Overview
Thanks to approximately $80 billion in additional funding for the IRS, allocated under the Inflation Reduction Act (IRA) that passed in October 2022, the IRS has increased transfer pricing scrutiny through the “large foreign-owned corporations transfer pricing initiative.”
The IRS is currently reviewing the U.S. tax returns of U.S. foreign-owned corporations to identify companies that have transactions with foreign-related parties and report losses or low profit margins year after year, which, in the eyes of the IRS, may be the result of improper transfer pricing implemented to avoid paying U.S. tax. The idea here is for the IRS to determine if the taxpayer complies with Internal Revenue Code (IRC) Section 482 or to uncover an inappropriate shift of profits elsewhere.
Specifics
The IRS is reviewing the U.S. income tax returns of companies of all sizes, not just large corporations, to determine if the company has reported losses or low profit margins, specifically as it relates to its intercompany transactions (please note that the IRS looks back several years, not just the most recent year). Specifically, the IRS reviews Form 5472, where intercompany transactions of foreign-owned companies are presented.
If the IRS suspects the taxpayer’s transfer pricing is not in line with §482, the IRS will send a notice to the taxpayer (Letter 6607) to reiterate the company’s U.S. tax obligations and incentivize self-correction through the filing of amended returns. To date, the IRS has already sent alerts to approximately 180 companies asking them to prove that their low margins or losses were not due to transfer pricing issues. In other words, the IRS will ask for a company’s transfer pricing documentation study that shows that their intercompany transactions have been priced at arm’s length. The IRS will give the taxpayer up to 30 days to produce such a study.
There is nothing to say that the IRS will stop here. The IRS may also start looking at other tax forms related to international and intercompany dealings, such as 5471, 8858, and 8865, to expand its scope. As such, companies filing any of these forms may also be at risk of additional IRS scrutiny.
What Should You Do?
The IRS’ investment of additional resources into enforcing the U.S. transfer pricing regulations should serve as a reminder for multinational corporations of the importance of complying with the arm’s length standard and preparing yearly transfer pricing documentation studies.
While not a legal requirement in the U.S., taxpayers should consider preparing an annual transfer pricing documentation study that supports the arm’s length nature of their intercompany transactions, especially in situations where profits are low or there are losses. The transfer pricing documentation study is the first line of defense in the case of a transfer pricing audit (and if the taxpayer receives a Letter 6607, the IRS will request such a study).
In addition, if all documentation requirements are met under IRC §6662 (penalty guidance), the study may also protect against any penalties that may be imposed in the case of a transfer pricing adjustment. Those penalties can reach up to 40% of the transfer pricing adjustment. Critically, to meet the requirements under IRC §6662, the U.S. transfer pricing documentation study must be substantially complete by the filing date of the annual U.S. income tax return. However, even transfer pricing documentation prepared after the fact can help to bolster a taxpayer’s evidence that their intercompany transactions were conducted at arm’s length and reduce the chances of adjustments in the first place.
Besides documenting year-end results of intercompany transactions, taxpayers also should consider reviewing the pricing of their intercompany transactions annually to ensure that the pricing will comply with the arm’s length standard, i.e., produce arm’s length results. If such intercompany pricing results in low margins or losses, the taxpayer should consider calculating transfer pricing adjustments on intercompany transactions prior to the closing of the books for the year. This will allow the taxpayer the opportunity to correct the pricing before the books are closed and the study or tax return is prepared/filed.
How Can Forvis Mazars Assist?
The IRS’ increased scrutiny of transfer pricing should serve as a reminder of the importance of preparing and maintaining annual transfer pricing documentation. The Transfer Pricing team at Forvis Mazars can help taxpayers proactively ensure adherence to the arm’s length standard and identify and correct intercompany pricing that is not compliant. If you received Letter 6607 from the IRS, or if you suspect you may need help in reviewing your transfer pricing, our team is happy to help. Our transfer pricing services include the following:
- Planning projects, i.e., setting up transfer pricing policies
- Benchmarking appropriate returns for various types of transactions (tangible goods, intangibles, services, financial services, etc.)
- Calculating transfer pricing adjustments
- Preparing transfer pricing studies for U.S. purposes as well as other countries (OECD Local Files and Master Files)
- Assisting in audit defense
If you have questions or would like to engage a professional to learn more about transfer pricing considerations, contact our Transfer Pricing team at Forvis Mazars.