Gross Services Margin

New method for pricing services is similar to the resale price method for tangible property

The "gross services margin" method is one of the six methods for determining the value of service transactions under the final and temporary regulations issued on August 1, 2006. This method takes the same approach to valuing services as the resale price method takes to valuing tangible property. This method values services provided among related parties by reference to profit margins of comparable services being provided among unrelated parties. The method is ordinarily used in transactions involving three or more parties where two parties that are not related conduct a main transaction, but a third party that is related to one of them provides some of the services associated with the transaction, either on a contract or supplemental basis to the main transaction.

The official definition of gross services margin as it applies under United States transfer pricing rules can be found in propose Section 482-9T(d) of the transfer pricing regulations:

(d) Gross services margin method--(1) In general. The gross services margin method evaluates whether the amount charged in a controlled services transaction is arm’s length by reference to the gross profit margin realized in comparable uncontrolled transactions. This method ordinarily is used in cases where a controlled taxpayer performs services or functions in connection with an uncontrolled transaction between a member of the controlled group and an uncontrolled taxpayer. This method may be used where a controlled taxpayer renders services (agent services) to another member of the controlled group in connection with a transaction between that other member and an uncontrolled taxpayer. This method also may be used in cases where a controlled taxpayer contracts to provide services to an uncontrolled taxpayer (intermediary function) and another member of the controlled group actually performs a portion of the services provided.

On August 21, the IRS issued a release discussing the new regulations. Here's what they had to say about the Gross Services Margin provisions:

The 2003 proposed regulations provided for a gross services margin method, which evaluated the amount charged in a controlled services transaction by reference to the gross services profit margin in uncontrolled transactions that involve similar services. The method was analogous to the resale price method for transfers of tangible property in existing §1.482-3(c).

Under the 2003 proposed regulations, this method would ordinarily be used where a controlled taxpayer performs activities in connection with a “related uncontrolled transaction” between a member of the controlled group and an uncontrolled taxpayer. For example, the method may be used where a controlled taxpayer renders services to another member of the controlled group in connection with a transaction between that other member and an uncontrolled party (agent services), or where a controlled taxpayer contracts to provide services to an uncontrolled taxpayer and another member of the controlled group actually performs the services (intermediary function).

The 2003 proposed regulations defined the terms “related uncontrolled transaction,” “applicable uncontrolled price,” and “appropriate gross services profit”. A “related uncontrolled transaction” is a transaction between a member of the controlled group and an uncontrolled taxpayer for which a controlled taxpayer performs either agent services or an intermediary function. The “applicable uncontrolled price” is the sales price paid by the uncontrolled party in the related uncontrolled transaction. The “appropriate gross services profit” is the product of the applicable uncontrolled price and the gross services profit margin in comparable uncontrolled services transactions. The gross services profit margin takes into account all functions performed by other members of the controlled group and any other relevant factors.

One commentator mistakenly interpreted the term “related uncontrolled transaction” to suggest that the comparable transaction under this method is one that takes place between controlled parties. While this was not intended, the Treasury Department and the IRS agree that the nomenclature is potentially confusing, and as a result, these regulations substitute the term “relevant uncontrolled transaction” in lieu of “related uncontrolled transaction” wherever that appeared. In other respects, the gross services margin provisions in these temporary regulations are substantially similar to the provisions in the 2003 proposed regulations.

Other methods available for valuing services transactions between related parties include:

Here is a pdf of the entire section as proposed on August 1, 2006: final and temporary transfer pricing services regulations.

Here are some articles that discuss the gross services margin method:

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