low or negative markup suggests the need for 
additional inquiry, the outcome of which may suggest that the cost of 
services plus method is not the most reliable measure of an arm's 
length result under the best method rule. Conforming changes have been 
made in Sec.  1.482-9T(e)(4) Example 3 of these temporary regulations.
5. Comparable Profits Method for Services--Temp. Treas. Reg. Sec.  
1.482-9T(f)
    The 2003 proposed regulations provided for a Comparable Profits 
Method (CPM) for services, which was similar to the CPM in existing 
Sec.  1.482-5. In general, the CPM for services evaluated whether the 
amount charged in a controlled services transaction is arm's length by 
reference to objective measures of profitability (profit level 
indicators or PLIs) derived from financial information regarding 
uncontrolled taxpayers that engage in similar services transactions 
under similar circumstances. The CPM for services applied only where 
the renderer of controlled services is the tested party.
    Section 1.482-9(e) of the 2003 proposed regulations provided that 
the profit level indicators (PLIs) provided for in existing Sec.  
1.482-5(b)(4)(ii) may also be used under the CPM for services. The 
relative lack of uniformity in financial accounting standards for 
services, combined with potentially incomplete information regarding 
the cost accounting practices of the

[[Page 44470]]

uncontrolled comparables, strongly suggest that PLIs that require 
accurate segmentation of costs may have limited reliability.
    The 2003 proposed regulations stated that the degree of consistency 
in accounting practices between the controlled services transaction and 
the uncontrolled services transaction might affect the reliability of 
the results under the CPM for services. If appropriate adjustments to 
account for such differences are not possible, the reliability of the 
results under this method will be reduced.
    Section 1.482-9(e)(2)(ii) of the 2003 proposed regulations provided 
for a new profit level indicator that may be particularly useful for 
controlled services transactions: the ratio of operating profits to 
total services costs, or the markup on total costs (also referred to as 
the ``net cost plus''). Because this profit level indicator evaluates 
operating profits by reference to the markup on all costs related to 
the provision of services, it is more likely to use a cost base of the 
tested party that is comparable to the cost base used by uncontrolled 
parties in performing similar business activities.
    The Treasury Department and the IRS received a number of comments 
concerning the CPM for services. Commentators questioned whether the 
definition of ``total services costs,'' which provides the net cost 
plus cost base under the CPM for services, included stock-based 
compensation. In response to these comments, the Treasury Department 
and the IRS clarify their intent that Sec.  1.482-5(c)(2)(iv) of the 
existing regulations apply to the CPM for services. Accordingly, new 
Example 3, Example 4, Example 5, and Example 6 are included in Sec.  
1.482-9T(f)(3) of these temporary regulations. These examples show the 
application of existing Sec.  1.482-5(c)(2)(iv) to fact patterns that 
involve differences in the utilization of or accounting for stock-based 
compensation in the context of controlled services transactions.
    One commentator expressed reservations concerning a statement in 
the preamble to the 2003 proposed regulations, which indicated that 
PLIs based on return on capital or assets might be unreliable for 
controlled services because the reliability of these PLIs decreases as 
operating assets play a less prominent role in generating operating 
profits. This commentator contended that such PLIs are reliable for all 
firms, including service providers. The Treasury Department and the IRS 
clarify that, although return on capital PLIs may produce reliable 
results in the case of certain service providers, in general, such PLIs 
are subject to the general reservation in existing Sec.  1.482-
5(b)(4)(i) to the effect that the reliability of such PLIs increases as 
operating assets play a greater role in general operating profits.
    Aside from the addition of the examples described above, the CPM 
for services provisions in these temporary regulations are 
substantially similar to the provisions in the 2003 proposed 
regulations.
6. Profit Split Method--Temp. Treas. Reg. Sec. Sec.  1.482-9T(g) and 
1.482-6T(c)(3)(i)(B)
    The 2003 proposed regulations provided additional guidance 
concerning application of the comparable profit split and the residual 
profit split methods to controlled services transactions. Generally, 
these methods evaluated whether the allocation of the combined 
operating profit or loss attributable to one or more controlled 
transactions is arm's length by reference to the relative value of each 
controlled taxpayer's contributions to the combined operating profit or 
loss.
