PRE-FILING MEMORANDUM
Request for Pre-Filing Conference under Revenue Procedure 2015-41
Bilateral Advance Pricing Agreement — United States and Federal Republic of Germany
April 14, 2025
Submitted to:
Advance Pricing and Mutual Agreement Program (APMA) Large Business & International Division Internal Revenue Service 1111 Constitution Avenue, N.W. Washington, D.C. 20224
Submitted by:
Calderwood & Harkness LLP 599 Lexington Avenue, 38th Floor New York, NY 10022
Re: Request for Pre-Filing Conference — Bilateral Advance Pricing Agreement (United States–Federal Republic of Germany)
Contact:
Leonard Cross, Partner Tax Department Calderwood & Harkness LLP 599 Lexington Avenue, 38th Floor New York, NY 10022 Telephone: (212) 558-4700
Email: lcross@calderwoodharkness.com
NOTICE: This memorandum is submitted on an anonymous basis pursuant to Rev. Proc. 2015-41, § 4.02. Neither the taxpayer nor the foreign related party is identified by name herein. Identifying information will be disclosed upon formal APA application filing. This memorandum constitutes a privileged and confidential attorney-client communication and attorney work product. It is submitted for the sole purpose of facilitating a pre-filing conference and does not constitute a formal APA application under Rev. Proc. 2015-41, § 4.04.
TABLE OF CONTENTS
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I. INTRODUCTION AND PURPOSE
Calderwood & Harkness LLP, on behalf of its clients — a German semiconductor manufacturer (hereinafter "Foreign Parent") and its wholly owned US subsidiary (hereinafter "US Sub" and, together with Foreign Parent, the "Applicants") — respectfully submits this pre-filing memorandum to the Advance Pricing and Mutual Agreement Program ("APMA") of the Internal Revenue Service ("IRS"), Large Business & International Division, requesting a pre-filing conference pursuant to Section 4.02 of Revenue Procedure 2015-41, 2015-35 I.R.B. 263.
The purpose of this memorandum is to provide the APMA program with sufficient background information to facilitate a meaningful pre-filing conference and to discuss the feasibility and scope of a proposed bilateral Advance Pricing Agreement ("APA") between the United States and the Federal Republic of Germany. The bilateral APA is contemplated under Article 25 (Mutual Agreement Procedure) of the Convention between the United States of America and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes, signed June 29, 2006 (the "Treaty"), and the procedural framework established by Rev. Proc. 2015-41.
The proposed APA would cover three categories of intercompany transactions in the US-Germany semiconductor supply chain between Foreign Parent and US Sub. In the aggregate, these transactions involve annual intercompany flows of approximately €1,280.6 million (approximately $1.39 billion at current exchange rates). The three covered transaction categories are: (i) the sale of tangible goods (semiconductor wafers and die) from Foreign Parent to US Sub; (ii) the payment of royalties by US Sub to Foreign Parent under an intellectual property license agreement; and (iii) cost-sharing contributions by US Sub under a Qualified Cost Sharing Arrangement for next-generation semiconductor process research and development.
The Applicants intend to file a formal APA application (IRS Form 14661, together with all required supporting documentation) promptly following the pre-filing conference, with a target filing date of July 7, 2025. In parallel, separate German tax counsel retained by the Applicants will submit a corresponding APA application to the Bundeszentralamt für Steuern ("BZSt"), the German competent authority, to initiate the bilateral competent authority negotiation process. The Applicants respectfully request that the APMA program and the BZSt coordinate the negotiation of the bilateral APA to the fullest extent practicable, in the interest of administrative efficiency and the avoidance of double taxation.
This memorandum is organized as follows: Section II provides a description of the taxpayer and the semiconductor industry context; Section III describes the three categories of covered transactions in detail; Section IV sets forth the proposed transfer pricing methods, benchmarking analyses, and best method considerations; Section V addresses the proposed APA term and rollback request; Section VI discusses the treaty basis and competent authority procedures; Section VII summarizes the applicable legal framework; Section VIII addresses the user fee requirement; Section IX sets forth the Applicants' request for a pre-filing conference; and Section X provides concluding remarks and contact information. Three appendices provide summary financial data, benchmarking results, and a proposed timeline.
II. DESCRIPTION OF THE TAXPAYER AND INDUSTRY
A. Foreign Parent
Foreign Parent is an Aktiengesellschaft (AG) organized and existing under the laws of the Federal Republic of Germany. Foreign Parent is publicly listed on the Frankfurt Stock Exchange (XETRA segment) and has its registered office (Sitz) and principal fabrication campus in the Free State of Saxony, Germany. Foreign Parent is a leading European semiconductor manufacturer specializing in the design and manufacture of advanced-node semiconductor wafers.
Foreign Parent's core competence lies in the development and fabrication of semiconductor wafers employing state-of-the-art process technologies, including 7-nanometer (nm), 5-nanometer (nm), and 3-nanometer (nm) nodes. These advanced-node semiconductors are designed and manufactured for deployment in three primary end markets: (i) automotive applications, including advanced driver-assistance systems ("ADAS") and vehicle electrification; (ii) industrial Internet-of-Things ("IoT") applications; and (iii) data-center and cloud computing applications. Foreign Parent's product portfolio encompasses a broad range of logic and mixed-signal semiconductor devices tailored to the performance, power efficiency, and reliability requirements of these high-growth end markets.
