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?