On this episode of “GILTI Conscience,” Nate Carden, David Farhat, Eman Cuyler and Stefane Victor are joined by transfer pricing expert Mike McDonald for an in-depth discussion on the commensurate with income (CWI) standard. The panel explores the legislative history, practical application and recent regulatory shifts surrounding CWI. Together, they unpack the implications for international tax disputes, treaty obligations and the future stability of the global tax system.
Episode Summary
In this episode of “GILTI Conscience,” Mike McDonald, one of the architects of Internal Revenue Code Section 482, joins Skadden’s Nate Carden, David Farhat, Eman Cuyler and Stefane Victor for an in-depth discussion of the “commensurate with income” (CWI) standard. The panel explores the legislative history and intent behind CWI, its complex relationship with the arm’s length principle and the evolution of regulatory approaches.
Key Points
- The IRS GLAM: The panel discusses the recent IRS guidance (GLAM), which moves away from a rebuttable presumption approach to a more formulaic, determinative application.
- The Courts: Recent decisions suggest courts are increasingly receptive to indirect valuation methods, including the income method. “I don’t think recent court cases would lead the IRS to be frustrated and say, ‘We have to go to the nuclear option of just applying pure hindsight,’” Mike said.
- Evolution of Regulatory Approaches and Methods: The episode highlights how Treasury and the IRS responded to Congressional concerns by introducing more robust and less comparables-dependent methods for valuing intangibles, such as the income method and profit split methods.
Voiceover (00:02):
This is GILTI Conscience, casual discussions on transfer pricing, tax treaties, and related topics. A podcast from Skadden that invites thought leaders and industry experts to discuss pressing transfer pricing issues, international tax reform efforts, and tax administration trends. We also dig into the innovative approaches companies are using to navigate the international tax environment and address the obligation everyone loves to hate. Now your hosts, Skadden partners David Farhat and Nate Carden.
Stefane Victor (00:35):
Hello and welcome to another episode of GILTI Conscience. My name is Stefane Victor, joined by hosts David Farhat and Nate Carden, along with co-host Eman Cuyler. Today, we are joined by one of our favorite guests, Mike McDonald, who at this point might not need an introduction, but we’ll give him one anyway. Mike was formerly a managing director of international tax and transactions, transfer pricing at Ernst & Young, after spending 16 years at the Department of the Treasury in the business and international tax division. Today, we’re discussing the commensurate with income standard, what it is, where it came from, and why it continues to shape some of the most important transfer pricing disputes involving high value intangibles. We’ll explore how courts are interpreting CWI in practice and what that means for the boundaries of the arm length standard under Section 482. Thank you.
David Farhat (01:26):
So Mike, you want to dive in?
Mike McDonald (01:28):
Well, I’m retired now, by the way.
David Farhat (01:30):
So you’ve got all the time in the world. Let’s go.
Mike McDonald (01:33):
I could basically join you guys anytime. And of course, if you’re covering something other than transfer pricing, I will just be there for comedic relief because I will have no idea. But yes, keep it in mind. Anyway, so I did a deep dive into CWI, but like a retirement version of deep dive, so I still watch my programs and things like that. But first, especially for those that may not be completely immersed in this thing called commensurate with income, the first sentence of the 482 statute is very empowering to the Treasury Secretary, in practice the IRS, to basically allocate income as it sees fit with the objective of preventing evasion of taxes and to clearly reflect income. Now, over the last 100 years, I think the notion of clearly reflect income has been interpreted as being following the arm’s length, and Congress has known that. That is how it’s been interpreted over this time.
(02:37):
Now, the second sentence is called the CWI sentence, the commensurate with income sentence. It says, “Income with respect to intangibles shall be commensurate with the income attributable to the intangible.” And it’s a directive. It shall be. So there’s always been a question, is the second sentence intended to be constrained by the first sentence? That is, it needs to be consistent with the arm’s length principle? Or is the second sentence intended to be independent of the arm’s length principle? And I think it would’ve been helpful if Congress at the time had done something that we did a lot in treaty writing, which is to have that second sentence begin either, “subject to” the first sentence, and then go on, or alternatively, “not withstanding” the first sentence. And that would sort of have clearly indicated exactly what the relationship is between the first two sentences, but it was missing.