Foreign Parent operates three semiconductor fabrication facilities ("fabs") in Germany. Two fabrication facilities are located in Dresden, Saxony, and a third fabrication facility is located in Freiberg, Saxony. These facilities collectively represent a multi-billion-euro capital investment and employ leading-edge lithography, deposition, etch, and metrology equipment. The Dresden campus serves as Foreign Parent's primary site for advanced-node wafer fabrication (5nm and 3nm process technologies), while the Freiberg facility supports mature-node and specialty process production (7nm and above).
For the fiscal year ended December 31, 2024 ("FY 2024"), Foreign Parent reported the following consolidated financial results:
• Consolidated revenue of approximately €8.74 billion;
• Earnings before interest, taxes, depreciation, and amortization ("EBITDA") of approximately €2.62 billion, representing an EBITDA margin of approximately 30.0%;
• Earnings before interest and taxes ("EBIT") of approximately €1.57 billion, representing an EBIT margin of approximately 18.0%; and
• Total research and development ("R&D") expenditure of approximately €1.42 billion, representing approximately 16.2% of consolidated revenue.
Foreign Parent's substantial R&D investment underscores the technology-intensive nature of its operations and the centrality of intangible property development to its business model. The vast majority of Foreign Parent's R&D activities are conducted at its German facilities, where the company maintains advanced process development laboratories, design centers, and test and characterization facilities.
As of December 31, 2024, Foreign Parent employed approximately 22,400 people globally, of whom approximately 14,600 (approximately 65%) are based in Germany. The German workforce includes a substantial proportion of highly trained engineers, scientists, and technicians engaged in semiconductor process development, device design, wafer fabrication, and quality assurance.
Critically, Foreign Parent is the owner and developer of the group's core intangible property. This intangible property portfolio includes, but is not limited to: (i) proprietary semiconductor process technology (including process recipes, process integration know-how, and yield-enhancement methodologies); (ii) design libraries (including standard cell libraries, memory compilers, and I/O libraries); (iii) electronic design automation ("EDA") tools and methodologies developed internally; (iv) patents and patent applications covering process technology and device architecture innovations; and (v) accumulated technical know-how and trade secrets relating to advanced-node semiconductor fabrication. Foreign Parent has invested cumulatively in excess of €7 billion in R&D over the past five fiscal years to develop and maintain this intangible property portfolio.
B. US Subsidiary
US Sub is a C-corporation organized under the laws of the State of Delaware and is a wholly owned subsidiary of Foreign Parent. US Sub functions as the exclusive distribution, marketing, and design-support entity for the group's semiconductor products in North America (the United States, Canada, and Mexico, with the United States representing approximately 94% of US Sub's third-party revenue).
US Sub is headquartered in Austin, Texas, where it maintains its principal administrative offices, logistics and inventory management operations, and certain marketing functions. In addition, US Sub operates a design center in San Jose, California, which provides application-specific design support and technical customer interface services. US Sub also maintains regional sales offices in Detroit, Michigan (serving the automotive OEM customer base) and Portland, Oregon (serving the data-center and cloud computing customer base).
US Sub's primary functions include: (i) the importation, warehousing, and distribution of semiconductor products manufactured by Foreign Parent in Germany; (ii) sales and marketing activities directed at unrelated US and North American customers; (iii) customer relationship management, including technical support and design-in assistance to help customers integrate Foreign Parent's semiconductor devices into their end products; (iv) order management and logistics coordination; and (v) limited design support activities (primarily application engineering and reference design development) performed at the San Jose design center.
For FY 2024, US Sub reported the following financial results:
• Net third-party revenue of approximately $4.12 billion, representing arm's-length resales of semiconductor products to unrelated US customers, including original equipment manufacturers ("OEMs"), electronic component distributors, and hyperscale data-center operators;
• Cost of goods sold ("COGS") of approximately $3.38 billion, inclusive of intercompany purchases of semiconductor wafers and die from Foreign Parent;
• Gross profit of approximately $740 million, representing a gross margin of approximately 17.96%;
• Operating expenses of approximately $542.2 million, consisting of selling, general, and administrative expenses ("SG&A"), marketing expenses, and the costs of design-support activities at the San Jose center (excluding R&D cost-sharing contributions, which are accounted for separately); and
• Operating income of approximately $197.8 million, representing an operating margin of approximately 4.80%.
As of December 31, 2024, US Sub employed approximately 2,850 people, primarily consisting of sales and marketing professionals, logistics and supply chain personnel, design engineers, and administrative staff. US Sub does not engage in fundamental semiconductor process research or wafer fabrication. Its design-support activities are limited to application engineering and do not give rise to ownership of core process technology intangibles.
US Sub's functional profile is that of a limited-risk distributor with ancillary design-support functions. US Sub does not bear significant risks associated with market demand fluctuations, manufacturing yield, or technology obsolescence, beyond inventory and credit risk in the ordinary course of its distribution activities. Foreign Parent retains the entrepreneurial risks associated with semiconductor process development, fabrication, and capacity investment.
