Part VII of George Mundstock’s US Taxation of Multinational Enterprise (July 28) suggests that the arm’s length standard for avoiding transfer pricing manipulation does not work. Maybe it’s the very high standards of discourse in his first sixth threads, but I found this argument a bit unconvincing. But I’d like to take this argument “To figure out an arm’s-length price, one needs a comparable transaction between unrelated parties. In every interesting case, there is no useful comparable”, and extend it to one aspect of the Cost Sharing regulations where enforcement has failed in practice.
Imagine that your team of Northern California R&D employees has a hot new MP3 technology that still is in its beta version as I chug beers on Grafton Street in Dublin, Ireland. I call you and offer up a joint venture where I market whatever comes out of this in-process R&D in Europe as you market it in North America. Even though I should pay you the fair market value for the European rights to in-process R&D, many U.S. multinationals grant these rights to their Irish subsidiaries literally for a song.
But let’s focus more on how we pay for the ongoing R&D to bring the technology to market assuming I hire one Irish R&D engineer for total compensation equal to $100,000 per year and you hire nine San Jose R&D engineers for the same total compensation, which consists of $80,000 in salary and $20,000 in employee stock options (ESOs). Assuming I get half of the anticipated benefits but only pay for one-tenth the costs directly, you would think I should pay you $400,000. But many taxpayers have argued that the ESOs are costless. Can someone call the Financial Advisory Standards Board – please?
This issue is being litigated and the latest Court testimony now has it that ESOs provide incentives to attract and retain good employees and for some odd reason cannot be costs. But wait a minute – the Giants attracted Barry Bonds from the Pirates over ten years ago and he still plays in San Francisco. Yes, his salary was an incentive, but it still represents a cost to the owners of the Giants. This taxpayer’s argument reminds me of some of Lawrence Kudlow’s arguments – and you know how I love the National Review.
If this taxpayer’s argument prevails, George may be right that the arm’s length standard fails on practice. But why? Is it that some “experts” are willing to spin for the right fee, while the government is spending too little to make what should be an easy case.