Investigating the presence of transfer pricing and its impact in U.S. airline mergers.

Bateman, Connie Rae ; Westphal, Ashley Droske

INTRODUCTION

For those that remember travel in the early days of the airline industry as "romantic", the recent cost cutting methods within the industry are unwelcome. From cutting free soft drinks on flights to charging for checked baggage, and seat selection, U.S. airlines are pulling out all of the stops to remain solvent in an increasingly difficult industry. On April 15, 2008, two of the country's largest carriers took further measures to remain solvent when they announced that they intended to merge in a $3.1 billion deal (Isidore, 2008). On October 29, 2008, the carriers received official approval from the Department of Justice to restructure their two business models into the world's largest airline in an attempt to cut inefficiencies and boost profitability (Corridore, 2008). Thus began what many see as the new era of the "mega airline."

Many factors have driven the new culture of mergers within the industry; rising fuel costs, a labor-relations culture that originated from government regulation of U.S. airlines, a reactive instead of proactive strategic management business model, a high risk of substitute products [particularly from the low cost sector, which in turn forced a downward trend in fares], and in Europe, a full liberalisation of airlines within E.U. borders.

Mergers in and of themselves, are highly complex issues that also relate to multifaceted questions related to transfer pricing (TP) practices. TP in the context of a merger would refer to the practice of internally pricing the goods, services, or brand that will be moving from one affiliate to another. TP is one highly proprietary issue that should not be overlooked in the merger dynamic. It should also be noted that TP is a strategic cost-cutting cool with the ability to appease tax liabilities, or (if used incorrectly) the ability to cost an organization a significant amount of money through tax penalties and higher tax liabilities. Will there be any foreseeable issues in TP planning with regards to airline mergers? If so, which TP method is appropriate? What are the implications if the organization fails to select the correct method? How does the issue of TP play into the strategic plans of the organization and its culture?

This paper attempts to examine the issue of TP within the scope of U.S. airline mergers. Specifically, the paper examines the most recent U.S. airline merger between Delta Air Lines, Inc. and the former Northwest Airlines Corporation (now a wholly owned subsidiary of Delta Air Lines, Inc.) and attempts to identify the potential TP issues that may have arisen between the two air carriers, a particularly challenging task due to the domestic nature of current airline mergers. Further analysis provides a look into the future of airline industry mergers, issues that may arise within the scope of TP, and how U.S. airlines should proceed if international mergers become a possibility under the Open Skies treaty. Additionally, it should be noted that airline mergers would be primarily suspect for TP violations when the merged companies continue to operate as two separate organizations under a single ownership.

DELTA AIR LINES, INC. AND NORTHWEST AIRLINES CORPORATION

Following the attack of the September 11, 2001 on the World Trade Center and Pentagon, there was an almost instant shift in the nature of the airline industry. What had once been a cyclical industry, now found itself in a downward slide not seen since the deregulation of the industry in the 1970's. But, even as airlines attempted to adjust to business life post 9/11, a new type of 9/11 came along--fuel costs. Jelveh (2008) notes "through the 1990's, with oil prices at $20 per barrel, fuel expenses made up between 10 and 20 percent of airlines' operating costs. As of the first quarter [of 2008], with oil prices at over $100 per barrel, most airlines reported fuel costs of between 30 and 40 percent of total expenses..." (p. 1)

After years of struggling to stay solvent in a changing market, a new wave came over the industry--bankruptcy. On September 15, 2005 Delta Air Lines, the nation's third largest airline, filed Chapter 11 bankruptcy in U.S. bankruptcy court (Isidore, 2005a; Unknown, n.d.:a; Unknown, 2005a). The nation's fourth largest carrier, Northwest Airlines followed just minutes later (Isidore, 2005b; Unknown, 2005a). For Delta, the filing followed a string of unprofitable quarters dating back to 2000 (Isidore, 2005a).

In late April and May of 2007, Delta Air Lines and Northwest Airlines (respectively) emerged from bankruptcy protection, restructured and ready to tackle the new market. It is reported that Delta, alone, had nearly halved its debt from its entrance into bankruptcy in 2005 to its emergence from bankruptcy in 2007 (Unknown, 2007b; Unknown, 2007c).

