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.
Whistleblower Awards and Transfer Pricing
Under section 7623, whistleblowers who send information on tax underpayment or tax law violations are entitled to awards if the IRS “proceeds with” an administrative action and collects money “based on information” the whistleblower provided. The statute generally requires payment to a whistleblower of 15 to 30 percent of the IRS’s proceeds. But when the IRS has initiated an action and obtains additional facts through examination that are unrelated to the activities described in the whistleblower information, the portions of the audit relating to the other facts are not eligible for an award.
As far as whistleblowing goes, transfer pricing has been a ripe area of law for an opportunistic—or perhaps disgruntled—current or former employee to try to reap an award. This is because transfer pricing is governed by subjective rules that are applied to a complex set of facts that at times encompass the entire value chain of the world’s most dynamic and sophisticated multinational companies to try to find the “arm’s length result.” The arm’s-length result is one that is consistent with the results that would have been realized if unrelated taxpayers had engaged in the same transaction under the same circumstances. Thus, by definition, transfer pricing is subject to interpretation. As a result, reasonable minds can differ and reach different conclusions. This has made disputes over transfer pricing common, and they can lead to adjustments worth billions of dollars. Given that there are often no black-or-white answers when it comes to transfer pricing and they present an opportunity for an individual to grab up to 30-percent of a potential billion dollar pie, Villa-Arce is not the first, nor is it likely that it will be the last of these cases that we will see.
In the whistleblower complaint submitted to the IRS, Villa-Arce alleged that a company improperly claimed “head tax” deductions of $1,000 per employee per month from 2000 through 2015, and attached a list of 30 taxpayer account codes for general and administrative expenses. Villa-Arce then supplemented his claim, and alleged that the subject company also improperly paid greater than arm’s-length prices to its parent for information technology services. Based on the facts, it is unclear what Villa-Arce’s role was with respect to the company or how he obtained the whistleblower information that he submitted to the IRS. But given its nature, it almost certainly came from some type of insider access to the organization.
The IRS then opened an examination into the head-tax and transfer pricing issues. During the examination, the revenue agent also identified additional issues and expanded the investigation. The investigation lasted more than two years, and the revenue agent reported over 400 hours of work, which included site visits, communications with company representatives, the submission of document requests, and the review of documents. Ultimately, the revenue agent’s investigation lead to the IRS ordering tax adjustments on the amount of foreign tax credits the company claimed, as well as several categories of improper deductions, including advertising, cost of goods sold, depreciation, other deductions, and repairs and maintenance.
In a final report, the revenue agent claimed that Villa-Arce’s information did not contribute to the investigation of the issues that led to the adjustments and determined that Villa-Arce was not entitled to an award as a result. Both the Tax Court and the D.C. Circuit credited that report. In particular, the D.C. Circuit noted that the revenue agent conducted “substantial independent information gathering,” and agreed that the IRS has a right to treat a portion of an examination into unrelated tax issues as a separate administrative action that is not entitled to an award.
While transfer pricing may be a lucrative area for potential whistleblowers, the fact-intensive nature of it might prevent whistleblowers from ultimately collecting. This is because an examination into transfer pricing issues would almost certainly require further “substantial independent information gathering.” And so long as the final adjustments are based on facts that differ enough from the activities described by the whistleblower, the whistleblower could be denied an award.
That might be cold comfort to a company facing a transfer pricing audit as a result of a whistleblower. Even if the audit ends with no transfer pricing adjustment, it could lead to a massive diversion of resources for the tax department—or an adjustment on some unrelated issue. Accordingly, corporate taxpayers should be mindful of their data security related to transfer pricing, including the number and type of insiders that have access to potentially sensitive internal records and tax reporting information. Villa-Arce’s role with respect to the company is unknown, but he almost certainly had access to such information before (or while) submitting his whistleblower complaints, and perhaps more protective measures could have prevented him from doing so. Companies should consider segregating transfer pricing models, studies, and other related information. Companies may also want to consider additional IT measures, such as download tracking. Those measures might have saved the company in this case some headaches, time, and money.
 68 F.4th 1328 (May 26, 2023), aff’g Order and Decision, T.C. Docket No. 8485-20W, Index No. 24 (Oct. 14, 2021).
 The IRS provides that within that range the award amount “shall depend on the extent to which the individual substantially contributed to such action.” See Sec. 7623(b)(1).
 Treas. Reg. § 301.7623-2(b)(1), ex. 2.
 Indeed, as members of our firm have written about, disgruntled former employees have tried before. See B. Kittle, G. Collins, J. Reed, Vanguard: A Cautionary Tale For Whistleblowers, Law 360 (Dec. 7, 2015).
 Treas. Reg. § 1.482-1.