Compaq Computer Corporation and Subsidiaries - Page 20




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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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