The IRS has made it clear once again that transfer pricing remains a key focus in its ongoing enforcement efforts. And with significant additional resources to do so over the next decade, the IRS is likely to focus some of these resources on taxpayers who have not undergone a transfer pricing audit in recent years or, perhaps, ever. For example, while the IRS is onboarding the many new transfer pricing experts it hired in 2023, it has sent compliance alerts to certain U.S. subsidiaries of foreign corporations that distribute goods in the U.S. where the IRS thinks that these subsidiaries are not paying their fair share of tax on the profit they earn on their U.S. activity. Taxpayers would be wise to take this time to prepare for an audit by reviewing their material intercompany transactions and undertaking a transfer pricing risk assessment.Continue Reading Transfer Pricing Audits: What Taxpayers Can Do to Prepare
On January 29, 2024, the OECD released the results and statistics for its growing International Compliance Assurance Program (“ICAP”). The data spans the life of the ICAP program, dating back to the first pilot program that began in January 2018, through its full program operations as of October 2023. In all, the statistics generally suggest that the program has been efficient and productive, with most participants receiving mostly low-risk outcomes from tax administrations.Continue Reading ICAP: Life in the Fast Lane
“Implicit support” comes charging out of the gates as an early candidate for Word or Phrase of the Year for 2024.
Before year’s end, the IRS Office of Chief Counsel dropped a new generic legal advice memorandum (“GLAM”), AM 2023-008, titled “Effect of Group Membership on Financial Transactions under Section 482 and Treas. Reg. § 1.482-2(a).” The GLAM visits some familiar territory, including the “realistic alternatives” principle, this time in the intracompany lending context.
Tax authorities and taxpayers, of course, each have incentives to police the arm’s length nature of interest paid (and deducted) to related parties. The section 482 regulations related to loans or advances say that in evaluating the interest rate, all relevant factors, “including…the credit standing of the borrower,” should be considered. Treas. Reg. § 1.482-2(a)(2)(i).
The GLAM describes what it asserts — without support — is the process by which credit rating agencies issue ratings, then concludes that the factors that inform the borrower’s rating include “the borrower’s role, level of integration within the group, and implicit support from affiliates” and therefore also inform the interest rate. For this purpose, the GLAM defines “implicit support” as the possibility that the borrower would obtain financial support from related parties even absent a legal obligation such as a written guarantee. GLAM at 2. Based on this review, the GLAM concludes that under Treas. Reg. § 1.482-2(a) it would not be appropriate to set an intracompany interest rate based exclusively on the credit rating of the borrower as an independent entity (i.e., without considering the group credit profile).
The GLAM also suggests that other areas of section 482 and its regulations further support the IRS’s position. First, it cites the realistic alternatives principle, which was codified in section 482 by the Tax Cuts and Jobs Act (Pub. L. No. 115-97), but which has been part of the section 482 regulations since 1993. See Treas. Reg. § 1.482-1(f)(2)(ii)(A); 58 Fed. Reg. 5253, 5266, 5275 (Jan. 21, 1993). In short, the realistic alternatives principle says that, unless the transaction as structured lacks economic substance, the IRS will not recast the transaction into a different form. It may, however, consider the alternatives realistically available to the taxpayer in evaluating whether the terms would be acceptable at arm’s length. Id. The GLAM says that in the financing context, the borrower’s financing options are informed by its credit rating, “which in turn may be affected by the entity’s standalone credit profile, the corporate group’s group credit profile, and implicit support available to the entity from the group.” GLAM at 4. The GLAM concludes that the borrower would never accept an interest rate greater than the rate it could borrow from in the market.
Second, the GLAM further asserts that transfer pricing regulations specifically for services transactions support its conclusion. In particular, Treas. Reg. § 1.482-9 says that no compensation is owed for any benefit arising solely from “passive association” in a corporate group. But the GLAM fails to explain whether implicit support is consistent with passive association or whether those regulations are even applicable to financial transactions. That said, the GLAM appears to conclude if a borrower gets some benefit from being part of a larger organization, then absent a written guarantee, it gets to keep the economic value of that benefit and should not have to pay it over to another group member in the form of a higher interest rate (or other imputed transaction).
IRS GLAMs, of course, are not binding authority and are not issued in a manner that complies with the Administrative Procedure Act. For the last couple years, however, the Transfer Pricing section of the IRS’s annual Priority Guidance Plan has mentioned “Regulations under §482 clarifying the effects of group membership (e.g., passive association) in determining arm’s length pricing, including specifically with respect to financial transaction.” Time will tell whether the positions taken in this new GLAM are echoed in these contemplated future regulatory efforts. In the meantime, we expect to see the IRS affirmatively use the GLAM against taxpayers, despite its flawed analysis and conclusions.