(03:37):
So I did my deep dive into the legislative history. I think I can summarize it this way. Congress in the mid ‘80s, I think there was a clear view that the US was getting ripped off. There were transfers of intangibles basically for a song, and I think they raised the question, is this a misapplication of 482, or is just a result of 482? And they also had a number of other points of frustration that they highlighted. One, is transactional comparability really any good? And I think it reflected a view that in order to apply the arm’s length principle, one has to find a comparable uncontrolled transaction to provide some insights.
(04:26):
And of course, there aren’t real comparable uncontrolled transactions, and I think there was a view, geez, if we look at these court cases and how the taxpayer providing basically an uncontrolled transaction that allows the results to flow in a way that I think Congress thought didn’t seem to be the right economic results, they were basically saying, “Is 482 really fit for purpose if it actually requires comparable uncontrolled transactions?” So I think at that point, the CWI provision was really something that might cut the Gordian cycle. Instead of having to apply 482, which they had problems with, maybe we should just have the second sentence, which just says ... It’s basically you’re supposed to apply maybe even like a hindsight rule.
(05:18):
But it didn’t stop there, and this is what I thought was particularly interesting. The legislative history, and again, I know if people are pure textualists, they get the vapors if we’re looking at something other than the text. I still found it very compelling because Congress also said, through the legislative history, that risks are real and should be respected. It kind of implied that the application of X post hindsight might be something that’s contrary to clear reflection of income. Congress also expressed its view that specifically cost sharing arrangements should be respected. And that has typically been the vehicle by which a lot of these problems have occurred. And cost sharing, I mean, just fundamentally involves sharing of risks, and that implies that returns to risks should be respected. Now, both of those points would argue to me that in a perfect world, this application of CWI should not just be a blind application of hindsight.
(06:29):
But again, maybe putting myself into their position at the time and maybe their frustration, but to the extent that 482 could not address the concerns they raised, then maybe hindsight is better than allowing the US to just continually get ripped off. And the final point in terms of the legislative history, Congress also explicitly said, showing some humility, that there are probably a lot of difficult issues that are not addressed anymore, they’re not resolved. So they called on Treasury and the IRS to examine the matter and potentially write new regulations. And I’ll pause there because I think what Treasury and the IRS did at that point was very instructive and I think is why the IRS and Treasury always interpreted CWI as being consistent with arm’s length. But let me pause there for thoughts, comments. If not, I can keep going there.
Nate Carden (07:30):
No, I think I know where you’re headed, and I think it’s going to be interesting. But is it fair to say that the McDonald version of CWI would be kind of a combination of the introduction of more income-based methods, CPM, DCF, RPSM. Things that are not necessarily tied to a traditional cut, plus maybe a dash of the 2007 GLAM view that the way to think about hindsight is as an evidentiary presumption, meaning if the actuals in the forecasts really don’t line up, it’s not that we’re going to use the actuals, it’s just going to give us a more skeptical eye toward the forecast in the first place. That’s sort of how I hear you putting CWI together.
Mike McDonald (08:27):
I’m sorry, that is exactly-
David Farhat (08:28):
Why are you so surprised that Nate was right?
Mike McDonald (08:34):
And if I could just say, I think the way that Treasury ... He knows me so well, he understands me. Finally I’ve met someone ... Because I think what Treasury and the IRS did, they not only tried to implement the very clear directive of CWI, but they also tried to address a number of the problems that Congress said, as you said, Nate, through less direct methods that don’t require comparables. And also importantly, they also upped the standards for what an uncontrolled comparable transaction should be. And it puts some meat in the word comparable. 482-4, if you read it, it’s like it’s hard to go through that threshold test and actually meet comparability. So a lot of the external cuts, for example, would drop off, but they said, “That’s okay. We have other guidance that’s less direct,” and I’d also add the income method that’s going to solve the problem. So yes, Nate, I think you summed it up perfect.
Stefane Victor (09:31):
So given that ... And I know we plan on talking about what industries might be most exposed. Are industries that generally are more speculative or are there certain industries that are especially exposed because there might be a greater delta between forecast and actual performance?
Mike McDonald (09:50):
Yeah, it seems to me that what this targeted, and so the types of transactions that are most vulnerable to it, are those that involve inchoate intangibles that are developed that especially might have a long gestation period. And that defines a lot of cost sharing arrangements. So again, I think the true development of risky intangibles in which the outcome is a number of years away is sort of the classic type of transaction that might be vulnerable to a CWI adjustment. And I would also say, just follow the cost sharing trail. What are the industries that tend to use cost sharing arrangements? Because a lot of the court cases are looking at those, those are the types of ones for which CWI should be particularly relevant.
