Eye-catching headlines in the Wall Street Journal seem to crop up with increasing regularity. In September 2006, GlaxoSmithKline agreed to pay $3.4 billion to the IRS to settle a dispute over the transfer prices paid by the United States to the United Kingdom. In November 2006, Merck disclosed that the Canada Revenue Agency had issued the company a notice for $1.8 billion in back taxes and interest related to intercompany pricing matters. Those who do not deal directly with international tax planning may read these articles with a touch of schadenfreude, relieved that the intricacies of transfer pricing are not their worry. But while transfer pricing generally is thought of in the context of international tax, intercompany transactions can result in significant state controversies as well. Moreover, the intercompany licensing of intellectual property, particularly legally protected assets such as patents and trademarks, seems to attract a higher degree of scrutiny from state tax authorities and federal tax authorities than other intercompany pricing arrangements.
This article reviews the New York State Division of Tax Appeals January 2006 decision for Hallmark Marketing Corporation, along with past state decisions involving Lowe’s Home Centers, Inc. and The Sherwin-Williams Company. In each case, economic analyses demonstrating compliance with an arm’s-length standard were deciding factors in disputes concerning the taxation of profits generated by intellectual property and other intangible assets. Thus, an intercompany license of intellectual property should be structured in conjunction with such an analysis in order to properly assess the risk of future controversy. Related-party transactions, even at the state level, are governed by the federal transfer-pricing regulations. These regulations are continually evolving with significant changes on deck for intercompany transactions involving intangible assets. Several key changes to the regulations concerning intellectual property and services are briefly summarized in this article.