United States: Consideration of tax consequences in determining arm’s length result (GLAM)

IRS generic legal advice memorandum

IRS generic legal advice memorandum

The IRS released a generic legal advice memorandum (GLAM)* that concludes that tax consequences that would result from a transaction subject to adjustment under section 482 or requiring income inclusions under section 367(d) may need to be considered to determine an arm’s length result (or appropriate charge) pursuant to the section 482 and 367(d) regulations. Per the GLAM, the regulations under sections 482 and 367(d) require the consideration of tax consequences through various provisions including realistic alternatives and the arm’s length standard because uncontrolled taxpayers generally consider tax consequences when negotiating and agreeing to a transaction price.

Read GLAM 2022-006 [PDF 255 KB] (release date of 18 November 2022, and dated 9 November 2022)


The GLAM describes a scenario in which a U.S. company (“USP”) owns a patent for a manufacturing process that it uses to manufacture a product in another country, Country A, for sale to unrelated distributors located in Country A. USP projects that if it were to continue to use the patent in its operations in Country A, it would earn income with a pre-tax present value of $135 over the useful life of the patent. USP’s marginal effective tax rate is assumed to be 26%, and therefore USP’s expected post-tax present value income related to the patent over the useful life of the patent is $100.

The memorandum then considers three possible scenarios for transactions USP may engage in with respect to the patent:

  • Scenario 1: License the patent to its wholly owned subsidiary (CFC) located in Country A for a royalty.
  • Scenario 2: Contribute the patent to CFC in a section 351 transaction subject to section 367(d) annual income inclusions by USP over the useful life of the patent.
  • Scenario 3: Form a cost-sharing arrangement (CSA) with CFC to improve the manufacturing process using the patent, under which CFC will have rights to use the improved process for sale of products in Country A, and USP will have rights in all other countries. CFC will make a platform contribution transaction (PCT) payment for the rights to use USP’s patent in Country A.

The memorandum states that in each scenario, the tax considerations of each controlled party related to the controlled transaction may be a relevant element in determining an arm’s length result. Further, in applying the realistic alternatives principle, the IRS will consider that uncontrolled parties to a transaction aim to maximize their post-tax profit, which represents the economic return for the transaction. Therefore, for example, the price the transferor receives for the sale of an asset must be sufficient to provide the transferor with income with a post-tax present value at least equal to the post-tax present value the transferor would have realized had it not transferred the asset.

Applying those principles to each of the scenarios, the IRS concludes that to comply with the arm’s length standard and satisfy the realistic alternatives principle, the total expected post-tax present value of income USP earns in each scenario must equal at least $100. Given that the income to USP in each of the three scenarios is taxable at the effective marginal tax rate of 26%, the GLAM concludes that the total expected pre-tax present value income to USP in each scenario must equal at least $135. In other words, the present value of royalties received by USP in scenario 1, the present value of the section 367(d) annual income inclusions of USP in scenario 2, and the present value of the PCT payments to USP in scenario 3 must equal at least $135 under the arm’s length standard.

KPMG observation

The realistic alternatives principle and the evaluation of post-tax outcomes under the realistic alternatives of parties to a controlled transaction in the determination of arm’s length pricing are not new concepts. As noted in the GLAM, the “Tax Cuts and Jobs Act of 2017” amended sections 367(d) and 482 to include consideration of realistic alternatives in determining the value of an intangible property transfer. Additionally, as noted in the GLAM, the section 482 regulations include references to the realistic alternatives principle and, in the context of a CSA, to a comparison of the present values of the post-tax income of the controlled participant under the cost sharing and licensing alternatives.

While the key concepts in the GLAM are not new, the GLAM may reflect a renewed focus of the IRS on the realistic alternatives principle and evaluation of post-tax values of realistic alternatives in the determination of arm’s length pricing for controlled transfers of intangibles.



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