However, in 2008, as the economy softened and fuel prices continued their dramatic rise, it became apparent to many in the airline industry that mergers may be the key to a solvent airline industry (Sorkin & Bailey, 2008). In the first two months of 2008, the Air Transport Association noted that average fares were up 6% from the same time frame in 2007 (Isidore, 2008). However, the U.S. Energy Department noted that average jet fuel prices were up 55% over the same period, leaving the airlines no choice but to look at alternative strategic planning options (Isidore, 2008). Thus, the merger talks and speculation grew rampant, with Northwest and Delta at the forefront of the discussions.

On April 15, 2008, Delta Air Lines finally announced the long anticipated deal to acquire Northwest Airlines for roughly $3.1 Billion, under which the airlines would merger operations, equipment, personnel, and branding under the Delta name (Isidore, 2008). On October 29, 2008, the justice department approved the deal, and thus began the process of merging the two airline giants (Corridore, 2008).

Transfer Pricing and Mergers

While the newly consolidated Delta Air Lines, Inc. continued to make headlines regarding its merger, airlines were certainly not the only industry being pushed towards mergers in the current economic climate. According to an article published on Business Week Online, the newspaper industry, the candy industry, the alcohol industry, the retail industry, and even the technology industry were all making significant steps towards mergers (Farrell, 2008). As such, the links between mergers and TP are moving into the forefront of tax authorities' minds and policies, and should be in the forefront of CEO and CFO minds, as well.

The importance of TP is a topic that's growing in significance in business strategic planning. Section 408 of I.R.S. code defines an appropriately set TP as "prices charged by one affiliate to another, in an intercompany transaction involving the transfer of goods, services, or intangibles, [that] yield results that are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (referred to as the Basic Arm's Length Standard (or BALS))," (Unknown, 2007d; p. 1). It is typically assumed that corporations are going to make TP decisions based upon their financial benefit (i.e., minimizing tax liability). As such, TP decisions have the potential to add a significant amount of value to a firm.

The idea that TP can add value to a firm is widely touted in academic literature. Anderson, Cheng, Rao, & Zhou (2006) note, "An effective transfer pricing scheme can mitigate transfer pricing exposure, ensure compliance with the local tax regulations, as well as reduce daily operating costs. Therefore, transfer pricing management should be a part of strategic planning as opposed to a postevent remedy." (p. 11) Bateman, et. al. (1997) further suggest, "The transfer pricing methodology chosen greatly affects an [organization's] perceived value and long term viability." (p. 23) These authors suggest that TP is an issue that should not be overlooked by managers.

However, in addition to adding value to a firm, TP can also represent a value leakage if improperly handled. Robertson-Kellie & Mahalingham (2006) notes four potential areas of value leakage for firms who are inefficiently handling TP in strategic planning:

1. A significant leakage of resources (both in management time and money) when TP audits arise,

2. Double taxation may be an additional issue for firms if TP issues arise in a multinational firm,

3. The failure to include TP in continual process reviews, and

4. Firms may miss opportunities to minimize global tax rates.

As the article illustrates, inefficient handling of TP can result in a significant value leakage to an organization.

Mergers present an even more challenging position for firms in handling potential TP issues. Alms, Rutges, Soh & Uceda (2008) note, "[Merger and acquisition] deals are alive with [TP] implications, not only in the bringing together of potentially inconsistent [TP] systems, but also in the integration objectives and financing needs of the acquirers." (p. 26) They further continue that "... we often recommend that deal related risk management should begin before the deal is completed." (p. 27) So, what can an organization like Delta Air Lines do to minimize TP risks in its acquisition of Northwest Airlines?

1. "Develop a sufficiently accurate understanding of the target company's [TP] structure to make key decisions..." (Alms, Rutges, Soh, & Uceda, 2008, p. 30).

2. "Decide what changes to make [in the company's TP process] and the [TP] risk management approach needed to manage the transition risks," (Alms, Rutges, Soh, & Uceda, 2008, p. 30).

The suggestions may seem broad, but they are the foundation for assessing the complex TP issues that may arise in a merger. As noted above, these issues should have been sufficiently addressed prior to Delta Air Lines acquiring Northwest Airlines on October 29, 2008, with the former being completed in the due diligence phase Alms, Rutges, Soh, & Uceda, 2008).

