In ancient Rome, a college of “augurs” would predict the future by observing the flight patterns of birds, examining the entrails of animal sacrifices, or interpreting natural phenomena. While perhaps less colorful, our method of divination will hopefully be a little more precise. To develop this blog post, we have consulted our own augurs and have summarized all our predictions for transfer pricing developments in the coming year.
- More Enforcement Overall. Three factors may lead to significantly increased transfer pricing enforcement in 2022. One, the Biden administration’s Build Back Better proposal includes a sizeable increase in the IRS’s enforcement budget, and, to increase revenue, the proposal leans heavily on the IRS’s ability to collect more tax from large multinationals. Two, the IRS has recently managed to reverse the perception that it has not fared well in big-ticket transfer pricing litigation. Several notable wins in the US Tax Court and in other forums may renew the IRS’s desire to pursue complex transfer pricing cases. Three, the pandemic has continued to put taxpayers in uncharted territory when setting their transfer pricing (e.g., accounting for losses from the pandemic or supply-chain issues), which could lead to more ambiguity and, ultimately, more scrutiny by the IRS.
- More Transfer-Pricing Penalties. In 2018, the IRS issued a directive warning exam teams that “[f]ailure to apply penalties when appropriate has adverse consequences” in transfer pricing disputes. Although our observation is anecdotal, we have seen a greater willingness on the part of the IRS to assert transfer pricing penalties as a matter of course. For example, as we explained in a prior post, the IRS has asserted $340 million in transfer pricing penalties in the Western Digital case in the US Tax Court. We expect this trend to continue in 2022.
- Greater Use of Technology in Audit. At the height of the pandemic, the IRS stopped conducting in-person functional interviews and site visits. While audits have obviously resumed, the IRS has been using Zoom more effectively, and we expect that exam personnel will rely more heavily on technology to perform audits going forward.
- New Regulations. In September 2021, the Treasury Department and the IRS issued its Priority Guidance Plan for 2021–2022, which included potential section 482 regulations projects addressing group membership (e.g., passive association) in financial transactions, the best method rule, risk allocations and periodic adjustments. While inclusion on the Priority Guidance Plan does not guarantee that any such regulations will be issued in 2022, as we noted in a prior post, these regulations projects align with the OECD’s 2017 overhaul of its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, and reflect areas that are ripe for dispute. For these reasons, we expect there to be significant momentum behind these regulations projects and a significant likelihood that proposed and/or temporary regulations addressing at least some of these topics will be issued by the end of 2022.
- More Cross-Border Information Gathering. For a long time, tax treaties have made it possible for taxing authorities to gather information relevant to a transfer pricing dispute, even if it is located in another country. Recently, however, we have noticed a marked uptick in the number of times that foreign taxing authorities are relying on treaty requests and other cross-border information-gathering techniques to extract documents from multinationals. (See our prior post on this topic.) These cross-border document requests invariably lead to nettlesome legal questions (e.g., application of legal privilege). In 2022, we expect US-headquartered multinationals to need to field more such requests.
- Continued Improvement in APA and MAP Process. During the pandemic, the IRS Advance Pricing & Mutual Agreement (“APMA”) Program and its counterparts in treaty jurisdictions around the world embraced technology to conduct both taxpayer and Competent Authority meetings virtually, much like the way that the IRS has adopted technology in audits. This has led to a more efficient process, unhampered by the limitations inherent in the pre-pandemic norm of negotiating case resolution primarily through periodic (but sometimes infrequent) in-person meetings. Indeed, available published statistics confirm that APMA has continued to resolve both APA and MAP cases efficiently during the pandemic. We would expect these trends to continue in 2022, with technology playing a pivotal role in efficient case processing even as some in-person meetings resume. We also expect demand for APAs and MAPs to remain high in 2022 (perhaps higher than ever), fueled by increased enforcement activities in the United States and globally and the uncertainty of the ever-changing international tax landscape.
- ICAP Comes of Age. In February 2021, the OECD officially rolled out its International Compliance Assurance Programme (“ICAP”), which was previously launched as a pilot program in 2018. (See our prior post on this topic.) ICAP seeks to provide multinationals with “comfort and assurance” from multiple tax administrations on transfer pricing and other international tax issues. The submission period to apply for the first ICAP cycle closed September 30, 2021, but multinational enterprises have additional opportunities to apply for ICAP in the upcoming cycles for which submission periods close March 31, 2022 and September 30, 2022. We expect interest among multinationals in ICAP to grow in 2022 in light of reports of positive experience with ICAP and the ability of ICAP to provide a high level of comfort (albeit not binding certainty) from more tax administrations and in less time than the APA and MAP processes.
- Pillar One Implementation Marches Ahead. In October 2021, the G20 formally endorsed the political agreement reached by 136 countries of the OECD/G20 Inclusive Framework on Base Erosion and Profit Shifting (IF) on a two-pillar framework to dramatically change the taxation of multinational enterprises (MNEs). While there are many unknowns, in 2022 we will likely see substantial progress toward implementing the agreement through proposed domestic legislation in many countries and the negotiation of a multilateral instrument with the objective of bringing the new rules into effect in 2023. As relevant to transfer pricing, we will likely see greater clarity on exactly how “Amount A” (a new formulary taxing right that reallocates profits of the world’s largest and most profitable MNEs) will interact with the arm’s length standard in practice, as well as detailed guidance on “Amount B,” a new safe harbor for compensating baseline marketing and distribution activities.
- Remote Work Will Continue to Pose Challenges. Early in the pandemic, the OECD and several countries issued guidance providing that, in certain circumstances, remote working would not create unintended permanent establishments. We described this guidance in a prior post. As COVID shifts from a temporary emergency into an ongoing reality, though, remote working has become a permanent or semi-permanent development for many companies. We therefore expect that similar permanent establishment issues will continue to crop up for companies in 2022.