Regulations Governing Assessment of Profit-Seeking Enterprise Income Tax on Non-Arm's-Length Transfer Pricing
The Profit Split Method prescribed in these Regulations refers to allocate the operating profit to each participant, which shall be calculated based on the contribution to the combined operating profits of all participants in the situation where the activities of the participants of the Controlled Transaction are highly integrated so that the profit or losses cannot be measured individually, or where each of the participants of the Controlled Transaction makes unique and valuable contributions in relation to the Controlled Transaction.
The combined operating profit shall be allocated based on the following steps:
1. Allocate regular income based on regular contributions: (1) Using the combined operating profit as a basis to allocate operating income to each party of the Controlled Transactions to provide a fair market return for its regular contributions of the relevant business activity.
(2) Regular contributions are contributions of the same or similar kind to those made by unrelated parties involved in similar business activities in which it is possible to identify the fair market returns.
(3) When calculating the regular profit, a functional analysis is required to identify the fair market returns on relevant business activities to be allocated in accordance with the functions performed, risks assumed, and resources employed by each participant. The fair market return can be determined pursuant to the 5 preceding Articles hereof.
2. Allocate residual profit in accordance with the contribution of intangible property:
The residual profit, which is equivalent to the amount of the combined operating profit less the regular profit allocated to each participant, shall be divided based on each participant’ s relative contribution to the intangible property in the relevant business activity. The relative value of the intangible property contributed by each participant may be measured by external market benchmarks that reflect the fair market value of such intangible property, the capitalized cost of developing the intangibles and all related improvements and updates, less an appropriate amount of amortization.
When evaluating the applicability of the Profit Split Method, the factors prescribed in Paragraph 1 of Article 8, particularly the following factors, shall be considered:
1. The factors to be considered when determining the fair market return of the regular contribution, including the functions performed, risks assumed, the assets employed.
2. The rationality and compatibility of the allocation of costs and expenses, income and assets between the relevant operating activities and other activities of the related parties.
3. Consistency in accounting practices.
4. The degree of reliability of the data used and the assumptions made in measuring the relative value of the intangible property contributed by each participant.
If there are any differences of the factors prescribed in Item 1 to Item 3 of the preceding Paragraph between the Controlled Transaction of the related parties and the Uncontrolled Transactions of comparables, appropriate adjustments should be made to eliminate the effect with respect to the differences. In the event that the effect of such differences cannot be eliminated by appropriate adjustments, other Arm's-length Methods as set forth hereunder shall be employed.