Whether or not these steps have been taken by Delta Air Lines may be a key indicator of the future success of the merger. It is with these ideas in mind that this paper sought to uncover TP miscues within the scope of the Northwest Airlines Corporation and Delta Air Lines, Inc. merger. Methodology for identifying these miscues will be discussed in further detail in the subsequent section.

METHODOLOGY

When assessing the potential foresight of TP problems in the Delta Air Lines, Inc. and Northwest Airlines Corporation merger, potential linkages in the individual value chains of the respective air carriers were sought. By identifying these potential linkages and their ownership, it may be possible to identify areas in which tax authorities may find a misrepresentation of the BALS.

Secondary research was utilized to identify issues. The first source of secondary research was several tax and airline related journals (i.e., CPA Journal, International Tax Review, International Journal of Commerce and Management, Internal Auditor, International Tax Journal). Terms such as 'transfer pricing', 'transfer price', 'intra-organization price', 'intra-company price', 'inter-organization transfer', and 'internal price' were utilized to identify potential existing research on the topic of airline mergers and transfer pricing. Upon inspection it became clear that existing research did not exist within the scope of this paper. Potential additional sources were identified in the separate areas of transfer pricing, transfer pricing in mergers, airlines, and airline mergers. Additionally, the Internal Revenue Service (I.R.S.) website was accessed to ascertain U.S. transfer pricing regulations, directives, and bulletins.

The next source of secondary research was the website of the U.S. Federal Trade Commission (FTC) (Unknown, 2009b). The FTC enforces TP laws through settlements called actions. Again, terms such as 'transfer pricing', 'transfer price', 'intra-organization price', 'intra-company price', 'inter-organization transfer', and 'internal price' were utilized to identify potential TP actions taken against airlines. It, once more, became apparent that no actions have been taken by the FTC against airlines regarding TP.

After probing existing airline TP articles and FTC actions, potential common holdings between Northwest Airlines and Delta Air Lines were examined to search for potential value chain TP issues between affiliates under the same corporate banner. FindLaw.com provided full bankruptcy filings for both Northwest Airlines Corporation and Delta Air Lines, Inc. Delta Air Lines, Inc.'s bankruptcy filing included a corporate ownership statement, wherein it identified organizations in which Delta Air Lines owned an interest. The companies identified in the corporate ownership statement included Aero Assurance, Ltd., U.S. Cargo Sales Joint Venture, LLC, ARINC Incorporated, Cordiem LLC, Cordiem Inc., DATE, and the Atlanta Airport Terminal Corporation.

Northwest Airlines Corporation did not include a corporate ownership statement. However, secondary research was completed on each of the organizations identified in Delta Air Lines' corporate ownership statement to attempt to identify common Northwest Airlines holdings. After seeking and finding ownership information on each of the companies listed in the Delta Air Lines corporate ownership statement, it was established that there were no common holdings between Delta Air Lines, Inc. and Northwest Airlines Corporation.

An additional search for holdings was launched through the use of the financial statements and the Securities and Exchange Commission (SEC) filings of both airlines, accessed through the company website (Delta) and Hoovers.com (Northwest). Financial statements and SEC filings revealed no common holdings between Northwest Airlines Corporation and Delta Air Lines, Inc. Additionally, potential TP issues were sought between the pre-merger parent airlines and subsidiaries (regional airlines). Research was completed to locate such TP issues through financial documents, as well as additional review of bankruptcy filings of the parent airlines. No TP issues were identified between the parent airlines and subsidiaries.

RESULTS

After reviewing FTC actions, academic literature, bankruptcy filings, SEC filings, and financial statements from the two air carriers, no common supplier holdings were identified between the airlines. Within the scope of this paper, this prevented any uncovering of violations of TP practices by Delta Air Lines, Inc. under its acquisition of Northwest Airlines Corporation.

Looking Forward: Airlines and Transfer Pricing

While no TP violations were identified between Northwest Airlines Corporation and Delta Air Lines, Inc., the airline industry is certainly not exempt from TP issues. As the industry is reshaped over the coming years, TP will not fall into the backburner of the minds of tax authorities, but rather, move front and center.

