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III. Respondent’s Allocations Are Inconsistent With the Arm’s-
Length Standard Mandated by Section 1.482-1, Income Tax
Regs.
A. Respondent’s Authority To Make Allocations
Section 482 provides respondent with wide latitude in
allocating income and deductions between controlled parties to
ensure such parties report their true taxable income. This broad
grant of authority, however, is constrained by section 1.482-1,
Income Tax Regs., which sets forth the “general principles and
guidelines to be followed under section 482.” Sec. 1.482-
1(a)(1), Income Tax Regs. The sections to which these general
principles and guidelines apply include, but are not limited to,
section 1.482-7, Income Tax Regs. Id.
Section 1.482-1(a)(2), Income Tax Regs., authorizes
respondent to “make allocations between or among the members of a
controlled group if a controlled taxpayer has not reported its
true taxable income.” In determining true taxable income, “the
standard to be applied in every case is that of a taxpayer
dealing at arm’s length with an uncontrolled taxpayer” (i.e.,
arm’s-length standard). Sec. 1.482-1(b)(1), Income Tax Regs.
(emphasis added). The arm’s-length standard is employed to
ensure that related party transactions clearly reflect the income
of each party and to prevent tax evasion.
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