    The 2003 proposed regulations provided that the guidance regarding 
the profit split methods in existing Sec.  1.482-6, as amended by 
proposed Sec.  1.482-6(c)(3)(i)(B) and by other changes, applied to 
controlled services transactions. Section 1.482-9(g) of the 2003 
proposed regulations also provided specific additional guidance 
concerning application of existing Sec.  1.482-6, as amended, to 
controlled services transactions.
    The Treasury Department and the IRS received numerous comments on 
the profit split method. Commentators objected in particular to 
references in the 2003 proposed regulations to ``interrelated'' 
transactions in Sec.  1.482-6(c)(3)(i)(B)(1), and to ``high-value 
services'' and ``highly integrated transactions'' in Sec.  1.482-
9(g)(1). Commentators viewed these terms as vague and subjective. 
Commentators also sought more specific guidance concerning the 
circumstances in which the residual profit split method would 
constitute the best method under the principles of existing Sec.  
1.482-1(c). In addition, some commentators suggested that one hallmark 
of a nonroutine contribution in the context of controlled services is 
that the renderer bears substantial risks. Another commentator 
suggested that the arm's length compensation for a function performed 
by an employee or group of employees should not in any event be 
evaluated under a profit split method. In this commentator's view, such 
an activity should be classified as routine because the market return 
for the function is equivalent to the total compensation paid to the 
employees. Commentators also raised several objections to the factual 
assumptions in the proposed analysis concerning Sec.  1.482-9(g)(2) 
Example 2 of the 2003 proposed regulations.
    The Treasury Department and the IRS agreed with a number of 
comments and, as a result, have made substantial changes to these 
provisions. Under these temporary regulations, all references to 
``interrelated'' transactions in Sec.  1.482-6(c)(3)(i)(B)(1), as well 
as references to ``high-value services'' and ``highly integrated 
transactions'' in Sec.  1.482-9(g)(1) have been eliminated. Section 
1.482-9T(g)(1) now states that the profit split method is ``ordinarily 
used in controlled services transactions involving a combination of 
nonroutine contributions by multiple controlled taxpayers.'' This 
change from the 2003 proposed regulations (which referred to ``high-
value'' or ``highly-integrated'' transactions), conforms to the changes 
to Sec.  1.482-6T(c)(3)(i)(B)(1), as described below.
    Section 1.482-6T(c)(3)(i)(B)(1) of these temporary regulations 
defines a nonroutine contribution as ``a contribution that is not 
accounted for as a routine contribution.'' In other words, a nonroutine 
contribution is one for which the return cannot be determined by 
reference to market benchmarks. Importantly, in this context, the term 
``routine'' does not necessarily signify that a contribution is low 
value. In fact, comparable uncontrolled transactions may indicate that 
the returns to a routine contribution are very significant.
    In response to the comments and in accordance with the revised 
definition of nonroutine contribution in these temporary regulations, 
the following references were eliminated as unnecessary: (1) 
Contributions not fully accounted for by market returns; and (2) 
contributions so interrelated with other transactions that they cannot 
be reliably evaluated on a separate basis. These changes will bring 
added clarity to the temporary regulations.
    The Treasury Department and the IRS believe that these revised 
provisions respond to the public comments and offer more specific 
guidance concerning the circumstances in which the profit split method 
would likely constitute the best method under existing Sec.  1.482-
1(c). In particular, the term ``high-value'' is not included in 
temporary Sec.  1.482-9T(g)(1), thus eliminating any implication that 
the profit split method is a ``default'' method for controlled services 
that have value significantly in excess of cost. This shift in emphasis 
is

[[Page 44471]]

also reflected in section B.2 of this preamble, which describes the 
deletion of language from several examples that some believed suggested 
that the residual profit split is a default method. The clear intent is 
that no method, including the profit split, is a default method for 
purposes of the best method rule. Rather, the profit split method 
applies if a controlled services transaction has one or more material 
elements for which it is not possible to determine a market-based 
return. The Treasury Department and the IRS believe that the above 
changes address the comments made and so do not believe that it is 
necessary for the regulations to adopt alternative definitions of 
nonroutine contribution put forward by commentators, such as 
definitions based on the degree of risk borne by the renderer of 
services or the extent to which an activity is performed solely by 
employees of the taxpayer.
    Finally, based on the public comments, and in light of the changes 
described in this preamble, Sec.  1.482-9(g)(2) Example 2 of the 2003 
proposed regulations has been withdrawn and replaced by a new example 
that more effectively illustrates application of the profit split 
method to nonroutine contributions by multiple controlled parties.