For the past 60 years, airlines have been governed by bilateral service agreements (Unknown, 2007a). "These agreements contain [legal] restrictions on the number of airlines and frequency of service on many international routes, while many countries have limits on airline ownership and control by foreign nationals," (Unknown, 2007a, p. 1). As an example, while the European Union (E.U.) restricts non-E.U. ownership in E.U. airlines to 49%, U.S. laws restrict non-U.S. ownership of U.S. airlines to 25% (Michaels, 2008). These restrictions amount to an airline industry that is fairly sheltered from international competition and unable to seek investment from non-domestic sources, which will likely affect the long-term viability of the industry.

However, post-9/11 and during the recent increase in fuel prices, there has been an increase in the push for liberalisation of the airline industry, specifically from Europe towards the U.S (Michaels, 2008). According to the International Air Transport Association (IATA), liberalisation has benefits for consumers and producers (airlines) alike, including lower prices, increased productivity, a higher level of choices, and increased profitability (Unknown, 2007a). However, one of the biggest changes that full liberalisation would bring is that, in this growing culture of mergers, airlines would be allowed to merge across international borders, provided they meet antitrust regulations.

Until now, in light of ownership laws and strict anti-trust enforcement from both sides of the Atlantic, airlines entered into alliances. These alliances allowed airlines to reap some of the benefits of a merger without presenting anti-trust issues. R. Hewitt Pate, Deputy Assistant Attorney General for the U.S. Antitrust division, in a statement before the Senate Subcomittee on Antitrust, Competition, and Business Rights called alliances (2001), "... somewhere between an outright merger and a traditional arm's-length (BALS) interline agreement." (p. 3) However, if the U.S. loosens its ownership restrictions in 2010, as it is required to do by the "Open Skies" treaty, there could be a significant wave of changes in the industry (Unknown, 2009a). The loosening of the restrictions and the so-called "failing firm doctrine"--the idea that antitrust authorities let some deals pass that would otherwise be blocked if there is a high risk that one of the firms could fail--would likely result in other countries following suit, which could present a wave of international airline mergers (Farrell, 2008) and have significant TP implications.

Choosing a Method

If airlines are allowed to merge across international borders, there may be a significant change in TP issues for airlines. Instead of simply managing an airline's own value-chain and related TP relationships; the airlines will be forced to deal with multiple tax authorities, jurisdictions, and TP regulations. This can present a complex scenario for airlines who presumably want to prevent value leakage and ensure an optimal addition of value to their individual firms.

The first portion of most international regulations requires that the price paid for the transferred good or service be at a BALS. This means that "[The price] can be the price that would have been paid if the parties had no special relationship," (Frank, 2008, p. 1). However, the most challenging portion of TP is actually achieving a BALS through a method that is satisfactory for tax authorities. The Institute of Management and Administration recently published an article entitled "5 Methods That Help Pros Walk the TP Tightrope" where the following methods for achieving BALS are identified (Frank 2008):

1. [a profit-based method] The comparable products method (CPM) is achieved by "... focus[ing] on the operating profit of the tested party as opposed to the gross margin of the transaction, eliminating the need to determine whether operating costs are comparable," (Frank, 2008, p. 2).

The advantage of this method is that the data is easy to find, and the method is easy to apply (Frank, 2008).

2. [a profit-based method] The residual profit split method (RPSM) is another profit-based method that is used most often when both ends of the transaction own "valuable nonroutine intangibles," (Frank, 2008; Unknown, 2009c). This method determines a "residual profit split," (Frank, 2008, p. 2).

3. [a transactional method] The comparable uncontrolled price (CUP) method. "[CUP] determines price based on a price charged for the same or a very similar good in a transaction between parties without a special relationship [uncontrolled parties]," (Frank, 2008, p. 2). The risk here, however, is [that airlines must find a transaction that represents a "very high degree of comparability ... between the goods, the volume and conditions of the sale, warranties, and so on," (p. 2) which would seem especially difficult in an industry that would be new to international mergers (Frank, 2008). However, if such a transaction can be located, this method is considered the most reliable of all of the methods (Frank, 2008).

4. [a transactional method] The resale price method focuses on the gross profit margin of the airline that is being acquired and operated under a parent airline, and can only be used when the airline does not add a substantial level of non-routine value, which would, again, be difficult to establish in the airline industry (Frank, 2008).

