Multinational enterprises have become a frequent target of tax authorities seeking to limit the use of transfer pricing strategies to reduce taxable income. It’s no wonder corporate tax executives consistently name transfer pricing a top tax concern and work with outside advisors to update transfer pricing strategies and identify possible risks.
The six reasons listed below explain why transfer pricing remains a top concern for multinationals.
Prevalence of transfer pricing
Transfer pricing controls the tax treatment of cross-border transactions between related parties. According to U.S. Census Bureau statistics, 42.6% ($1.6 trillion) of total U.S. imports and exports were between related parties in 2020. Each of these transactions involve transfer pricing. The actual scale of transfer pricing is even higher because the Census Bureau data does not include intercompany services, loans and intangibles payments.
Transfer pricing has been the subject of the largest tax disputes in U.S. Tax Court history. In 2006, the IRS settled with GlaxoSmithKline for $3.4 billion in additional tax, penalties and interest in a transfer pricing dispute — the largest single payment made to resolve a tax dispute. Over the years, companies have had success against the IRS in transfer pricing disputes. Recently, the IRS prevailed over Coca-Cola Co. in Tax Court regarding amounts charged to foreign affiliates in connection with their intercompany licensing agreements. The decision produced an additional tax liability of $3.3 billion. The taxpayer is expected to appeal.
Breadth of exposure
A transfer pricing issue can be initiated by any affected country. In most cases, only two countries are affected, but some royalty arrangements or headquarters cost allocations can affect multiple countries. Further, the number of countries that enforce transfer pricing rules has risen dramatically over the last three decades to more than 70 countries.
Section 6662(e) and (h) impose 20% and 40% penalties for transfer pricing valuation misstatements. A carve-out is available for transactions where the taxpayer reasonably relied on a transfer pricing approach. Other countries have also established penalty regimes for transfer pricing — some even more severe than U.S. rules.
Complicated and expensive dispute resolution
The cross-border nature and the operational aspect of transfer pricing issues create complications not encountered with other tax issues. The processes to resolve transfer pricing between countries are complex and expensive due to the size and ambiguity of transfer pricing issues, as well as the need to satisfy laws in at least two countries.
Even after resolving transfer pricing issues, the processes required to amend tax returns are complicated and expensive. Once the IRS, the other country involved and the taxpayer agree on transfer pricing adjustments, the taxpayer must file amended returns reflecting those adjustments for each affected year in each country. Since a change in federal taxable income generally affects the state tax base, amended state tax returns are also likely. Finally, companies that use transfer pricing analysis to value goods for customs purposes may need to make a revised customs filing.
Financial and tax reporting
Financial reporting rules under ASC 740 require companies to identify and report on the financial statement certain uncertain tax positions (UTPs) over a minimum recognition threshold. Given the size of transfer pricing issues and the IRS scrutiny of transfer pricing transactions, transfer pricing has become one of the most significant UTPs. The IRS requires similar reporting for corporations on Schedule UTP (Form 1120).
Transfer pricing issues will continue to command attention from corporate tax executives due to the size, complexity, and subjectivity of transfer pricing determinations, the involvement of multiple countries in the dispute, and the harsh penalties and reporting requirements.
International tax insights you need to know
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