time that the Treasury promulgated the former temporary transfer pricing regula-
tions.^19 Nevertheless, the Regulations stepped back from these particular profit split
provisions. The Treasury did not carry these provisions forward when the Treasury
promulgated the final transfer pricing regulations, thus creating a gap in the need to
have viable profit split regulations.
The profit split methods, as now constituted, are difficult to perform and are rarely
applied. Nevertheless, we continue to believe in the potential efficacy of profit split
methods. In response to that need for viable profit split transfer pricing methodolo-
gies, we are proposing one of the most important potential transfer pricing method-
ologies—a profit split based on a comparison of the functions being performed,
which we term the functions employed comparison(FEC). This transfer pricing
method could permit the taxpayer and the IRS to develop an arm’s length price that
is wholly independent of external data sources.
There would be three steps in computing the FEC method:
1.Compute the composite rate of return.
2.Sever transfer pricing transactions from nontransfer transactions.
3.Make economic adjustments.We believe the FEC method could be effectuated by the IRS under audit, with the
first two steps being effectuated by international examiners plus an assist from cost
accountants. Transfer pricing economists would undertake the final step. We further
suggest that the IRS develop a new form that could be used to better effectuate the
FEC method.
(a) Begin with Composite Return on Investment. The first step in applying the func-
tions employed comparison, at the outset, would be to apportion total composite in-
come or profits, determined on a net basis, using a constant rate of return concept.
This income would be apportioned based on total assets where these amounts are de-
termined on a worldwide basis.
A and B are portions of the worldwide business, W is income and assets determined
on a worldwide business, I is income, and R is the amount of assets. This inquiry does
not end the transfer pricing process, but instead would be the beginning point. Ad-
justments to this process take place later.
Assume that the enterprise has activities in two locations, Location A and Loca-
tion B. Assets are $2 billion in Location A and $4 billion in Location B, or $6 billion
in total, and that overall profits for the enterprise are $900 million. It is then appro-
priate to apportion the $900 million profit to $300 million in Location A and $600
million in Location B to equate the returns of each location (e.g., a 15% return at each
location)
IR>RWIA>RAIB>RB29.17 “COMPARISON OF FUNCTIONS EMPLOYED” METHODOLOGY 29 • 23(^19) Richard M. Hammer and Robert Feinschreiber, “Profit Split Methodologies,”Transfer Pricing
Handbook#2, 3rd ed., edited by R. Feinschreiber (New York: John Wiley & Sons, 2001): Section 47.2.