5. [a transactional method] The cost plus method of calculating arm's length, "although similar to resale price, here the focus is not on the good but on the typical gross margin expected to be earned by the ultimate seller." (p. 20) This method would typically be used when a U.S. airline were being acquired and operated by a foreign airline, and asks "what is the profit margin of the [foreign airline], and is it comparable to that of others?" (Frank, 2008, p. 2).

It's highly important to note that different countries' tax authorities may prefer different methods which achieve an approved BALS price (the U.S. gives preference to the transactional methods), so airlines should be particularly aware of the individual jurisdictions they will be working with (Hayuka, 2008). Additionally, the penalties for failing to meet BALS are steep; for example, in the U.S., IRC Section 6662 states that "A penalty may be imposed that is between 20 percent and 40 percent of the understatement of tax attributable to the TP error, depending on the size of the error," (Frank, 2008, p. 2). Airlines, when treading in the uncharted waters of international TP, need to mindful of these penalties, as well as the value leakage that inefficient TP can lead to, even if undiscovered by tax authorities. In addition, the importance of keeping thorough and proper documentation cannot be overstated. "If thorough documentation kept by the [airline] demonstrates a good-faith compliance effort, penalties may be avoided" (Frank, 2008, p. 3).

Transfer Prices, Audits, & Advanced Pricing Agreements

An increasing number of countries are creating and amending legislation in relation to TP (Robertson-Kellie & Mahalingham, 2006). As such, many currently practicing multinational organizations are experiencing an increase in TP audits by tax authorities, and audits have also increased in force (Robertson-Kellie & Mahalingham, 2006). According to a survey conducted by Ernst & Young in 2005, 63% of multinational firms have been subject to a TP audit, with 40% of those audits resulting in adjustments being made by the auditing tax authorities (Lo & Wong, 2007). Additionally, interviews have revealed that tax authorities view TP as "a top audit issue" (Ackerman, Hobster, & Landau, 2002). This illustrates an increasingly intense and complex environment for airlines entering into international mergers.

So, what draws the attention of tax authorities? According to Anderson, Cheng, Rao, & Zhou (2006), there are three key criteria for tax authorities to focus in on a TP audit target:

1. "consecutive losses",

2. "fluctuating profits", and

3. "low [profits] or losses but continuously expanding operations."

A 2008 article in Internal Auditor also adds corporate restructuring to that list (Clemmons, 2008). Unfortunately, due to the unique nature of the industry, many (if not all) airlines fall into one of these categories at one time or another. This indicates a need for airlines to be uniquely prepared to handle TP audits.

The key issue for airlines in protecting the organization from value leakage due to TP audits is to ensure proper documentation of TP decisions. A 2003 I.R.S. directive instructed auditors to request documentation in all audits with international transactions (Foley, 2004/2005). The directive notes that penalties will apply unless the auditor finds that the taxpaying organization had documentation at the time the return was prepared or submitted documentation to the auditor within 30 days of the auditor's request, and the documentation meets the standards of regulations (Foley, 2004/2005).

The most effective method of documentation for airlines to prevent value leakage due to TP audits is to establish an advanced pricing agreement, or APA. The APA is an agreement between the tax authority (I.R.S.) and the taxpayer (airline) in which a transfer price for a good or service is agreed upon between the two entities, and ultimately establishes a contract between the taxpayer and the tax authority (Frank, 2008). Frank (2008) notes, "The advantage of this approach is obvious: Securing government agreement regarding a product's value before importation eliminates the possibility of fines, unanticipated higher duty, or delays should I.R.S.... later determine the good was undervalued." (p. 2) If an APA cannot be or is not established, documentation must be able to justify the price of the good using an approved BALS method.

An additional topic that deserves attention is, that there is a real and identifiable risk that airlines may be audited by tax authorities from outside their home jurisdiction. A 2008 article in the International Tax Journal addresses this very issue and points out that, in the past, U.S. based companies engaging in foreign TP activities have primarily had to deal with I.R.S. audits (O'Brien & Oates, 2008). Today, however, there has been a marked increase in not only the number of foreign TP audits, but also the level of sophistication and aggressiveness of these audits. When (rather than if) an airline is subject to a foreign TP audit, O'Brien & Oates (2008) recommend a few key tips:

1. "Take an active role in the foreign tax audit," (p. 8). The authors basically suggest that airline treat the foreign audit with the same gusto and level of seriousness as it would when facing an I.R.S. audit and provide the proper documentation justifying its TP decisions.