7. Unspecified Methods--Sec.  1.482-9T(h)
    The 2003 proposed regulations provided that an unspecified method 
may provide the most reliable measure of an arm's length result under 
the best method rule. Such an unspecified method must take into account 
that uncontrolled taxpayers compare the terms of a particular 
transaction to the realistic alternatives to that transaction.
    No significant comments were received concerning the unspecified 
method provisions. Consistent with the general aim to coordinate the 
analyses under the various sections of the regulations under section 
482 so that economically similar transactions will be evaluated 
similarly, however, Sec.  1.482-9T(h) has been modified to provide that 
in applying an unspecified method to services, the realistic 
alternatives to be considered include ``economically similar 
transactions structured as other than services transactions.'' This 
provision allows flexibility to consider non-services alternatives to a 
services transaction, for example, a transfer or license of intangible 
property, if such an approach provides the most reliable measure of an 
arm's length result. The Treasury Department and the IRS are 
considering similar changes to Sec. Sec.  1.482-3(e)(1) and 1.482-
4(d)(1) of the existing regulations. Public comments are requested 
regarding the advisability of such changes and the form they should 
take. Aside from this change, the unspecified method provisions in 
these temporary regulations are substantially similar to the provisions 
in the 2003 proposed regulations.
8. Contingent-Payment Contractual Terms--Temp. Treas. Reg. Sec.  1.482-
9T(i)
    The contingent-payment contractual term provisions in the 2003 
proposed regulations built on the fundamental principle that, in 
structuring controlled transactions, taxpayers are free to choose from 
among a wide range of risk allocations. This provision in the 2003 
proposed regulations also acknowledged that contingent-payment terms--
terms requiring compensation to be paid only if specified results are 
obtained--may be particularly relevant in the context of controlled 
services transactions. The 2003 proposed regulations provided detailed 
guidance concerning contingent-payment contractual terms, including 
economic substance considerations as well as documentation 
requirements.
    Under Sec.  1.482-9(i)(2) of the 2003 proposed regulations, a 
contingent-payment arrangement was given effect if it met three basic 
requirements: (1) The arrangement is contained in a written contract 
executed prior to the start of the activity; (2) the contract makes 
payment contingent on a future benefit directly related to the outcome 
of the controlled services transaction; and (3) the contract provides 
for payment on a basis that reflects the recipient's benefit from the 
services rendered and the risks borne by the renderer.
    Commentators generally supported the contingent-payment terms 
provision as providing guidance concerning a contractual structure with 
particular relevance to controlled services transactions. However, they 
also raised three fundamental concerns regarding the scope and 
operation of this provision. First, the commentators questioned whether 
controlled taxpayers would need to identify uncontrolled comparables 
for any contingent-payment terms that they seek to adopt. Second, they 
pointed out that certain references to economic substance provisions 
and documentation requirements were either unclear or duplicative of 
provisions in existing Sec.  1.482-1(d)(3). Third, commentators 
expressed concern that the IRS might improperly impute contingent-
payment terms as a means of addressing erroneous transfer pricing in 
situations that do not involve lack of economic substance, for example, 
non-arm's length pricing of activities such as marketing or research 
and development.
    The temporary regulations respond to each of these concerns. First, 
under Sec.  1.482-9(i)(1) of the 2003 proposed regulations, one factor 
that needed to be considered was whether an uncontrolled taxpayer would 
have paid a contingent fee if it engaged in a similar transaction under 
comparable circumstances. In response to comments, the temporary 
regulations eliminate this requirement and instead emphasize the 
importance of the economic substance principles under Sec.  1.482-
1(d)(3) of the existing regulations. That is, whether a particular 
arrangement entered into by controlled parties has economic substance 
is not determined by reference to whether it corresponds to 
arrangements adopted by uncontrolled parties.
    Second, in response to comments, the temporary regulations 
eliminate duplicative or unnecessary references to the economic 
substance rules. For example, Sec.  1.482-9T(i)(2)(ii) has been 
modified to provide that the contingent-payment arrangement as a whole, 
including both the contingency and the basis of payment, must be 
consistent with economic substance, as evaluated under existing Sec.  
1.482-1(d)(3)(ii)(B). This section eliminates the additional 
requirement under the 2003 proposed regulations, that the arm's length 
charge under a contingent-payment arrangement must be evaluated by 
reference to economic substance principles.