C. Other Affiliated Entities (Not Within APA Scope)
The Foreign Parent group also includes affiliated entities in Japan and China. Specifically, the group includes a Japanese subsidiary organized as a Kabushiki Kaisha (KK) with its principal office in Tokyo, Japan, and a Chinese subsidiary organized as a wholly foreign-owned enterprise ("WFOE") with its principal office in Shanghai, People's Republic of China. These entities perform distribution and sales-support functions in their respective markets.
Neither the Japanese subsidiary nor the Chinese subsidiary is proposed to be within the scope of the bilateral APA that is the subject of this memorandum. The intercompany transactions between Foreign Parent and these entities are subject to separate transfer pricing policies and documentation. The Applicants may, at a future date, consider pursuing separate APAs covering transactions with these entities, but no such request is made at this time.
D. Industry Overview
The global semiconductor industry is one of the most capital-intensive and technology-driven industries in the world economy. The industry is characterized by the following structural features, each of which has important implications for transfer pricing analysis:
Capital Intensity. Semiconductor fabrication requires enormous capital investment. A single advanced-node fabrication facility can cost in excess of $15–$20 billion to construct and equip. This capital intensity creates significant barriers to entry and limits the number of companies capable of manufacturing leading-edge semiconductor devices. Foreign Parent's three German fabrication facilities represent a cumulative capital investment in excess of €12 billion.
R&D Intensity. The semiconductor industry is among the most R&D-intensive industries globally. Successful semiconductor companies typically invest 15–25% of revenue in R&D to maintain technological competitiveness and advance to the next process node. Foreign Parent's R&D-to-revenue ratio of approximately 16.2% in FY 2024 is consistent with industry norms for integrated device manufacturers.
Cyclicality. The semiconductor industry is subject to pronounced cyclical fluctuations driven by inventory cycles, end-market demand variability (particularly in automotive and consumer electronics), and periodic overcapacity. These cyclical dynamics can result in significant year-to-year variation in profitability, which has implications for the selection of multi-year benchmarking periods and the use of averaging conventions in transfer pricing analyses.
Key End Markets. Foreign Parent's products serve three primary end markets: (i) automotive, driven by the proliferation of ADAS, autonomous driving, and electric vehicle ("EV") platforms, which require increasingly sophisticated semiconductor content; (ii) industrial IoT, reflecting the digitalization of manufacturing, logistics, and infrastructure; and (iii) data-center and cloud computing, fueled by demand for high-performance computing, artificial intelligence ("AI") training and inference, and 5G network infrastructure.
Competitive Landscape. The semiconductor industry includes both integrated device manufacturers ("IDMs"), which design and fabricate their own chips, and entities operating under a fabless/foundry model, in which design and manufacturing are separated. Foreign Parent operates as an IDM, maintaining vertically integrated design-through-fabrication capabilities. Principal competitors include other European, Asian, and North American IDMs, as well as foundry operators that manufacture chips designed by fabless semiconductor companies. The IDM model is particularly prevalent in the automotive and industrial semiconductor segments, where close integration of design and process development is valued for achieving the high reliability and quality standards demanded by these end markets.
intellectual Property. Semiconductor companies maintain extensive portfolios of intellectual property, including patents, trade secrets, and proprietary process know-how. The economic value of semiconductor IP is substantial, as process technology intangibles are the primary differentiating factor enabling advanced-node fabrication and are the product of cumulative multi-billion-dollar R&D investment over many years.
III. DESCRIPTION OF COVERED TRANSACTIONS
The proposed bilateral APA would cover three categories of intercompany transactions between Foreign Parent and US Sub. Each transaction category is described in detail below.
A. Transaction 1: Tangible Goods — Sale of Semiconductor Wafers and Die
Transaction Description. Foreign Parent manufactures semiconductor wafers and singulated die at its fabrication facilities in Dresden and Freiberg, Germany. Foreign Parent sells these semiconductor wafers and die to US Sub under a Master Intercompany Supply Agreement (the "Supply Agreement"). The Supply Agreement was originally effective as of January 1, 2019, and was amended on July 1, 2022 to update pricing terms, delivery scheduling provisions, and product specification annexes reflecting the introduction of 3nm process technology products.
Under the Supply Agreement, Foreign Parent ships semiconductor wafers and die to US Sub's distribution center in Austin, Texas, where US Sub performs incoming inspection, inventory management, and order fulfillment. In certain cases, products are shipped directly from Foreign Parent's German facilities to US Sub's customers' facilities in the United States under a drop-ship arrangement, with title passing through US Sub. US Sub then resells finished and packaged semiconductors to unrelated US customers, including automotive OEMs and their Tier 1 suppliers, electronic component distributors, and hyperscale data-center operators.
Transfer Pricing Terms. The intercompany price for semiconductor wafers and die under the Supply Agreement is established on a product-by-product basis, reflecting a cost-plus methodology adjusted periodically to target a return for US Sub consistent with its limited-risk distributor functional profile. Prices are denominated in Euros and invoiced on 60-day net payment terms.