In a recent case, Villa-Arce v. Commissioner, a whistleblower sent information to the IRS that he believed showed that the company was using improper transfer pricing practices and taking unjustified deductions. The IRS opened an examination that resulted in other adjustments, but none based on the information from the whistleblower. For that key reason, the D.C. Circuit affirmed the Tax Court decision that the whistleblower was not entitled to an award for the collection of proceeds from the unrelated adjustments. Yet while the whistleblower walked away empty-handed, the case illustrates a unique type of transfer pricing and audit risk that comes from whistleblowers that companies should recognize. And given the indefinite nature of transfer pricing and the potential amount of dollars at stake, we will likely see more whistleblower actions involving transfer pricing.Continue Reading Blowing the Whistle on Transfer Pricing
Last week, the IRS released a mysterious new audit “campaign” that may implicate – inadvertently or otherwise – transfer pricing practices. The campaign, which was announced on August 8, is simply entitled “Inflated Cost of Goods Sold.”
The only glimmer of explanation the IRS gives as to what exactly this is all about is the brief statement that the campaign “focuses on LB&I taxpayers that have indications of inflated Cost of Goods Sold to reduce taxable income.”
But this tells us very little. Absent book-tax differences (e.g., FIFO/LIFO materials inventory conventions), an increase in COGS will always decrease taxable income. This is hardly revelatory. Two old IRS practice units from 2014 (“Purchase of Tangible Goods from Foreign Parent – CUP Method” and “Sale of Tangible Goods from a CFC to USP – CUP Method”) recognize the truism that increasing COGS reduces taxable income. So what? What facets of COGS gives the IRS concern? Direct Labor? Overhead? Standard Material Costs? Variances?Continue Reading Compliance Campaign: COGS Cops Coming
In a recent case, the IRS sued a corporate taxpayer in district court for supposedly unpaid taxes—without issuing a notice of deficiency first. The taxpayer claimed that this move was improper, but the district court sided with the IRS. In an opinion issued in June, the court held that the deficiency process is essentially optional for the IRS.Continue Reading Liberty Global and the Burden of Proof
In Moore v. U.S., Mr. and Mrs. Moore challenge the constitutionality of the transition tax under § 965. The Moores ask the Supreme Court to reaffirm a realization requirement for income taxable under the Sixteenth Amendment. The Moores argue that this realization requirement applies to § 965 and that §965, as a tax on unrealized gain, is unconstitutional. In contrast, the government argues that the transition tax is a permissible extension of tax regimes like Subpart F that already tax undistributed corporate earnings. (See our recent client alert on the case generally.)
A ruling on the realization requirement bears on whether Pillar Two might be constitutional in the United States. Specifically, a ruling that § 965 does not comply with a realization requirement, if not suitably cabined, could imperil the ability of the U.S. to implement Pillar Two legally, because Pillar Two might be viewed as similarly not complying with the realization requirement.Continue Reading Moore and Pillar Two: Possible Interactions
Today, the Supreme Court decided to hear a case that could have wide-ranging implications on US taxation of income earned abroad. The case challenges a key international provision in the Tax Cuts and Jobs Act: the Section 965 transition tax. The case has attracted attention (including multiple Wall Street Journal writeups) for its potential impact on Biden’s proposal to impose a wealth tax on high-income Americans. But the case is also of interest to the corporate tax community.Continue Reading Moore Money, Moore Problems
Mayer Brown announced today that Sonal Majmudar, former international tax counsel with the Internal Revenue Service (IRS), joined its Tax practice as a partner. Sonal will be resident in the firm’s Washington DC office. Her arrival bolsters Mayer Brown’s market-leading, global tax offerings, particularly with regard to transfer pricing controversies and high-stakes international disputes.
On April 25, 2023, the IRS’s Advance Pricing and Mutual Agreement (“APMA”) Program issued new interim guidance for its review of taxpayer Advance Pricing Agreement (“APA”) requests. Notably, the guidance introduces an “optional pre-submission review” for taxpayers that wish to submit a prefiling memorandum before submitting a formal APA request. Based on the pre-submission review, APMA will give a preliminary opinion whether it believes that an APA is well-suited to achieve tax certainty for the proposed covered transactions. The new interim guidance also instructs APMA personnel on how to review formal taxpayer APA requests for acceptance to the program, or whether to suggest an “alternative workstream” such as the International Compliance Assurance Program (“ICAP”) or a joint audit.Continue Reading APMA’s New Interim APA Guidance