    Third, the temporary regulations respond to the concern identified 
by commentators that the IRS might apply the contingent-payment 
provisions in an inappropriate manner, for example, to correct 
erroneous transfer pricing in prior taxable years that are not under 
examination. As discussed in more detail in section C of this preamble, 
the temporary regulations include an example to illustrate factual 
circumstances in which contractual terms pertaining to risk allocations 
(provided they are otherwise consistent with taxpayers' conduct and 
arrangements) are fully respected, notwithstanding that on examination 
the activities were determined to have been priced on a non-arm's 
length basis. Other concerns, relating to interaction of the 
contingent-payment terms provision with the commensurate with income 
standard, are also addressed in section C of this preamble.
    New Sec.  1.482-9T(i)(5) Example 3 illustrates the application of 
these rules to a situation in which the contingency identified in a 
contingent-payment

[[Page 44472]]

provision is not satisfied. The example responds to a request by 
commentators for additional guidance to address such a factual 
scenario.
9. Total Services Costs--Temp. Treas. Reg. Sec.  1.482-9T(j)
    Section 1.482-9(j) of the 2003 proposed regulations defined ``total 
services costs'' for purposes of the SCBM, the CPM for services, and 
the cost of services plus method where the gross services profit was 
restated in the form of a markup on total services costs.
    Under the 2003 proposed regulations, total services costs included 
all costs directly identified with provision of the controlled 
services, as well as all other costs reasonably allocable to such 
services under Sec.  1.482-9(k). The Treasury Department and the IRS 
intended that, in this context, ``costs'' must comprise provision for 
all resources expended, used, or made available to render the service. 
Generally accepted accounting principles (GAAP) or Federal income tax 
accounting rules may provide an appropriate analytic platform, but 
neither would necessarily be conclusive in evaluating whether an item 
must be included in total services costs. The issue of determining 
total services costs is not a new one; it is relevant under the current 
1968 regulations as well.
    Commentators objected that Sec.  1.482-9(j) of the 2003 proposed 
regulations failed to list the specific items that were included in 
total services costs. Some commentators suggested that, absent more 
precise guidance in this regard, controlled taxpayers should be 
permitted to rely on the definition of costs applicable under GAAP or 
Federal income tax principles. Commentators also requested 
clarification whether total services costs included stock-based 
compensation.
    The Treasury Department and the IRS view the definition of total 
services costs in the 2003 proposed regulations as having struck the 
correct balance between specificity and flexibility. In general, the 
accounting standards applicable to services do not provide a uniform 
means of determining all costs that relate to the provision of 
services. Consequently, the Treasury Department and the IRS conclude 
that total services costs for purposes of section 482 cannot be 
determined solely by reference to GAAP or other accounting standards or 
practices.
    In response to comments, however, Sec.  1.482-9T(j) of the 
temporary regulations clarifies that all contributions in cash or in 
kind (including stock-based compensation) are included in total 
services costs. In addition, the third sentence of Sec.  1.482-9T(j) 
states that ``costs for this purpose should comprise provision for all 
resources expended, used, or made available to achieve the specific 
objective for which the service is rendered.'' To better reflect, for 
example, the inclusion of stock-based compensation in total services 
costs, the term ``provision'' is adopted in place of the term 
``consideration'' as used in the 2003 proposed regulations.
    Commentators also observed that the definition of total services 
costs in the 2003 proposed regulations did not address situations in 
which the costs of a controlled service provider include significant 
charges from uncontrolled parties. Commentators posited that such 
third-party costs should be permitted to ``pass through,'' rather than 
being subject to a markup under the transfer pricing method used to 
analyze the controlled services transaction. The Treasury Department 
and the IRS agree that these comments raised an issue that needs to be 
addressed, but decided to do so in a manner different from that 
suggested by the commentators. In response to this comment, the 
temporary regulations add Sec.  1.482-9T(l)(4), which under certain 
circumstances allows a controlled services transaction that involves 
third-party costs to be evaluated on a disaggregated basis. See section 
A.11.e of this preamble.
