Coordinated IRS campaign keeps close watch on US subsidiaries

Transfer pricing specialists from CLA Global member firm DHPG examines why US subsidiaries are coming under greater scrutiny for their transfer pricing policies.

In the ever-changing field of international corporate taxation, the transfer pricing policies of US subsidiaries of foreign corporations are being closely watched. Much of this is being driven by the Inflation Reduction Act (IRA), which is giving the US Internal Revenue Service (IRS) greater financial resources to invest in monitoring and enforcing tax regulations for complex partnerships, large companies and high-income and wealthy individuals.

Specifically, the IRS cautioned in September 2023 that, following a top to bottom review of enforcement efforts, greater attention will now be directed towards US subsidiaries of foreign companies. This is to ensure compliance with tax obligations, particularly adherence to Transfer Pricing Regulations.

Compliance alert letters issued

Using AI, the IRS initially identified potential non-compliance cases involving predominantly partnerships and issued approximately 150 letters earlier this year. Corporations that received a letter 6608 – mostly corporations that distribute goods in the US – are being asked to explain potential discrepancies in the amounts reported year-on-year, specifically intercompany transactions with reported losses or low profit margins between 2017 and 2021 that may not comply with IRC Section 482.

Urging US subsidiaries to review their transfer pricing policies and amend their tax returns as they deem appropriate, the IRS advises recipients of a letter 6608 that Section 482 of the Internal Revenue Code authorizes it to adjust income, deductions and credits of affiliated corporations to prevent tax evasion.

These letters send a clear signal that the IRS will be paying increased attention to transfer pricing issues in the future.

Reviewing the implications

Transfer pricing refers to a set of rules and methods for pricing intercompany transactions between companies that are related through ownership or management relationships. If transfer pricing regulations are applied incorrectly, group profits could potentially be shifted to different jurisdictions.

The non-compliant application of transfer pricing rules can consequently have a significant impact on where and to what extent the profits of a corporate group are taxed. This campaign by the IRS focuses on US subsidiaries of foreign companies that operate in the US but do not, in their opinion, adequately fulfil their tax obligations. Losses or reported low profit margins are considered indicative of possible irregularities that could require further investigation.

Navigating this additional attention

Given this more rigorous focus by the IRS on transfer pricing issues, international mid-sized groups with a presence in the US are advised to take proactive steps to prepare for an audit by evaluating their transfer pricing policies and intercompany agreements. To ensure compliance, it is advisable that companies:

• Prepare proper documentation: it is critical to maintain detailed and comprehensive documentation of all intercompany transactions, and the pricing methodologies applied to them. In the event of a tax audit, this documentation serves as decisive proof of the correct application of and compliance with transfer pricing regulations.
• Review and update applicable transfer pricing guidelines: These transfer pricing rules and standards are closely linked to business and general economic conditions. It is therefore important to regularly review and adjust applicable transfer pricing policies to ensure that they reflect current economic conditions.
• Plan for possible tax audits: Even if not issued a letter 6608, given the likely increase in tax audits going forward, corporate groups are advised to plan ahead and regularly review transfer pricing policies and intercompany agreements, making the appropriate adjustments.

Seek support

CLA Global member firms are well-placed to offer transfer pricing guidance to multinational corporations with US subsidiaries. This multi-national support may prove invaluable given that interest by the IRS is expected to ramp up further.

Recipients of a letter 6608 should follow the instructions carefully. Note that 6608 is a voluntary compliance letter. Receiving one is indicative that the IRS is monitoring tax filings and provides corporations with a prompt to review their records.

The IRS confirms this by stating: This isn't an audit of your tax return or of your failure to file one. This inquiry doesn't constitute an examination under Internal Revenue Code Section 7605(b) or a contact regarding an examination under Treasury Regulation 1.6664-2(c)(3)(i)(A) for purposes of defining a qualified amended return.

For further information

Benno Lange
Senior Partner
dhpg
https://www.dhpg.de/en/company/team/detail/benno-lange

Nadine Sinderhauf
Partner
dhpg
https://www.dhpg.de/en/company/team/detail/nadine-sinderhauf

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