R3-4/5 Flashcards
The IRS often makes adjustments when there are transfer pricing issues. Transfer pricing issues exist under which of the following circumstances?
a.
A U.S.-based taxpayer sells tangible property to an affiliate that is subject to U.S. income tax.
b.
A U.S.-based taxpayer enters into a service contract with an affiliate that is subject to U.S. income tax and files a consolidated income tax return with the U.S.-based taxpayer.
c.
A U.S.-based taxpayer shares costs with an affiliate that is not subject to U.S. income tax and does not file a consolidated income tax return with the U.S.-based taxpayer.
d.
A U.S.-based taxpayer leases intangible property from an affiliate that is subject to U.S. income tax.
Choice “c” is correct. Transfer pricing issues exist when a U.S.-based taxpayer shares costs with an affiliate that either (i) is not subject to the U.S. income tax or (ii) does not file a consolidated income tax return with the U.S.-based taxpayer.
Choice “a” is incorrect. Transfer pricing issues arise when a U.S.-based taxpayer transfers, sells, purchases, or leases tangible property or intangible property to or from an affiliate that either (i) is not subject to U.S. income tax; or (ii) does not file a consolidated income tax return with the U.S.-based taxpayer.
Choice “b” is incorrect. Transfer pricing issues arise when a U.S.-based taxpayer enters into loan agreements or service contracts with an affiliate that either (i) is not subject to U.S. income tax; or (ii) does not file a consolidated income tax return with the U.S.-based taxpayer.
Choice “d” is incorrect. Transfer pricing issues arise when a U.S.-based taxpayer transfers, sells, purchases, or leases tangible property or intangible property to or from an affiliate that either (i) is not subject to U.S. income tax; or (ii) does not file a consolidated income tax return with the U.S.-based taxpayer.
The IRS has the authority to adjust upward or downward the gross income and deductions between or among certain organizations to prevent the evasion of taxes or to clearly reflect the income of two or more organizations. Which one of the following is a characteristic of these organizations?
a.
The organizations must be organized in the United States.
b.
The organizations must be incorporated.
c.
The organizations may be members of an affiliated group that file a consolidated U.S. tax return.
d.
The organizations must be directly owned by the same interests.
Explanation
Choice “c” is correct. The organizations that are subject to these provisions of the IRC extend to members of an affiliated group that file a consolidated U.S. income tax return.
Choice “b” is incorrect. The organizations are not required to be incorporated in order to be subject to the provisions of the IRC that allow the IRS to adjust gross income, deductions, credits, and allowances to prevent the evasion of taxes.
Choice “d” is incorrect. The organizations can be either directly or indirectly owned by the same interests. Direct ownership is not required.
Choice “a” is incorrect. The IRC does not require that the organizations be organized in the U.S.
A binding contract between the IRS and the taxpayer by which the IRS agrees not to seek a transfer pricing adjustment for a covered transaction if the taxpayer files its return for a covered year consistent with the agreed transfer pricing method is called a(n):
a.
Section 482 study.
b.
Request for competent authority.
c.
Advance Pricing Agreement Program.
d.
Controlled transaction analysis agreement
Choice “c” is correct. The APA is a binding contract between the IRS and the taxpayer by which the IRS agrees not to seek a transfer pricing adjustment for a covered transaction if the taxpayer files its return for a covered year consistent with the agreed transfer pricing method.
Choice “a” is incorrect. A section 482 study is prepared by the taxpayer based upon allowable pricing methods set forth by the IRS and is completed by the time the taxpayer files the federal income tax return. The taxpayer must determine that the prices for controlled transactions and controlled transfers are in accordance with the allowable pricing methods and that the use of such method was reasonable.
Choice “b” is incorrect. A “request for competent authority” is a request by the taxpayer that the IRS and taxing officials in the other jurisdiction together determine the appropriate transfer price so that the taxpayer group is not taxed twice on the same income.
Choice “d” is incorrect. A controlled transaction analysis agreement is not an official document in the transfer pricing area.
Martin & Sons is seeking tax advice from the company’s CPA regarding a possible investment in a new production facility. Which of the following statements is likely to be good advice for the company?
a.
Asset purchases for the new facility will be analyzed in light of future pretax cash flows.
b.
Asset sales from the old facility may result in a loss on sale, and the tax effect will be treated as an increase in the recorded amount of the new investment.
c.
Asset trade-ins could result in lower taxes payable in later years.
d.
Asset abandonments from the old production facility will not have a tax effect because those assets were purchased in the past, and are almost fully depreciated.
Choice “c” is correct. Generally, no gain or loss is recognized on the trade-in of an old asset for tax purposes; hence, there is no tax effect. The traded-in asset’s book value becomes a portion of the depreciable basis of the new asset, resulting in additional depreciation for tax purposes in later years and the reduction of taxes payable in those later years. Therefore, the cash outflows in later years will decline.
Choice “d” is incorrect. If an asset is abandoned, the net salvage value is treated as a reduction of the initial investment in the new asset. The abandoned asset’s book value is considered a sunk cost, and therefore not relevant to the decision-making process. The remaining book value (for tax purposes) is deductible as a tax loss, which reduces the liability in the year of abandonment. This tax liability is considered a reduction of the new asset’s initial investment in capital budgeting.
Choice “a” is incorrect. Financial models used for capital decisions focus the financial manager on the cash flows associated with the investment and the comparison of those cash flows to expected rates and amounts of return. Because income taxes are a significant cash flow, they are considered in capital investment decisions, so the cash flows used are after-tax cash flows, not pretax cash flows.
Choice “b” is incorrect. The amount of income tax paid on a gain on a sale is treated as a reduction of the sales price (which increases the initial expenditure). Conversely, a reduction in tax resulting from a loss on sale is treated as a reduction of the new investment.