10. Allocation of Costs--Temp. Treas. Reg. Sec.  1.482-9T(k)
    Section 1.482-9(k) of the 2003 proposed regulations retained the 
flexible approach of existing Sec.  1.482-2(b)(3) through (6), which 
permitted taxpayers to use any reasonable allocation and apportionment 
of costs in determining an arm's length charge for services. In 
evaluating whether the allocation used by the taxpayer is appropriate, 
the 2003 proposed regulations required that consideration be given to 
all bases and factors, including practices used by the taxpayer to 
apportion costs for other (non-tax) purposes. Such practices, although 
relevant, need not be given conclusive weight by the Commissioner in 
evaluating the arms length charge for controlled services.
    Commentators urged that any technique that a taxpayer uses to 
allocate costs should be entitled to deference, provided it is 
consistent with GAAP. For the reasons expressed above concerning Sec.  
1.482-9T(j), GAAP may provide an appropriate analytic platform but is 
not necessarily controlling in evaluating the arm's length charge for 
controlled services.
    In the case of administrative or support services, commentators 
suggested that the Commissioner should accept any reasonable allocation 
used by the taxpayer, for example, revenue, sales, or employee 
headcount. In general, the cost of a service that provides benefits to 
multiple parties must be allocated in a manner that reliably reflects 
the proportional benefit received by each of those parties. This 
standard is intended to be substantially equivalent to the standard in 
Sec.  1.482-2(b)(2)(i) and 1.482-2(b)(6) of the existing regulations. 
In response to comments, Sec.  1.482-9T(b)(5)(i)(B) of these temporary 
regulations also provides rules whereby the costs of covered services 
subject to a shared services arrangement are allocated to participants 
in a manner that the taxpayer reasonably concludes will most reliably 
reflect each participant's reasonably anticipated benefits from the 
services. See section A.1.c of this preamble.
11. Controlled Services Transactions--Temp. Treas. Reg. Sec.  1.482-
9T(l)
a. Definition of Activity--Temp. Treas. Reg. Sec.  1.482-9T(l)(2)
    Section 1.482-9(l) of the 2003 proposed regulations set forth a 
threshold test for determining whether an activity constituted a 
controlled services transaction subject to the general framework of 
Sec.  1.482-9. The 2003 proposed regulations broadly defined a 
controlled services transaction as any activity by a controlled 
taxpayer that resulted in a benefit to one or more other controlled 
taxpayers. An ``activity'' was in turn defined as the use by the 
renderer, or the making available to the recipient, of any property or 
other resources of the renderer.
    One commentator interpreted this provision as indicating that any 
activity properly analyzed under one or more other provisions of the 
transfer pricing regulations should not be subject to Sec. 1.482-9 of 
the 2003 proposed regulations. Other commentators suggested that the 
``predominant character'' of a transaction should control whether it is 
analyzed as a controlled service under Sec. 1.482-9 of the 2003 
proposed regulations or under other provisions of the section 482 
regulations.
    Controlled taxpayers have a great deal of flexibility to structure 
transactions in various ways that are economically equivalent. In some 
cases, an overall transaction may include separate elements of 
differing characters, for example, a transfer of tangible property 
bundled together with the provision of

[[Page 44473]]

a service. The structure adopted may sometimes be more reliably 
analyzed on either a disaggregated or an aggregated basis under the 
relevant section of the section 482 regulations, for example, either as 
a separate transfer of tangible property under the existing section 482 
regulations in Sec.  1.482-3 and a separate controlled services 
transaction under these temporary regulations in Sec.  1.482-9T, or as 
an overall controlled services transaction under these temporary 
regulations. To the extent that a controlled transaction is structured 
so that it is most reliably evaluated as a controlled services 
transaction, it will be analyzed as such. To the extent that multiple 
elements of a single overall transaction potentially create an overlap 
between the section 482 regulations applicable to other types of 
transactions and these temporary regulations concerning controlled 
services transactions, the Treasury Department and the IRS believe that 
the appropriate coordination is achieved by applying the rules in Sec.  
