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semiannually by the Compaq U.S. tax department and were based on
Compaq U.S. standard manufacturing costs that Compaq U.S. used as
a benchmark for purchasing PCA's from unrelated subcontractors.
The prices did not, however, include compensation for overtime,
rework performed, changes in material prices, changes in the
delivery schedule, material cancellation costs, inventory
shrinkage, production scrap, setup charges, or obsolete
inventory.
Specifically, in 1991 and 1992, the transfer prices for
Compaq Asia PCA's were set using a cost-plus formula, pursuant to
section 1.482-2A(e)(1), Income Tax Regs. The formula was Compaq
U.S. labor and overhead costs minus Compaq U.S. overhead costs
that would continue to be incurred by Compaq U.S. despite
manufacture of PCA's at Compaq Asia (Compaq U.S. fixed overhead
costs) multiplied by 1.15 plus Compaq U.S. material costs.
Compaq Asia costs were not used as part of the transfer price
analysis.
In 1992, the formula was amended, and Compaq Asia material,
labor, and overhead costs were multiplied by 1.3, plus a total
location savings times .3. The total location savings was
calculated by subtracting Compaq Asia material, labor, and
overhead costs and Compaq U.S. fixed overhead costs from Compaq
U.S. standard material, labor, and overhead costs.
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