FY 2024 Volume. For FY 2024, the aggregate intercompany value of tangible goods (semiconductor wafers and die) transferred from Foreign Parent to US Sub was approximately €987.6 million. At the average 2024 EUR/USD exchange rate of 1.0896, this is equivalent to approximately $1,076 million (approximately $1.076 billion).
Flow of Goods and Payments. The flow of tangible goods is from Germany to the United States. The corresponding flow of intercompany payments is from US Sub (United States) to Foreign Parent (Germany).
B. Transaction 2: Royalties — IP License
Transaction Description. US Sub pays Foreign Parent a royalty for the right to use Foreign Parent's proprietary semiconductor process technology, design libraries, and related intangible property in connection with US Sub's distribution, marketing, and design-support activities in North America. The royalty is paid pursuant to an intellectual Property License Agreement (the "IP License Agreement"), effective as of January 1, 2019.
The intangible property licensed under the IP License Agreement includes: (i) Foreign Parent's proprietary semiconductor process technology and process know-how; (ii) design libraries (standard cell libraries, memory compilers, I/O libraries); (iii) trademarks, trade names, and brand identities used in the North American market; and (iv) technical documentation, application notes, and reference designs. The license is exclusive to the North American territory (United States, Canada, and Mexico) for the term of the agreement.
Royalty Computation. The royalty is computed as 6.0% of US Sub's net revenues attributable to the licensed intangible property. The IP-attributable share of US Sub's total net revenues is computed annually based on a product-level revenue allocation methodology. For FY 2024, the IP-attributable share was determined to be approximately 18.1% of US Sub's total net revenues, reflecting the proportion of revenue derived from products embodying Foreign Parent's most advanced proprietary process technology (principally 5nm and 3nm node products).
FY 2024 Volume. For FY 2024, aggregate royalty payments from US Sub to Foreign Parent under the IP License Agreement were approximately €68.4 million. At the payment-date weighted average EUR/USD exchange rate of 1.0307, this is equivalent to approximately $70.5 million.
Flow of Payments. The flow of royalty payments is from US Sub (United States) to Foreign Parent (Germany).
C. Transaction 3: Cost-Sharing Contributions — Qualified Cost Sharing Arrangement
Transaction Description. Foreign Parent and US Sub are parties to a Qualified Cost Sharing Arrangement (the "CSA") for the joint development of next-generation semiconductor process technologies, specifically 2-nanometer and sub-2-nanometer (2nm and sub-2nm) process R&D. The CSA was entered into effective July 15, 2018, and is governed by the terms of a Cost Sharing Agreement (the "CSA Agreement") executed on that date.
Under the CSA, Foreign Parent and US Sub share the costs and risks of developing next-generation process technology intangibles, with each party obtaining specified rights to exploit the resulting intangible property in designated geographic territories. Foreign Parent retains exploitation rights for all territories worldwide other than North America (the United States, Canada, and Mexico). US Sub obtains exploitation rights for the North American territory. The CSA is structured as a qualified cost sharing arrangement within the meaning of Treasury Regulation § 1.482-7.
Cost-Sharing Percentages. US Sub's cost-sharing percentage under the CSA is 22.5%, reflecting its anticipated benefit share from the exploitation of developed intangible property in the North American market. This percentage was determined at the inception of the CSA based on an analysis of the reasonably anticipated benefits ("RAB") to each participant, measured by reference to projected future income streams attributable to the exploitation of the developed IP in each participant's assigned territory. Foreign Parent's corresponding cost-sharing percentage is 77.5%.
FY 2024 Contributions. For FY 2024, total qualified R&D costs incurred under the CSA were approximately €998.2 million. US Sub's 22.5% share of these costs was approximately €224.6 million (approximately $231.3 million at prevailing exchange rates). These cost-sharing contributions are remitted quarterly by US Sub to Foreign Parent.
Platform Contribution Transaction (PCT). At the inception of the CSA on July 15, 2018, US Sub made a platform contribution transaction ("PCT") buy-in payment to Foreign Parent of $312.5 million. The PCT compensated Foreign Parent for the pre-existing intangible property (principally, process technology know-how, experimental data, and early-stage 2nm feasibility studies) that Foreign Parent contributed to the CSA as a platform for the joint development effort. The PCT was valued using the income method prescribed by Treasury Regulation § 1.482-7(g)(4), employing an 11.8% risk-adjusted discount rate and a 15-year projection period for the anticipated income streams from the North American exploitation of the developed IP. The PCT valuation was performed by an independent valuation firm with recognized expertise in semiconductor industry intellectual property valuations.
Periodic Adjustment. The anticipated benefit share underlying US Sub's 22.5% cost-sharing percentage is reviewed and, if appropriate, adjusted on a triennial basis, in accordance with the CSA Agreement and the principles of Treasury Regulation § 1.482-7(i). The first triennial review was completed in 2021, and the second triennial review is currently in progress (covering the period 2021–2024). No adjustment to the 22.5% percentage was made as a result of the first triennial review.
Flow of Payments. The flow of cost-sharing contribution payments is from US Sub (United States) to Foreign Parent (Germany).