2. Seek advice from a foreign tax advisor and "call upon the advisor to give a written opinion." regarding the TP decision of the airline. This opinion may be critical documentation in disputing an audit decision.

3. Fully review any applicable tax treaties between the U.S. and the foreign country and "preserve its rights to consideration while the foreign tax audit and controversy are pending," (p. 8).

4. If a tax treaty is already present, seek an early consultation with a U.S. competent authority. This consultation can provide information on recent negotiations with the applicable country, as well as addressing other country-specific issues that may prevent value leakage for the airline.

5. Specifically quantify the possible outcome of the audit, both from the foreign audit, and from the applicable adjustments that may arise in the domestic jurisdiction, so that if it becomes necessary to negotiate with the foreign jurisdiction on the TP adjustments, it fully understands the financial implications of the negotiations at home and abroad and to be fully understood.

Ultimately, the key takeaway for airlines regarding preventing value leakage through TP audits is that not only does an appropriate method for pricing the good, intangible asset, or service need to be selected, but proper documentation must fully support the decision. Without documentation, airlines would expose themselves to a higher level of risk exposure, not only in the U.S. jurisdiction, but also abroad.

Assets

Given the nature of the airline industry, one of the most important discussions regarding TP is also one of the most challenging. The pricing of intangible assets continues to be one of the most difficult issues facing multinational companies. From revenue management--intellectual property (IP)--to slots--to the market power created by long-standing brand recognition (for an airline in particular), intangible assets create an immense amount of value.

Not unlike "traditional" assets, the valuation of intangible assets requires that prices be established by the BALS. While an intangible like a slot (the price airlines pay to garner an opportunity to land at a high-traffic airport--typically heavily controlled and limited) may be more easily valued by market rates, IP presents a steeper challenge for airlines.

As noted earlier, the RPSM is the method most commonly used for non-routine intangible assets (Frank, 2008). Under this method, "the overall profit is split between the related parties based on the functions performed by the related party not owning the intangible assets, with the residual profit allocated to the other related party," (Unknown, n.d.:d, p. 5). So, for mergers involving larger and/or legacy carriers, establishing the residual split will be a high-priority component of preventing value leakage.

An Assurance-Based Approach

A very important piece of the TP puzzle for airlines is to ensure an assurance-based approach is highly valued in the strategic TP plan. For the relatively uncharted waters of airline mergers (particularly international) and TP planning, this starts with a commitment to recognizing TP as a key value addition opportunity and value leakage threat for the airline, specifically when evaluating the transfer of intangibles. Once this has been established, it is important for airlines to ensure they are continually reviewing the strategy to ensure that it evolves with the industry and the airline's individual business.

Robertson-Kellie and Mahalingham (2006) note that "TP is one of the most important business concerns faced by multinational groups today," (p. 4) and continue "an assurance review, update, and ongoing health check of a group's TP process can create substantial opportunities for multinational groups..." (p. 3) The Assurance-Based Approach to TP is intended to ensure that an organization is utilizing the right method of calculating BALS, ensuring that an organization is adequately prepared to defend its position, and ensuring that an organization understands and respects the importance of TP planning for the health of the business.

While short-sighted TP approaches ["TP design and planning with no consideration as to the effective implementation and documentation necessary to sustain the benefits and defend the policy" and "Documentation of existing transfer prices with an annual roll forward of this documentation which does not consider business change or tax mitigation opportunities" (p.3)] will neglect the evolution of the TP environment, adopting an assurance-based approach can produce some positive outcomes for organizations (Robertson-Kellie & Mahalingham, 2006):

1. Reduced costs associated with TP audits,

2. Reduced chance of double taxation,

3. Greater control of the TP process in conjunction with overall internal control process reviews,

4. Increased expertise in indentifying TP opportunities for lower tax rates.

These outcomes present an opportunity for airlines to not only prevent leakage, but to ultimately add value to their organizations. Additionally, an assurance-based approach can assist in uncovering other strategic planning oversights and errors by carrying through the evolving plan to other areas of their business.