1.482-9T(m). See section A.12.a of this preamble.
b. Benefit Test--Temp. Treas. Reg. Sec.  1.482-9T(l)(3)
    Section 1.482-9(l)(3) of the 2003 proposed regulations provided 
rules for determining whether an activity provides a benefit. Under 
Sec.  1.482-9(l)(3)(i), a benefit is present if the activity directly 
results in a reasonably identifiable increment of economic or 
commercial value that enhances the recipient's commercial position, or 
is reasonably anticipated to do so. Another requirement is that an 
uncontrolled taxpayer in circumstances comparable to those of the 
recipient would be willing to pay an uncontrolled party to perform the 
same or a similar activity, or be willing to perform for itself the 
same or similar activity. The 2003 proposed regulations thus made 
significant changes to the benefit test under the existing regulations, 
which is based on whether an uncontrolled party in the position of the 
renderer would expect payment for a particular activity. The 2003 
proposed regulations adopted the so-called ``specific benefit'' 
approach, which mandates an arm's length charge only if a particular 
activity provides an identifiable benefit to a particular taxpayer. In 
addition, Sec.  1.482-9(l)(3)(ii) of the 2003 proposed regulations 
provided that no benefit is present if an activity has only indirect or 
remote effects.
    Commentators viewed the 2003 proposed regulations as providing 
insufficient guidance concerning methods that controlled taxpayers 
might use to allocate or share expenses or charges, in particular with 
respect to centralized services performed on a centralized basis for 
multiple affiliates.
    In response to these comments, the temporary regulations authorize 
the use of shared services arrangements for centralized services that 
qualify for the SCM in Sec.  1.482-9T(b). By entering into such 
arrangements, taxpayers can, among other things, reduce the burden 
associated with analysis of centralized services, which would 
presumably include activities that provide benefits on only an 
occasional or intermittent basis. See section A.1.c of this preamble, 
concerning shared services arrangements.
    One commentator suggested that, because the benefit test in the 
2003 proposed regulations focused on the recipient, the arm's length 
charge should also be analyzed from the perspective of the recipient 
and economic conditions in the recipient's geographic market. The 
commentator misunderstands the application of the benefit test. 
Although the benefit test focuses on the recipient, evaluation of the 
arm's length charge under the best method rule in a particular case 
(for example, under a profit split method) may require analysis of the 
recipient, the renderer, or both (depending, for example, on which 
party performs the simplest, most easily measurable functions).
c. Specific Applications of the Benefit Test--Temp Treas. Reg. Sec.  
1.482-9T(l)(3)(ii) through (v)
    The 2003 proposed regulations provided additional rules concerning 
application of the benefit test to particular circumstances, such as 
application to activities with indirect or remote effects, duplicative 
activities, shareholder activities, and passive association. These 
rules in the 2003 proposed regulations were substantially similar to 
the rules in existing Sec.  1.482-2(b)(2). For example, Sec.  1.482-
9(l)(3)(ii) and (l)(3)(iii) provided that no benefit is present if an 
activity has only indirect or remote effects or merely duplicates an 
activity that the recipient has already performed on its own behalf. 
Section 1.482-9(l)(3)(iv) provided that shareholder activities do not 
confer a benefit on controlled parties and therefore do not give rise 
to an arm's length charge. Shareholder activities were defined as 
activities that primarily benefit the owner-member of a controlled 
group in its capacity as owner, rather than other controlled parties.
    In addition, Sec.  1.482-9(l)(3)(v) of the 2003 proposed 
regulations provided that certain ``passive association'' effects do 
not give rise to a benefit within the meaning of the regulations 
concerning controlled services. Passive association was defined as an 
increment of value that a controlled party obtains on account of its 
membership in the controlled group. Section 1.482-9(l)(3)(v) of the 
2003 proposed regulations provided, however, that membership in a 
controlled group may be considered in evaluating comparability between 
controlled and uncontrolled transactions.
    Concerning indirect or remote effects, one commentator suggested 
that if a centralized activity by a parent confers only occasional or 
intermittent benefits on a subsidiary, such benefits should be 
classified as indirect or remote. As to the shareholder provisions, 
commentators noted that the 2003 proposed regulations failed to address 
the potential that an activity that confers a reasonably identifiable 
increment of value on a controlled party might also be appropriately 
classified as a shareholder activity. As to the passive association 
provisions, commentators questioned whether membership in a controlled 
group is relevant to evaluation of comparability. Commentators raised 
the concern that virtually any uncontrolled transaction could 
potentially be considered unreliable, because it generally would not 
reflect the same efficiencies and synergies as the controlled services 
transaction.
    Regarding the comments concerning indirect or remote effects, the 
Treasury Department and the IRS believe that to equate occasional or 
intermittent benefits in all cases with indirect or remote effects 
would conflict with the specific-benefit rule. That rule requires that 
any service that produces an identifiable and direct benefit warrants 
an arm's length charge, even if the service is provided only 
occasionally or intermittently. Accordingly, the temporary regulations 
retain this provision without change.
