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During 1990 through 1993, 93 percent of Compaq U.S.
purchases from unrelated subcontractors were from subcontractors
located in the United States. Compaq U.S. had some bad
experiences with unrelated subcontractors in foreign countries,
and, when demand for Compaq U.S. products increased in 1992,
Compaq U.S. increased its purchases from unrelated subcontractors
in the United States rather than purchasing from Far East
subcontractors.
Respondent's Audit Determination
In response to information requests during the audit,
petitioner described its transfer price formula as "a cost plus
formula inclusive of location savings" and stated that the
comparable uncontrolled price method (the CUP method) was not
applicable to petitioner's purchase of PCA's from Compaq Asia.
Respondent adopted a modified cost-plus or profits-based fourth
method pursuant to section 1.482-2A(e)(1)(iii), Income Tax Regs.,
marking up Compaq Asia manufacturing costs by an operating profit
markup of 7.5 percent. This method was based on the report of
respondent's staff economist, Peter Balash (Balash), and produced
an aggregate price for Compaq Asia PCA's that was $232,402,000
less than the Compaq U.S. 1991 and 1992 combined return
positions. Accordingly, respondent determined that the prices
that Compaq U.S. paid to Compaq Asia for PCA's during 1991 and
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