D. Aggregate Intercompany Flows
The following table summarizes the aggregate annual intercompany flows for FY 2024 across all three covered transaction categories:
The aggregate annual intercompany flows of approximately €1,280.6 million (approximately $1.28 billion, or more precisely approximately $1.378 billion) represent a substantial volume of cross-border related-party transactions, underscoring the importance of advance certainty regarding the arm's-length character of the intercompany pricing for both the US and German tax administrations.
IV. PROPOSED TRANSFER PRICING METHODS
This Section IV sets forth the Applicants' proposed transfer pricing methods for each of the three covered transaction categories, including the rationale for each method selection under the best method rule, the identification of the tested party, the profit level indicator or rate employed, the results of the benchmarking analyses, and the application of the benchmarking results to the Applicants' actual intercompany pricing.
A. Tangible Goods (Wafer/Die Sales) — Transactional Net Margin Method / Comparable Profits Method
1. Proposed Method
The Applicants propose the Transactional Net Margin Method ("TNMM"), as described in Chapter II of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (2022 ed.) ("OECD Guidelines"), and its US domestic law equivalent, the Comparable Profits Method ("CPM"), as set forth in Treasury Regulation § 1.482-5, as the transfer pricing method for the intercompany sale of semiconductor wafers and die from Foreign Parent to US Sub.
2. Tested Party
The Applicants propose US Sub as the tested party. US Sub is the least complex entity in the tangible goods transaction, functioning as a limited-risk distributor with routine functions (distribution, marketing, design support, and customer service), limited ownership of intangible assets (US Sub does not own or develop core process technology intangibles), and bearing primarily inventory risk (holding approximately 45–60 days of inventory on hand) and credit risk (accounts receivable from unrelated customers). US Sub does not bear significant risks associated with product development, manufacturing yield, capacity utilization, or technology obsolescence — these entrepreneurial risks are borne by Foreign Parent, which is the manufacturer, IP owner, and developer of the group's semiconductor products.
By contrast, Foreign Parent is the complex party in the transaction, performing high-value manufacturing, R&D, and IP development functions and bearing the associated entrepreneurial risks. Reliable comparable data for companies performing Foreign Parent's full range of complex functions is difficult to obtain, whereas reliable comparable data for limited-risk semiconductor distributors is more readily available. Accordingly, testing US Sub's profitability against that of comparable independent distributors is the most reliable approach.
3. Profit Level Indicator
The Applicants propose operating margin on net resales (i.e., operating income divided by net third-party revenue) as the profit level indicator ("PLI"). Operating margin is selected because it is the most commonly used and widely accepted PLI for distribution entities under both the TNMM and the CPM. Operating margin appropriately captures the return attributable to US Sub's distribution, marketing, and design-support functions while accounting for the cost structure (both COGS and operating expenses) associated with those functions. Furthermore, operating margin is less affected by differences in product mix and cost allocation practices among comparable companies than gross margin, enhancing comparability.
4. Benchmarking Study
The Applicants conducted a benchmarking study to identify independent companies whose functions, risks, and asset profiles are comparable to those of US Sub in its capacity as a limited-risk distributor of semiconductor products in North America. The benchmarking study employed the following screening criteria:
• Industry: Companies classified in SIC codes 5065 (Electronic Parts and Equipment, Not Elsewhere Classified) and 5045 (Computers and Computer Peripherals and Software), and/or NAICS codes 423690 (Other Electronic Parts and Equipment Merchant Wholesalers) and 423430 (Computer and Computer Peripheral Equipment and Software Merchant Wholesalers);
• Geography: North American companies (United States and Canada);
• Functional Profile: Companies primarily engaged in the distribution and resale of semiconductor and electronic components, without significant manufacturing or proprietary IP development activities;
• Size: Companies with annual revenues between $100 million and $10 billion;
• Data Availability: Companies with publicly available financial data for the five-year period FY 2020 through FY 2024; and
• Independence: Companies not controlled by or affiliated with semiconductor manufacturers (to ensure arm's-length results).
After applying these screening criteria and performing a detailed functional comparability review, the Applicants identified 17 comparable North American semiconductor distributors. The benchmarking analysis uses five-year weighted average operating margins for the fiscal years 2020 through 2024, consistent with the OECD Guidelines' recommendation to use multi-year data to smooth out the effects of industry cyclicality and short-term fluctuations.
5. Benchmarking Results
The interquartile range of operating margins for the 17 comparable companies, computed on a five-year weighted average basis, is as follows:
6. Application to US Sub
US Sub's FY 2024 operating margin on net resales was 4.80% ($197.8 million operating income ÷ $4,120 million net revenue). This result falls within the interquartile range of 2.8% to 6.1% and is above the median of 4.4%. Accordingly, US Sub's actual operating margin is consistent with the arm's-length range established by the benchmarking study, confirming that the intercompany transfer prices for semiconductor wafers and die under the Supply Agreement produced arm's-length results in FY 2024.
