The current “old” service regulations”, published in 1968, have weathered the test of time for almost 39 years. They have brought us joy and laughter, just like Jack Benny, who passed away at the age of “39”.

In September 2003, the IRS published its Proposed Section 482 Rules for Services and Intangibles. The purpose of these regulations was to provide guidance to better coordinate and harmonize the rules applicable to service transactions with the rules for other types of transactions under section 482, in particular, transfers of intangible property. After taking into consideration taxpayer and practitioner concerns and comments, the U.S. Treasury Department and the IRS, on July 31, 2006, issued temporary service regulations. These regulations would be effective for all tax years starting after December 31, 2006. Taxpayers can elect to apply the temporary regulations retroactively to all tax years beginning after September 10, 2003.

The 2003 proposed regulations specified six methods that would be applicable to the analysis of controlled services transactions. These methods were identified to reflect similarly named methods that were currently being utilized for tangible goods. The regulations stated that the arm’s length amount charged in a controlled services transaction was required to be determined under one of the following methods:

• The Comparable Uncontrolled Services Price Method (CUSP)
• The Gross Services Margin Method (GSMM)
• The Cost of Services Plus Method (CSPM)
• *The Simplified Cost-Based Method (SCBM)
• Comparable Profits Method (CPM)
• Profit Split Methods
• Unspecified Methods

The 2006 Temporary Service Regulations replaced The Simplified Cost-Based Method (SCBM) with the Services Cost Method (SCM). Manufacturing, research and development and financial transactions are not eligible for SCM use. The SCM supersedes the “safe harbor” rule found in the 1968 regulations. It allows “cost” to be charged in a controlled services transaction without a markup. SCM is elective and the taxpayer must make a statement in its books and records of its intent to use this method. If the taxpayer elects to use SCM, and the transaction is qualified, then SCM will be deemed to be “the best method” and as such, its selection cannot be challenged by the IRS. There is a business judgment rule that is clarified by Notice 2007-5. SCM can be used where the taxpayer can reasonably conclude, in its business judgment, that the service performed does not significantly contribute to or provide a competitive advantage, core capabilities or fundamental risks of success or failure in one or more trades or businesses of a controlled group.