David Farhat (10:42):
So if you and Nate come to a similar understanding of where you were going, I’m not going to suggest agreement just yet, I’m just going to say it’s a similar-
Mike McDonald (10:51):
I don’t know that Nate was saying he agreed with that. He was just describing my position.
David Farhat (10:55):
Yeah, yeah, that’s what I’m saying. I’m not suggesting agreement yet. If he could understand-
Nate Carden (11:02):
I’m still here and yeah, I’m largely simpatico.
David Farhat (11:04):
So why has there been so much disagreement with the two of you? I’ll put it that way. Because again, I don’t think what you’ve described has been how CWI has been used.
Mike McDonald (11:15):
Oh, on what?
Nate Carden (11:16):
No, correct. I guess, David, just to say it, there’s a lot of people out there, at least there’s some people out there who don’t see the wisdom of what you’re saying.
David Farhat (11:25):
Exactly.
Nate Carden (11:26):
Channel them. What’s their take?
Mike McDonald (11:32):
Well, I need to understand more what they-
Nate Carden (11:32):
Yeah, let’s sort of come up with the other side of it. I think there is a newer view, maybe I’d call it, of CWI. We could talk about whether the 2025 GLAM is reflecting this, but I certainly sense, and I would say this is a little bit of an international trend, but we can start with the US, that would view CWI as much more of a true lookback and hindsight provision. Something that just said, “Look, we don’t care if the arm’s length price at the time of an intangible transfer was X. If things work out a lot better, then the US is going to tax that income period full stop. And we don’t care whether that is consistent with the arm’s length principle, that’s how we’re going to read Congress’s directive.” I hear that position, maybe put a little bit more gently, but I hear that position articulated a lot more than I used to.
Mike McDonald (12:38):
I see, yes. So I guess what I was describing in the beginning was a view of CWI and other things that are in fact consistent with the arm’s length principle on how you can have CWI and the arm’s length. And prior to this recent IRS GLAM that we’ll talk about, I thought the IRS and Treasury were actually straddling that line very well. Now, this other view you’re talking about, which is just a pure hindsight view, pure hindsight. Fine, if that’s the way you want it, fine, that’s your view. But you should understand that there’s a real cost to that and it’s a cost of walking away from treaty obligations, which provides the arm’s length principle, and more importantly, twofold.
(13:25):
One, the fact that to the extent that a pure hindsight rule is going to be applied, then there is going to be wicked double taxation, because the other side doesn’t have to respect it. And I think maybe even worse is now that the OECD has this hard to value intangibles guidance, and they see the United States just applying pure hindsight, and why on Earth wouldn’t they do that as well? So you can have that view that you want it to be a pure hindsight rule, fine, but there are going to be costs. So that’s why I think that is a shortsighted view and the US is going to shoot themselves in the foot if that’s how this is applied.
David Farhat (14:05):
And Mike, I think we’re seeing some of that in some of the MAP cases and APAs that we’re dealing with. A more aggressive view from the US. And I do want to unpack that a bit, but I have two questions. One, where do you think that ... And again, I know it might be easier for some governments just to look at a winner and say, “No, I should get a piece of this.” Where is that view coming from? And you mentioned double tax and double tax treaties, but is it compatible with this new tax environment that we’re in with Pillar Two? I know we have side by side now, but with Pillar two and tax equalization. Does that kind of aggressive interpretation of CWI fit into this new environment?
Mike McDonald (14:49):
Well, even under Pillar Two there are still going to be disputes as to where income belongs, even though some of the rate arbitrage is gone. So the notion that as far as countries are concerned, this is important. But again, I think it just may reflect shortsightedness that, for example, we are looking at this power that Congress gave us, so I’m now talking about the US, and can a position be taken that that word shall means shall and it’s independent? Absolutely it could be taken and possibly supported in court.
(15:25):
Again, I don’t think that the US had to go that far in terms of the power it already had prior to the GLAM. Still being able to link it to the arm’s length principle that is a principle has so many practical benefits that I think they’re going to be discovering if they take this more aggressive view are simply going to disappear, and I think the world’s going to be less stable than more stable. So that’s why I was very disappointed by the IRS GLAM, which we should maybe back up at some point and talk about what exactly that said, because I thought it basically -
David Farhat (15:59):
No, let’s dive into that.