7. Best Method Considerations
The TNMM/CPM is selected as the best method under the best method rule set forth in Treasury Regulation § 1.482-1(c) and Paragraph 2.2 of the OECD Guidelines, for the following reasons:
• Least complex party: US Sub is the least complex party in the tangible goods transaction, and reliable benchmarking data for entities performing US Sub's limited-risk distribution functions is available;
• Reliable comparable data: The 17 comparable companies identified perform sufficiently similar functions, bear similar risks, and employ similar assets to US Sub, providing a reliable basis for comparison;
• Robustness of PLI: Operating margin is a well-established and reliable PLI for distribution entities, and is less sensitive to product-mix differences and accounting classification differences than gross-margin indicators;
• Alternative methods considered: The Comparable Uncontrolled Price ("CUP") method was considered but rejected because the semiconductor products sold by Foreign Parent to US Sub are highly differentiated (incorporating proprietary process technology at the 7nm, 5nm, and 3nm nodes), and sufficiently comparable uncontrolled transactions involving identical or closely comparable products were not identified. The resale price method was also considered but deemed less reliable than the TNMM/CPM because gross margin comparisons are more sensitive to differences in product mix, level of value-added, and cost classification among distributors.
B. Royalties (IP License) — Comparable Uncontrolled Transaction Method
1. Proposed Method
The Applicants propose the Comparable Uncontrolled Transaction ("CUT") method, as set forth in Treasury Regulation § 1.482-4(c) and described in Chapter VI of the OECD Guidelines, as the primary transfer pricing method for the royalty payments made by US Sub to Foreign Parent under the IP License Agreement. The CUT analysis is corroborated by a residual profit split analysis, which serves as a confirmatory check on the reasonableness of the royalty rate.
2. Tested Party
The CUT method evaluates the royalty terms of the controlled transaction by reference to the royalty terms of comparable uncontrolled transactions. In this context, the analysis focuses on Foreign Parent as the licensor, comparing the royalty rate charged by Foreign Parent to US Sub with royalty rates observed in comparable arm's-length license agreements involving similar types of semiconductor intangible property.
3. Benchmarking Study
The Applicants conducted a benchmarking study to identify comparable uncontrolled license agreements for semiconductor intellectual property. The study drew upon two primary data sources: (i) a subscription royalty rate database (specifically, the Sundial Health IT royalty rate database), which aggregates licensing data from public filings, court proceedings, and voluntary submissions; and (ii) publicly available SEC filings (including Forms 10-K, 10-Q, and 8-K) disclosing material license agreements involving semiconductor IP.
The following comparability criteria were applied:
• Industry: License agreements involving semiconductor or related electronic component technology;
• Type of Intangible: License agreements covering process technology, design libraries, manufacturing know-how, or similar technology intangibles (as distinguished from pure patent licenses or trademark licenses);
• License Structure: Running royalty agreements (as opposed to lump-sum paid-up licenses), with royalty rates expressed as a percentage of net revenues or net sales;
• Exclusivity: License agreements involving exclusive or semi-exclusive territorial rights, comparable to the exclusive North American territory granted to US Sub;
• Arm's-Length Nature: License agreements between unrelated parties; and
• Recency: License agreements executed or in effect during the period 2016–2024.
After applying these criteria and performing a detailed comparability analysis, the Applicants identified eight comparable uncontrolled license agreements.
4. Benchmarking Results
The interquartile range of royalty rates observed in the eight comparable uncontrolled license agreements is as follows:
5. Application to the IP License
Foreign Parent's royalty rate of 6.0% on IP-attributable revenues falls within the interquartile range of 3.5% to 8.2% and is above the median of 5.6%. The effective royalty rate on US Sub's total net revenues (i.e., 6.0% × 18.1% IP-attributable share = approximately 1.09% of total net revenues) is consistent with the rates observed in the comparable uncontrolled license agreements when adjusted for the scope and breadth of the licensed technology.
6. Corroboration by Residual Profit Split
The Applicants have performed a residual profit split analysis as a confirmatory method. Under the residual profit split, each party is first allocated a routine return for its functions (US Sub's routine return is computed at the TNMM/CPM-determined operating margin, and Foreign Parent's routine manufacturing return is computed by reference to comparable contract manufacturers). The residual profit — attributable to the parties' non-routine contributions (principally Foreign Parent's intangible property) — is then allocated between the parties based on their relative contributions of unique and valuable intangible property. The results of the residual profit split analysis are consistent with the 6.0% royalty rate, confirming that the royalty paid by US Sub appropriately compensates Foreign Parent for its intangible property contributions without over- or under-allocating residual profits.
7. Best Method Considerations
The CUT method is selected as the best method for the following reasons:
• Availability of comparable uncontrolled transactions: Eight comparable arm's-length license agreements were identified, providing a sufficient basis for reliable comparisons;
• Comparability: The comparable agreements involve similar industries (semiconductor), similar types of intangibles (process technology and design libraries), and similar license structures (running royalties on net revenues with territorial exclusivity), enhancing the reliability of the comparison;
• Corroboration: The residual profit split analysis independently corroborates the reasonableness of the CUT-derived royalty rate, strengthening confidence in the result; and
• Alternative methods: The TNMM/CPM was not selected as the primary method for the royalty transaction because the royalty is a separate intercompany transaction (distinct from the tangible goods transfer), and direct comparable licensing data is available, making the CUT a more direct and reliable method. The profit split method, while informative as a corroborative method, was not selected as the primary method because the CUT provides a more direct and less subjective comparison.