    In response to comments relating to shareholder activities, Sec.  
1.482-9T(l)(3)(iv) of the temporary regulations refers to the ``sole 
effect'' rather than the ``primary effect'' of an activity. This change 
clarifies that a shareholder activity is one of which the sole effect 
is either to protect the renderer's capital investment in one or more 
members of the controlled group, or to facilitate compliance by the 
renderer with reporting, legal, or regulatory requirements specifically 
applicable to the renderer, or both. As modified, the definition in 
temporary Sec.  1.482-9T(l)(3)(iv) now conforms to the general

[[Page 44474]]

definition of benefit in Sec.  1.482-9T(l)(3)(i).
    In response to commentators' request for clarification regarding 
the passive association rules, new Sec.  1.482-9T(l)(5) Example 19 
illustrates a situation in which group membership would be taken into 
account in evaluating comparability.
    The Treasury Department and the IRS have inserted the word 
``generally'' in the description of duplicative activities in Sec.  
1.482-9T(l)(3)(iii). This change clarifies that although a duplicative 
activity does not generally give rise to a benefit, under certain 
circumstances, such an activity may provide an increment of value to 
the recipient by reference to the general rule in Sec.  1.482-
9T(l)(3)(i). In such cases, the activity would be appropriately 
classified as a controlled services transaction.
d. Guarantees, Including Financial Guarantees
    The proposed regulations appear to have created confusion on the 
part of some taxpayers regarding the appropriate characterization of 
financial guarantees for tax purposes. The provision of a financial 
guarantee does not constitute a service for purposes of determining the 
source of the guarantee fees. See Centel Communications, Inc. v. 
Commissioner, 920 F.2d 1335 (7th Cir. 1990); Bank of America v. United 
States, 680 F.2d 142 (Ct. Cl. 1980). Nevertheless, some taxpayers have 
suggested that guarantees are services that could qualify for the cost 
safe harbor and that the provision of a guarantee has no cost. This 
position would mean that in effect guarantees are uniformly non-
compensatory. The Treasury Department and the IRS do not agree with 
this uniform no charge rule for guarantees. As a result, financial 
transactions, including guarantees, are explicitly excluded from 
eligibility for the SCM by Sec.  1.482-9T(b)(3)(ii)(H). However, no 
inference is intended by this exclusion that financial transactions 
(including guarantees) would otherwise be considered the provision of 
services for transfer pricing purposes. The Treasury Department and the 
IRS subsequently intend to issue transfer pricing guidance regarding 
financial guarantees, in particular, along with other guidance 
concerning the treatment of global dealing operations. See Section 
A.12.e of this preamble for a discussion of coordination with global 
dealing operations. Such guidance will also include rules to determine 
the source of income from financial guarantees.
e. Third-Party Costs--Temp. Treas. Reg. Sec.  1.482-9T(l)(4)
    Commentators observed that the definition of ``total services 
costs'' in Sec.  1.482-9(j) of the 2003 proposed regulations did not 
address situations in which the costs of a controlled service provider 
included significant charges from uncontrolled parties. Commentators 
claimed that such third-party costs should be treated as ``pass 
through'' items that, in most cases, should not be subject to the 
markup (if any) applicable to costs incurred by the renderer in its 
capacity as service provider. This comment was potentially relevant to 
all cost-based methods in Sec.  1.482-9 of the 2003 proposed 
regulations. The Treasury Department and the IRS agreed that these 
comments raised an issue that needed to be addressed, but decided to do 
so in a manner different from that suggested by the commentators.
    In response to this comment, these temporary regulations include a 
new Sec.  1.482-9T(l)(4). Under this provision, if total services costs 
include material third-party costs, the controlled services transaction 
may be analyzed either as a single transaction or as two separate 
transactions, depending on which approach provides the most reliable 
measure of the arm's length result under the best method rule in 
existing Sec.  1.482-1(c). Consistent with the best method rule, in 
determining which approach provides the most reliable indication of the 
arm's length result, the primary factors are the degree of 
comparability between the controlled services transaction and the 
uncontrolled comparables and the quality of the data and assumptions 
used. New Sec.  1.482-9T(l)(5) Example 20 and Example 21 provide 
illustrations of this rule.