Australian multinational enterprises warned ahead of US transfer pricing crackdown
Baker McKenzie experts have warned Australian multinational enterprises to prepare for increased IRS transfer pricing scrutiny.
Increased funding and new organisational priorities suggest that Australian multinational enterprises (MNEs) with US operations need to ensure their transfer pricing is compliant.
“Although US tax obligations pertaining to transfer pricing have not changed, the US tax environment is no longer the same,” wrote Baker McKenzie principal economist Gene Tien and partner John Walker in a recent article.
“If your US subsidiary has not already received a notice, it’s most likely simply a matter of time until one arrives,” they said, adding that even those MNEs who regularly produce transfer pricing documentation could be affected by the IRS’ changing priorities.
In the past, the IRS has used a “light touch” when it comes to transfer pricing audits. Now, the landscape for US-inbound multinationals is changing.
In the decade leading to 2021, the watchdog was asked to do more with less. Over the decade, its enforcement and support resources were cut by 20 per cent, while it was required to process seven per cent more tax returns.
So stretched, the agency “reduced the number of audits, deprioritized transfer pricing examinations,” and instead prioritised other activities.
Under the Inflation Reduction Act of 2022, however, the IRS has been promised a funding boost to the tune of tens of billions of dollars.
In late 2023, armed with broader resources and newer technologies, the agency shared news of its first transfer pricing initiative of large, US-inbound MNEs.
In language that will sound familiar to Australian taxpayers, the IRS said it would increase its compliance efforts to capture those who “do not pay their fair share of tax on the profit they earn on their US activity.”
“These foreign companies report losses or exceedingly low margins year after year through the improper use of transfer pricing,” it added.
At the time, it said it would begin its crackdown by sending compliance alerts to 150 subsidiaries of foreign corporations to “reiterate their US tax obligations and incentivise self-correction.”
In February this year, it expanded this pool to 180 subsidiaries.
While these alerts do not rise to the level of an audit, they can be construed as something approximating a notice for risk assessment or pre-audit, said Tien and Walker.
Since 2011, the IRS has been more selective in deciding which transfer pricing audits it will advance to litigation. According to Tien and Walker, its 2020 victory against Coca-Cola highlights the agency’s stricter enforcement approach.
Notably, the decision suggested that the IRS will apply the arm’s length standard where intercompany agreements lack clarity. That they chose to apply a method agreed upon for a closing agreement did not imply that the agreement was arm’s length.
That case concerned the transfer pricing of intangible property but has “much broader implications to all US taxpayers,” they said.
Since the Tax Court handed down that ruling, the IRS has called into question the legal structures of many similar arrangements and their economic substance.
“With only one transfer pricing initiative aimed directly at US subsidiaries of inbound multinationals, it is not difficult to predict where the IRS will focus its compliance efforts as it relates to these transfer pricing cases,” said Tien and Walker.
To avoid being targeted, MNEs reporting losses or lower than typical returns in the US should consider applying transfer pricing adjustments to increase their US taxable income.