Mike McDonald (16:00):
I basically thought it broke the agreement that we had when we first started ... I was one of the drafters of the authors of the transfer price, well, 482-7 and all that stuff. And at the time we really had a clear view as to how this relates to the arm’s length principle in a way that still made CWI a very strong tool for the IRS. And the fact that they sort of broke it and made it a hindsight rule, I was very disappointed about. So you want to talk about what the GLAM did, anyone?
Stefane Victor (16:33):
I would love to.
Mike McDonald (16:34):
Essentially, in a nutshell, I think the old view basically made CWI a rebuttable presumption. There was a CWI trigger, so something happened that caused the formula to be greater than 1.5. So there’s a trigger and there’s then effectively a rebuttable presumption that the taxpayer is going to be subject to the formulary periodic adjustment rules, the CWI rules. But we kind of made clear that to the extent that the upfront X anti-valuation was good, and this was simply risks playing out, and if the taxpayer can convince the IRS that is, “Hey, this is just risk playing out, like risks really played out,” then there wouldn’t be an adjustment.
(17:18):
And the IRS backed that up and Treasury backed that up by saying, “You can have an APA that, as long as the IRS kicks the tires on an X anti-basis, we’ll turn off CWI.” And the 2025 GLAM basically said, “It’s no longer rebuttable presumption. It’s determinative. If you fail the formulary test and some of the specific exceptions don’t apply, and those exceptions could be pretty narrowly defined, then you’re subject to CWI.” It basically turned it into a formula.
Nate Carden (17:53):
What do you think is motivating that? Is it just sort of endless frustration with how the arm’s length standard works? Do you think that it’s shortsighted money grab? It’s obviously speculative, but I’m just curious as to what you think is going on in the international tax community that is prompting this.
David Farhat (18:16):
Yeah, because it seems like the IRS is fighting an old war.
Mike McDonald (18:18):
I can’t really speculate because I see there are just so many downsides to this. It makes it hard for me to put myself in their place without coming to the conclusion. They’re making a mistake. So it might be a short-sighted, short-term money grab. It might reflect some frustration and flailing out there. But I just think it’s so unnecessary to achieve their objectives and it does so much collateral damage vis-a-vis other countries.
David Farhat (18:48):
Could it be a frustration with the cost sharing rates?
Mike McDonald (18:50):
Well, I don’t see how ... I’m not sure that it would be, given a couple of things, for example. Recent Facebook opinion, which basically strongly supported the income method. Now, the judge then set the parameters, and so it led to a result that was closer to the taxpayers, but it basically showed that, hey, there’s something to some of the guidance that’s out there, and maybe even more of the Amazon decision and that footnote, that I guess is dicta in the world of law. But that footnote nevertheless said, “Hey, if we were operating under the new regs rather than the old regs, and if we were operating under the TCJA definition of intangibles, then that dicta said flat out the taxpayer...” I mean, the IRS would win this case. It was actually a very strong ...
(19:42):
So I think that should hearten the IRS to say, “Hey, our valuation guidance, in fact, is pretty darn strong and we should be able to prevail, maybe not completely, maybe not so much as a CPM return.” But in other words, that should go a long way towards addressing a lot of the positions we’ve taken. So I don’t think recent court cases, for example, would lead the IRS to be frustrated and say, “We have to go to the nuclear option of just applying pure hindsight.”
Eman Cuyler (20:15):
Mike, going back to the Facebook decision, I completely agree that as far as the method, the court said, “Yeah, the income method is the right method,” but they ended up making a lot of adjustment when they were looking at what is actually a compensable IP for PCT payments. Can you talk a little bit about that, especially since the definition of IP has evolved from the pre ‘09 regs to what we have today?
Mike McDonald (20:38):
I have views on that. Again, so those of us that wrote the reg, we did our little jig when they said the income method is fine. But what was interesting ... And again, I haven’t done a deep dive into Facebook and tried to look at whatever finances we get, but it was interesting to me that one of the things that did, and the thing that really drove the fact that the results were close to the taxpayer, is they had such different discount rates between the cost sharing alternative and the licensing alternative, huge different discount rates, and that tends to drive low results. I wish that someone would put it through the differential income stream part of our precious regulation.