C. Cost-Sharing Contributions (R&D CSA) — Income Method
1. Proposed Method
The Applicants propose the income method, as prescribed by Treasury Regulation § 1.482-7(g)(4), as the transfer pricing method for evaluating the arm's-length character of the CSA, including both (i) the determination of US Sub's cost-sharing percentage (anticipated benefit share) and (ii) the valuation of the PCT buy-in payment.
2. Anticipated Benefit Share Analysis
US Sub's cost-sharing percentage of 22.5% was determined based on an analysis of the reasonably anticipated benefits to each participant from the exploitation of the intangible property developed under the CSA in each participant's assigned geographic territory.
The anticipated benefit share analysis was conducted using the following methodology:
• Revenue Projections: Projected future revenue streams from the exploitation of 2nm and sub-2nm process technology in the North American market (US Sub's territory) and all other worldwide markets (Foreign Parent's territory) were developed based on semiconductor industry demand forecasts, the Applicants' business plans, and publicly available market intelligence from recognized industry analysts;
• Profit Attribution: Revenue projections were converted to operating profit projections by applying product-line-specific operating margins;
• discount Rate: Projected future profit streams were discounted to present value using a risk-adjusted discount rate reflecting the stage of technological development, the probability-weighted likelihood of commercial success, and market-specific risk factors; and
• Benefit Share Computation: US Sub's anticipated benefit share was computed as the present value of its projected North American profit stream divided by the total present value of projected worldwide profit streams from all participants' territories.
The resulting anticipated benefit share of 22.5% for US Sub is consistent with the North American market's share of the global addressable market for advanced-node semiconductor devices in the product categories targeted by the CSA R&D.
3. PCT Valuation
At the inception of the CSA on July 15, 2018, US Sub made a lump-sum PCT buy-in payment of $312.5 million to Foreign Parent. This payment compensated Foreign Parent for the value of the pre-existing platform intangible property (process development data, experimental results, feasibility studies, and early-stage engineering work product related to 2nm process technology) that Foreign Parent contributed to the CSA.
The PCT was valued using the income method specified in Treasury Regulation § 1.482-7(g)(4). The key parameters of the PCT valuation were:
• discount Rate: 11.8%, reflecting a risk-adjusted weighted average cost of capital appropriate for early-stage semiconductor process technology development;
• Projection Period: 15 years, reflecting the anticipated useful economic life of the platform intangible property contributed by Foreign Parent;
• Income Stream: Projected incremental income attributable to the platform contribution, measured as the difference between the income projected to be earned by US Sub with the benefit of the platform contribution and the income projected without such benefit;
• Terminal Value: No terminal value was assumed beyond the 15-year projection period; and
• Independent Valuation: The PCT valuation was performed by an independent valuation firm with recognized expertise in semiconductor industry intellectual property valuations. The valuation report is available for inspection by the APMA program.
4. Periodic Adjustment Evaluation
The anticipated benefit share underlying US Sub's 22.5% cost-sharing percentage is subject to triennial review and adjustment, in accordance with the CSA Agreement and the principles of Treasury Regulation § 1.482-7(i). The triennial review evaluates whether the actual exploitation outcomes and market developments are materially consistent with the projections used to determine the original anticipated benefit share. If the actual results diverge materially from the original projections, the cost-sharing percentage is subject to prospective adjustment. The first triennial review, covering the period 2018–2021, was completed in 2021, and no adjustment to the 22.5% percentage was made. The second triennial review, covering the period 2021–2024, is currently in progress.
5. Best Method Considerations
The income method is the specified method under the cost-sharing regulations (Treasury Regulation § 1.482-7) for valuing platform contributions and evaluating the arm's-length character of cost-sharing arrangements. The income method is the most reliable method for the following reasons:
• Regulatory specification: The income method is the method specifically prescribed by the Treasury Regulations for PCT valuations;
• Economic rationale: The income method directly measures the value of the platform contribution by reference to the incremental income it is expected to generate, which is the most economically meaningful measure of value for intangible property at the development stage;
• Consistency with CSA structure: The anticipated benefit share analysis uses the same income-based framework to allocate costs among CSA participants, ensuring internal consistency between the benefit share determination and the PCT valuation; and
• Independent verification: The PCT valuation was performed by a qualified independent valuation firm, providing additional assurance of the reliability and objectivity of the analysis.
D. Summary Table of Proposed Methods
The following table summarizes the proposed transfer pricing methods, tested parties, profit level indicators or rates, benchmark ranges, and actual results for each covered transaction category:
The Applicants submit that each of the proposed methods satisfies the best method rule under Treasury Regulation § 1.482-1(c) and is consistent with the OECD Guidelines. The proposed methods produce results that are within the arm's-length range and appropriately compensate each party for its functions performed, risks assumed, and assets employed.
V. PROPOSED APA TERM AND ROLLBACK REQUEST
A. Prospective APA Term
The Applicants propose a prospective APA term of five tax years, commencing January 1, 2025 and ending December 31, 2029. Both Foreign Parent and US Sub have a December 31 fiscal year-end for both US federal income tax and German corporate income tax purposes. Accordingly, the five prospective APA years would correspond to the following tax years:
• Tax Year 2025 (January 1, 2025 – December 31, 2025)
• Tax Year 2026 (January 1, 2026 – December 31, 2026)
• Tax Year 2027 (January 1, 2027 – December 31, 2027)
• Tax Year 2028 (January 1, 2028 – December 31, 2028)
• Tax Year 2029 (January 1, 2029 – December 31, 2029)
The five-year prospective term is consistent with the standard APA term contemplated by Rev. Proc. 2015-41 and provides an appropriate period of certainty for both the taxpayers and the tax administrations.