CONCLUSION

Primary Research Opportunities

Several primary research opportunities exist within the scope of TP and airline mergers, with the most obvious being additional attempts to locate TP issues within pending and rumored airline mergers. The most likely choice for further exploration would be various combinations between United Airlines, Continental Airlines, and American Airlines. Additional research opportunities exist with potential U.S. foreign mergers, particularly the most likely possible merger between British Airways, Iberia, and American Airlines.

Narrowing the scope of potential airline merger implications, primary research possibilities exist in the strategic management arena surrounding TP in airline mergers. One topic of particular interest would be primary research involving the level of understanding and conceptual TP strategic planning that occurs within airlines. A way of accomplishing this primary research would be to conduct and analyze an anonymous survey of airline employees and administration.

Opportunities for primary research also exist in the marketing arena. With a high level of value coming from intangibles, brand recognition and TP play an important role in international airline mergers. Primary research on the market power of airline logos and their valuation in the international arena would be a potential option.

A list of hypothesis that may be considered in future research include:

H1: International TP miscues exist within the rumored future merger between American Airlines, Iberian Airlines, and British Airways.

H2: Airlines are experiencing a significant value leakage by not actively pursuing a TP strategic plan.

H3: Airline executives do not have an adequate understanding of the implications of TP for the airline industry.

H4: Airlines are not adequately prepared for the TP issues that may arise from the use of intangibles by a subsidiary airline.

Merger Mania

Facing one of the most difficult economic environments the airlines have faced since deregulation, "merger mania" may be making a re-appearance with a vengeance. Faced with increased costs and decreased load factors, analysts predict that rampant merger rumors are likely to strike the U.S. airline market again with the most likely partners being seen as some combination of United Airlines, Continental Airlines, and American Airlines (Bukoveczky, 2009). However, the challenges the airline industry faces and the subsequent merger mania are not unique to the U.S. market. In fact, talks have been confirmed and rumored in most major travel markets, with the exception of the Asian market (which has thus far avoided the wave of consolidation). Among the top prospects include British Airways and Australia's Quantas (talks have been confirmed), British Airways and Iberia (seeking anti-trust), Austrian Airlines and German's Lufthansa (in the integration phase), Spain's ClickAir and Vueling (approved) and Air Jamaica, Trinidad's Caribbean Airlines, and Antiqua's LIAT (rumored). The domestic mergers present opportunities for airlines to increase efficiencies and reduce the oversaturated capacities that the industry currently faces.

However, "the real prize," Business Travel World says, "... is a [EU] deal with [a] major U.S. carrier," (Unknown, 2009a; p. 2). This presents not only opportunities for U.S. airlines, but challenges, as well, and TP issues remain one of the most challenging aspects of mergers and acquisitions. If the Open Skies treaty is amended to relax U.S. and E.U. ownership restrictions, provided they meet antitrust regulations, travelers can expect to see a wave of U.S.-International air carrier mergers, particularly with the legacy carriers who have established international routes and alliances.

TP within the scope of international airline mergers presents unique challenges. Not only does the merger present a complex environment for taxpayers, but the amplified amount of intangible assets steepens the challenges presented to airlines. Add to these factors the fact that TP audits have increased in scope and aggressiveness both at home and abroad, and U.S. airlines are faced with a uniquely demanding TP environment.

Additionally, airlines may be more likely to be struck with TP problems if one airline effectively acquires another airline, and both airlines continue to operate as separate business entities. Careful consideration of TP issues (particularly with intangibles) should be an active part of strategic planning.

TP not only presents a threat to the airlines if violations are discovered, but can also be a valuable cost-cutting tool. The environment airlines are currently facing requires the industry to seek efficiencies and cost cutting methods (the reason for the push for consolidation). Effective TP planning and execution presents an opportunity for airlines to make a significant impact on their bottom lines through tax liability reduction.

Ultimately, to thrive in such a demanding environment, airlines must stay abreast of TP practices, and most importantly, take an assurance-based approach to strategic TP planning. Value addition or leakage is dependent upon the ability of the airline to understand, execute, and document TP decisions and implications. This understanding, execution, and documentation can represent a significant opportunity or threat to an airline and should be carefully considered at all stages of the strategic planning process.

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Connie Rae Bateman, University of North Dakota

Ashley Droske Westphal, University of North Dakota