(21:19):
That’s a part of the regulations that said, “It’s not clear that there’s such a difference in risk between the cost sharing and the licensing alternative,” and therefore one would expect them to be fairly close together. But nevertheless, the differential income stream provides a test to say, “Hey, plug in the different discount rates that are used, find whatever they are.” There’s an implied third discount rate that falls out of it, which is sort of the direct measure of riskiness associated with the IP. And does that give a reasonable number? I would love for that test. I would love for the differential income stream guidance to be applied to that because I wonder if that drives weird results. I don’t know the answer, by the way. I didn’t delve into the numbers.
Nate Carden (22:03):
You’re retired. You got time. Just go for it.
Mike McDonald (22:06):
Yeah, more free work. Yes, just what I want in retirement. But it’s funny because I think that that’s an important question and it’s a question that really doesn’t necessarily have any significance beyond the case itself, because it doesn’t. But I wonder if the judge had taken that additional step and gone through the differential income stream guidance, whether or not the judge would’ve taken another step back and say, “Hold on, we need to think about these parameters more.”
David Farhat (22:36):
So again, Mike, backing up a little bit and talking about your treaty point and obligations under treaty with CWI, I think that’s where I’ve seen a lot of this friction of that interpretation and causing the double tax. Can we unpack that a bit more? Because I do see your point that if the US goes down this road and the OECD also follows suit and goes down this road as well, you’re going to have a tug of war. I think DEMPE has created some of that already. And I think we talked about that a bit last time, and I think this can only exacerbate the problem. So can we talk about that?
Mike McDonald (23:12):
It’s even worse than the so called DEMPE problems, which again, I think has led to the biggest misinterpretation of the beautiful guidelines that we wrote back there. But it’s worse. Whereas the misinterpretation of the guidelines in DEMPE, yes, it could lead to further disagreements and make MAP more difficult because everyone’s deciding what the actual transaction was, which is a recipe for disaster. This is worse because it’s both sides giving up. Both sides saying, “Hey, F this. I’m going to apply a hindsight rule.” And the other side maybe is going to do the same thing, so there’s definitely going to be double taxation. There’s not going to be MAP resolutions, especially to the effect that countries interpret MAP as needing to be in coherence with how they apply 482, and 482 includes ...
(24:02):
So I think it would be even worse. And David, it’s so unnecessary. That is the biggest thing. CWI is already a powerful tool, but it can be used in a way that we could go to our treaty parties and said, “Yes, we did a CWI application, but here’s why it is consistent with the arm’s length principle. Because of information asymmetry at the time, it was not a good faith initial.” And now, David, we’re back in MAP and we can talk about that. Was it really an upfront bad estimate or was it in fact risks just playing out? That’s something that I think can be resolved in MAP. But application of hindsight by both sides of a treaty, you’re not going to MAP your way out of that one. That’s my thought, David, or you guys, do you agree?
David Farhat (24:53):
To an extent, yes. I don’t think you can’t MAP your way out of it. It makes the MAP process a lot more difficult. I think relying on profit splits becomes more essential at that point because then you just look at the pie and say how we split it, but then how you get to that split becomes more difficult as well. I think an argument they could use for the aggressive stance is, yeah, we throw the position in MAP and we let the competent authorities figure it out, but we have a stronger starting point. Now, I don’t know if that’s negotiating in good faith or adjusting in good faith, or that or even the folks making the adjustments, if they take this position on either side, kind of care about the MAP process. But it could be a little extra seasoning before you send it in.
Mike McDonald (25:37):
Right, it makes the starting points even more extreme.
David Farhat (25:42):
And I mean, and then you have the folks who have the arbitration. I think that makes it a lot more difficult, but that will force the competent authorities to get a bit closer, because I don’t think you want to send some of these hindsight positions to arbitration too often.
Mike McDonald (25:56):
Hindsight should be like a third rail. If there’s an application of hindsight under an Article IX Treaty, it’s like, “Ooh, you’re starting from a bad position,” because that’s clearly contrary to something that’s not just fundamental, it’s foundational to the arm’s length. And again, you can do whatever you want. The statute says what it says in a post-Loper Bright world, you could look at that statute, to me, ignore the legislative history and say, “Hey, we’re doing what we’re authorized to do.” But the long-term consequences are going to, I think, put everyone, every country in a worse position than they are now.
Nate Carden (26:33):
Maybe pivoting a little bit, I am curious, setting aside the extraordinarily formulate version of CWI that appears in dash seven, if you look at CWI in dash four, it doesn’t say much.
Mike McDonald (26:50):
It doesn’t.
