All companies with related party cross-border transactions should focus on transfer pricing issues and documentation, even those with what management would consider occasional or insignificant transactions. Many other countries around the globe are placing increased focus on transfer pricing laws, with most developed countries adopting and enforcing transfer pricing rules, including China, Russia, and Ireland.
The IRS’s new Uncertain Tax Positions form (Form UTP) requires certain taxpayers to report uncertain tax positions on their U.S. federal income tax returns. The schedule requires that transfer pricing positions be identified separately from general tax positions. This form will surely draw the IRS’s attention to taxpayers’ transfer pricing issues.
Transfer pricing has become a routine part of an IRS exam; multinational taxpayers can expect an Information Document Request (“IDR”) to be issued requesting the transfer pricing documentation. An IRS examination of a multinational company, regardless of size, can expect to have an international examiner and perhaps an economist involved on the IRS audit team. The IDR requesting transfer pricing documentation must be answered within 30 days of issuance. As part of the increased focus on international issues, the IRS has approval to add up to 700 more international examiners over the next few years.
If all of this hasn’t made you lose sleep, just remember, in addition to tax adjustments, substantial penalties can be assessed by the IRS for non-compliance with transfer pricing, at up to 40% of the adjustment amount (not merely the tax amount).
Technical Update - Cost-Sharing Arrangements (for R&D):
With the rise in globalization of businesses, we note that many of our clients are centralizing R&D activity, but sharing the results within the entire group, irrespective of jurisdiction. The IRS issued final regulations (along with temporary and proposed regulations) for cost-sharing arrangements on December 19, 2011. The IRS continues its scrutiny of cost-sharing arrangements (CSA) and we can expect some further significant litigation in this area. Two fairly recent cases continue to provide cloudiness in this area.
The U.S. Court of Appeals for the Ninth Circuit in the Xilinx case (3/22/10) reversed its earlier decision and held that stock-based compensation does not have to be included in the R&D cost base of companies entering into cost-sharing arrangements. This decision is in direct contrast to the current cost-sharing arrangement regulations, which require the sharing of the stock-based compensation. As a result of this opinion, it is likely that taxpayers will challenge the regulations that require such costs to be shared.
In the Veritas Software Corp. case (12/10/09), the taxpayer won a case involving cost-sharing buy-in payment when the Tax Court ruled the IRS’s adjustment of such payment was based on an arbitrary, capricious and unreasonable basis. The IRS, which did not file an appeal, did issue a statement of nonacquiesce in the result and reasoning of the opinion.
Looking to the future in the U.S., the President’s budget includes a proposal to tax currently “excess returns” associated with transfers of intangibles offshore and a proposal to clarify the fact that goodwill, going concern value, and workforce in place are intangibles under transfer pricing rules. The documentation of arm’s length pricing standards for intercompany transactions will continue to be an important subject (i.e. “target”) for Congress and the IRS going forward.
There has been some good news for taxpayers. In India, the Supreme Court reversed the prior ruling in the Vodafone case. In this case, the Indian tax authority tried to assert source-based taxation on the purchase of stock of an Indian company, even though the deal was structured and occurred outside of India. The judgment, if upheld, would have resulted in approximately $2 billion in additional taxes!
Schneider Downs & Co., Inc. can assist you in complying with transfer pricing issues, including analysis and documentation of transactions, and transfer pricing audits. When it comes to transfer pricing, an ounce of prevention is worth a pound of cure!
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