B. Rollback Request
The Applicants respectfully request that the terms of the bilateral APA be rolled back to cover three prior tax years, specifically:
• Tax Year 2022 (January 1, 2022 – December 31, 2022)
• Tax Year 2023 (January 1, 2023 – December 31, 2023)
• Tax Year 2024 (January 1, 2024 – December 31, 2024)
The rollback request is made pursuant to Section 8 of Rev. Proc. 2015-41, which provides that the APMA program may, in its discretion, agree to apply the terms and conditions of an APA to prior tax years if the taxpayer requests a rollback and the relevant conditions are met.
The Applicants submit that the rollback request is justified for the following reasons:
1. Consistency of Pricing Policies. The intercompany pricing policies and transfer pricing methods described in this memorandum have been consistently applied by Foreign Parent and US Sub throughout the rollback period (2022–2024). The Supply Agreement, the IP License Agreement, and the CSA Agreement have been in effect throughout this period, and the intercompany pricing terms have been determined using the same methodologies described in Section IV.
2. Stability of Functional Profiles and Risk Allocations. The functional profiles of Foreign Parent and US Sub, the allocation of risks between the parties, and the economic circumstances of the covered transactions have remained substantially unchanged since at least January 1, 2022. Foreign Parent has continued to serve as the group's principal manufacturer, R&D center, and IP owner, while US Sub has continued to function as a limited-risk distributor with ancillary design-support activities. There have been no material changes in the parties' functions, assets, or risks during the rollback period.
3. Elimination of Double Taxation. Granting the rollback would provide certainty for the entire eight-year period (2022–2029) and would eliminate the risk of double taxation with respect to the covered transactions for all years within the combined rollback and prospective APA term. This is consistent with the objectives of the bilateral APA program and the Treaty's Mutual Agreement Procedure.
4. Administrative Efficiency. Addressing the rollback period in connection with the prospective APA avoids the need for separate audit proceedings, competent authority referrals, or other dispute resolution processes with respect to the transfer pricing of the covered transactions for the 2022–2024 tax years.
C. Total Covered Period
If the rollback request is granted, the total covered period would encompass eight tax years: Tax Year 2022 through Tax Year 2029 (January 1, 2022 through December 31, 2029). The Applicants believe that this eight-year covered period is appropriate given the consistency of the intercompany pricing policies and the stability of the parties' functional profiles throughout this period.
VI. TREATY BASIS AND COMPETENT AUTHORITY PROCEDURES
The proposed bilateral APA is sought under the authority of Article 25 (Mutual Agreement Procedure) of the Convention between the United States of America and the Federal Republic of Germany for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital and to Certain Other Taxes, signed on June 29, 2006 (the "Treaty"). Article 25 of the Treaty provides the framework for the competent authorities of the United States and Germany to endeavor to resolve, by mutual agreement, difficulties or doubts arising as to the interpretation or application of the Treaty, including cases involving the taxation of income not in accordance with the provisions of the Treaty.
Article 9 (Associated Enterprises) of the Treaty sets forth the arm's-length standard applicable to transactions between associated enterprises. Specifically, Article 9(1) provides that where conditions are made or imposed between two associated enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly. Article 9(2) provides the corresponding adjustment mechanism to relieve double taxation.
The competent authority for the United States for purposes of the Treaty and the bilateral APA is the Advance Pricing and Mutual Agreement Program (APMA) of the Large Business & International Division of the Internal Revenue Service. The competent authority for the Federal Republic of Germany is the Bundeszentralamt für Steuern (BZSt), located in Bonn, Germany.
Separate German tax counsel has been retained by the Applicants to prepare and submit a parallel APA application to the BZSt. The Applicants anticipate that the German application will be filed on or about August 15, 2025, following the submission of the formal US application to the APMA program. The Applicants respectfully request that the US and German competent authorities coordinate the bilateral APA negotiation process to the fullest extent practicable. In particular, the Applicants request that the competent authorities consider conducting joint or coordinated meetings, sharing relevant information (subject to applicable confidentiality and tax treaty information exchange provisions), and working toward a simultaneous conclusion of the bilateral APA.
The Applicants are committed to cooperating fully with both competent authorities throughout the APA negotiation process and to providing any additional information, documentation, or analyses that may be requested.
VII. LEGAL FRAMEWORK
The following legal authorities are relevant to the proposed bilateral APA and the transfer pricing analyses described in this memorandum:
United States Domestic Law:
• Internal Revenue Code § 482. Section 482 authorizes the Secretary of the Treasury to distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among organizations, trades, or businesses owned or controlled by the same interests, if the Secretary determines that such distribution, apportionment, or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations, trades, or businesses. Section 482 establishes the arm's-length standard as the governing principle for transfer pricing in the United States.