Nate Carden (26:50):
Practically speaking, how do you think, if CWI applies, how do you think it works in the dash four context? Because the words don’t help you very much.
Mike McDonald (27:01):
Yeah, well, that’s the thing. And by the way, I was talking earlier about how we went from the congressional frustration in ‘86 to how Treasury and the IRS responded through, for example, the 1994 regs. I actually think it’s extraordinary what Treasury and the IRS did, because again, they didn’t just implement CWI, they fixed, I think, a lot of the underlying problems. So you look back at those regulations and the white paper and things like that, and I think it’s absolutely extraordinary, the people that did that. So now we look at dash four, and you say, “Oh, dash four doesn’t really tell you much about CWI.” And that, by the way, is one of the reasons that we modified CWI as it applies in dash seven, but hopefully there are insights from that in a way that makes it more administrable, it’s more mechanical. All you need are projections, financial projections and a discount rate, and you can basically apply it to see whether or not there’s a periodic trigger.
(28:03):
But if I’m going back to dash four, I would just sort of put on my valuation hat and say, look, we have to respect a couple of things. We have to deal with the fact that it is a ... For example, it turns out to be a valuable, intangible. There’s no doubt it turned out to be a valuable, intangible. So the returns to one of the sides seems to be extraordinary. But I think the overarching objective should be ... I want to try to differentiate those two and disentangle those two, returns to the value versus the returns to risk. The income method, the approach that applied in dash seven says, “Hey, we can kind of value risk through the notion of what should be the appropriate anticipated return.”
(28:51):
So to the extent we can put ourselves back in that situation, even under dash four, to try to tease out the inherent returns to the valuable intangibles that were there incipient at the time the transaction took place from risks, then that’s keeping with the spirit of what I think CWI is trying to do, or I should say more generally, congressional intent is asking us to do. When you look at how Congress says, “We got to respect risks, cost sharings are real, but let’s not get ripped off.” So again, I actually think some of the valuation tools that were in both the dash four regs and the dash seven regs and the dash nine and dash one, blah, blah, blah, I think they’re very powerful tools to apply CWI, even in a way that doesn’t require you to use hindsight. So I don’t know.
David Farhat (29:44):
What do you think the future is for controversy just on the domestic side, controversy and litigation with what’s happening?
Mike McDonald (29:52):
A couple of things, is one, if something is not really a stable equilibrium, then it’s not going to continue. So I don’t think a hindsight interpretation of CWI is a stabile ... So I imagine it’s going to ultimately come back to the way we thought about it when we wrote the regulations. Now, two years, five years, ten years, I mean, who knows? So I think that’s going to happen. And the second thing I’ll say is courts seem to be more accepting of some of the indirect valuation guidance that is laid out there, including the income method and the notion of trying to more directly measure risk. And I just think that’s a good thing because it implies to me that we’ll maybe be able to resolve a lot of what might seem now like intractable problems through the valuation guidance. I think on net, it’s going to result more wins for the IRS, or at least adjustments that are closer to the IRS position as a matter of course. So again, I think Treasury and the IRS should be heartened by what the future holds for how future court cases are going to go.
David Farhat (31:05):
And a somewhat related question. Why is it that every time we talk about some of this stuff that you had a hand in writing, people misinterpret it so violently?
Mike McDonald (31:13):
As you know, David, I’ve made a career, post-government career of saying why these are misinterpretations. They’re not, “We thought that they thought that.” So I’m bringing this up. This is not the first time. Everyone needs to get a copy of this. I was just at a conference in Vienna where I said ... So it was with Europeans and I said, “Look, you need to look at the guidelines holistically because paragraph 1.105 says what it says, but it says it in step six of the six step process and it is preceded by other clear guidance.” So thank you for asking that question though, David. So elegantly.
David Farhat (31:57):
I wanted you to be able to get it off your chest.
Mike McDonald (31:58):
Why does everyone in the world take a different view than you and they’re wrong? Basically, that’s what you’re saying.
David Farhat (32:05):
We agree with you, Mike. We agree with you. Go ahead, Nate.
Nate Carden (32:10):
The last topic that I want to throw out there for discussion is that we also seem to be seeing a lot of references to CWI in areas where, at least to me, it is alien. So it’s coming up in the block income discussions. There’s some noise around it with respect to some other bases for transfer pricing positions that are being taken, et cetera. Do you think it’s fair to say, given you’ve done the most recent deep dive into the history of the second sentence of section 482, that there was no indication at all that anybody was thinking about anything other than the issues that we’ve been talking about for the last half hour?
