If your business operations cross outside U.S. borders (or, are planning to do so), it’s always the right time to consider transfer pricing. It is critical to ensure that your business has the right strategy in place where profits in each tax jurisdiction align with that entity’s relative contribution to the global business. Transfer pricing scrutiny has been increasing around the globe, so a consistent global strategy that reflects the economic substance of your business is the best way to stay off the radar of the world’s tax authorities. The signing of the Inflation Reduction Act is a clear indication in the U.S. that the IRS will continue to be focused on transfer pricing scrutiny, among other increasing enforcement activities.
On August 16, 2022, President Biden signed into law the Inflation Reduction Act of 2022 allocating approximately $80 billion, in addition to its regular appropriations, to the IRS through September 30, 2031. This includes approximately $45.6 billion for enforcement, $25.3 billion for operations support, $4.8 billion for technology modernization, and $3.2 billion for taxpayer services. The Congressional Budget Office estimates the IRS will raise $203 billion in additional revenue through 2031 as a direct result of this additional funding.
Nearly 60% of the $80 billion is allocated towards IRS enforcement activities which include but are not limited to, determination and collection of unpaid taxes, legal and litigation support, criminal investigations (including funding for investigative technology), and enforcement of criminal statutes to violations of internal revenue laws and other financial crimes. However, IRS Commissioner Retting recently reinforced that the objective behind these provisions is to target wealthy corporations and high net-worth individuals who avoid paying taxes while directing the IRS not to use the additional funding to increase audits on small businesses or households making under $400,000 annually.
This additional funding for the IRS is expected to increase its scrutiny of the intercompany arrangements of large multinational companies operating in the U.S. Taxpayers should ensure that their transfer pricing documentation is compliant with Section 482 of the Internal Revenue Code and that affiliated entities are operating consistent with arm’s length, or market rate principles. Taxpayers should also consider following the ‘substance over form’ doctrine and avoid indefinite accrual of intercompany revenue/expenses. Remember, transfer pricing is not just about the transfer of products/tangible goods but also includes accounting for services, intercompany financing, intangible valuation and their license, and cost allocations, amongst other things.
While it is yet to be seen how the IRS will go about selecting the corporations for potential new transfer pricing audits, we believe all taxpayers with global businesses need to be prepared. It will likely be similar to audit selection before the increased funding, a combination of larger multinational enterprises along with middle market businesses that are less resource-intensive to audit. Unlike other jurisdictions, there is no magnitude threshold to trigger transfer pricing compliance in the U.S., so all businesses involved in cross-border activities should anticipate scrutiny. Taxpayers need to be proactive in their compliance, ensuring transfer pricing compliance is prepared annually, and that the contemporaneous documentation study aligns with the intercompany legal agreements and the substance of the accounting/financials. For more information, see the article 5 Ways to be Proactive and Prepared for Transfer Pricing Audits.
This may also be a great time to revisit the overall transfer pricing strategy of the business to ensure it is still the optimal structure for the company and to potentially gain more certainty in the increasing audit landscape by exploring prospective options with the IRS such as Advance Pricing Agreements (APA) and Mutual Agreement Procedures (MAP). Transfer pricing is typically the largest tax uncertainty for multinational corporations, so any certainty that can be gained in this area will decrease the risk of adjustment under audit.
If you want to ensure your company’s intercompany arrangements are tax compliant, Withum’s dedicated transfer pricing professionals would be happy to assist you. Withum can create critical transfer pricing documentation to support the economic substance of the transactions and ensure the results are consistent with the arm’s length standard of worldwide tax regulations.