Mike McDonald (33:00):
I have to admit, I thought it was me, Nate, because I also hear discussions of these cases and the CWI, and I’m wicked confused as to ... I don’t see the CWI connection. So I kind of agree with it, but I thought it was me. We’re speaking of stunad.
Nate Carden (33:14):
We’re simpatico. Strange day.
David Farhat (33:17):
It concerns me, gentlemen. It concerns me.
Mike McDonald (33:19):
I completely ... With one exception, though. The Altera decision, the latest one, which I think did properly point to some of the language. And again, I’m going to the legislative history rather than to say, yeah, there actually is a connection between CWI and the notion of whether stock options should be part. But with the exception of that, and with the exception of where it more obviously might apply, like in Facebook or maybe Amazon, I agree, Nate. I’m not seeing how they draw that line, although maybe there is a line to be drawn. It might just be us.
Nate Carden (33:54):
I don’t see it either. I am curious as to how you think treaty partners will deal with these random introductions of CWI, not just into hindsight, but it seems like it’s coming forward in a lot of different ways. And it just worries me that, as you said, we’re headed toward a world of extraordinary double tax.
Mike McDonald (34:19):
Oh, very well could be heading down. If I’m on the other side, if I’m another country and I see the US apply CWI under any regime, under the one we wrote in 2009, I have a lot of questions to say the least. And if I further see that the US is not even considering whether or not it’s an application of hindsight or not, then it’s like, oh, the battle lines are drawn at that point because now I’m going to look at the HTVI guidance and I’m effectively going, “I’m another country. Now I’m going to apply it willfully. Take that. Take that.”
(34:55):
And there’s so much good guidance in HTVI about the rationale for it being information asymmetry. That was the driving thing behind the US regulations. It’s information asymmetry. It’s not the application of hindsight. So if the US is going to throw that away, then why on Earth wouldn’t other countries throw it away as well? And just if things worked out, that’s ours. If things didn’t work out, we followed the contract.
Nate Carden (35:22):
Is it fair to say that HTVI is thematically similar to the 2007 GLAM in its view of essentially the evidentiary presumptions, and I assume that was intentional by a wise drafter.
Mike McDonald (35:37):
Yes, it was intentional, and it’s even more explicit than in 482 because it specifically talks about information asymmetry, it specifically talks about rebuttable presumption, and it specifically talks about when HTVI won’t be applied, how HTVI won’t be applied if it simply risks playing out. So I thought the HTVI guidance established those guardrails quite well. And that’s the thing. So effectively, they’d have to overcome those guardrails that are actually in the HTVI language in order to apply hindsight, but that hasn’t stopped countries before willfully misinterpreting what the transfer pricing guidelines actually say, David. I’m not saying that you misinterpret it, but I’m going back to your earlier question. Why shouldn’t they misinterpret HTVI the same way they misinterpret DEMPE?
David Farhat (36:25):
100%, Mike, and I think to show some empathy for the governments, because I think that’s really who we’re criticizing when they’re misinterpreting these things. Sometimes it’s just easier to do it that way. It makes it simpler. But I think the takeaway from this with CWI and with the hard to value intangibles guidance is to really do the work, to go in there, look at the facts and use it as an appropriate tool as opposed to kind of a catchall to get to where you want.
Mike McDonald (36:50):
Yeah. Short-term EC is long-term bad sometimes.
David Farhat (36:53):
It can cause real chaos and havoc, and if we’re in a world where governments are resource constrained, the last thing you want is all of these positions flowing into MAP with very, very different interpretations.
Mike McDonald (37:06):
I agree.
David Farhat (37:07):
Very, very, very different positions. But I think with that, what I’ll say is it’s great to have the original gang back, and I think it’s appropriate to have Mike with the original gang. It’s always a pleasure to have you, Mike. And again, this has been an episode of GILTI Conscience. Thanks all.
Mike McDonald (37:20):
My pleasure. Now that I’m retired, man, I can be here any day, day or night. I’m available. Want to do this next week?
David Farhat (37:28):
Don’t threaten us with a good time.
Nate Carden (37:31):
Any topic?
Mike McDonald (37:32):
Well, no, not any topic. I only know transfer pricing. That’s all I can speak to. Thanks.
Nate Carden (37:38):
Regular listeners understand that’s not a constraint on what we talk about on this show.
Voiceover (37:43):
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