All questions
Overview
The United States' transfer pricing regime consists of a single statute in the Internal Revenue Code (Code) and a large body of implementing regulations. The transfer pricing regime applies broadly in the federal income tax context in both purely domestic and cross-border settings (i.e., the United States permits transfer pricing adjustments whether or not cross-border transactions are involved). In the event of a 'controlled' transaction, the US regime permits the US Internal Revenue Service (IRS) to allocate income, deductions, credits, basis or any other element that affects taxable income. US regulations define 'controlled' very broadly to include any kind of control, including control that is deemed to arise from the actions of two or more taxpayers acting in concert to shift income. There is no strict ownership or relationship test in order for the IRS to establish that a transaction is 'controlled' for purposes of applying the transfer pricing regime. The regime applies broadly to any person, organisation, or trade or business, whether or not they are subject to any internal revenue tax.
Though most transfer pricing audits in recent years have concerned cross-border tangible and intangible services and financial transactions between related corporations, the IRS has also historically applied the transfer pricing regime to transactions between shareholders and the corporations they own. Beyond the tax realm, whether transactions between a shareholder and a corporation are at arm's length is an issue to which US courts can look in deciding whether to pierce the corporate veil.
There are transfer pricing regulations that apply specifically to certain financial transactions (i.e., loans). There are also other rules that apply to financial transactions to limit interest deductions under certain circumstances. There are special (non-transfer pricing) rules that apply in the case of outbound transfers of intangible property to foreign corporations that would have otherwise qualified for non-recognition treatment under rules that provide for tax-free treatment under certain circumstances (e.g., in the case of a contribution of property to a controlled corporation in exchange for stock). Those rules cross-reference the transfer pricing rules.
The Organisation for Economic Cooperation and Development (OECD) transfer pricing guidelines are not incorporated in the US transfer pricing statute or regulations. In the domestic setting (i.e., outside the competent authority process under a treaty), the IRS and US courts are required to apply the US regulations, not the OECD guidelines. The IRS's position is that the US transfer pricing regulations are consistent with the OECD guidelines. While that position is subject to debate, it is certainly the case that the OECD guidelines have been modified over the past decade to bring them into closer alignment with principles already reflected in the US statute and transfer pricing regulations.
In theory, the accounting treatment of uncertain tax positions attributable to transfer pricing could present a major IRS audit risk. However, the IRS has exercised a policy of restraint in requesting work papers underlying the accounting treatment of uncertain tax positions. Taxpayers are required to file a certain schedule with their returns that lists material uncertain tax positions and contains a general description of the underlying issue. Although there is no penalty for failing to file such a form, many taxpayers file them nonetheless. Because a fair number of transfer pricing issues will inevitably appear on the form, the maintenance of a tax reserve for a large uncertain transfer pricing position is a factor that increases IRS audit risk.
Broader taxation issues
In 2017, Congress enacted the Tax Cuts and Jobs Act (TCJA), which included several provisions aimed at discouraging the shifting of profits to lower-tax jurisdictions. Specifically, the TCJA included the Base Erosion and Anti-Abuse Tax (BEAT), which many view as a type of diverted profits tax. The BEAT is intended to reduce the shifting of profits out of the US taxing jurisdiction by imposing an additional 5 per cent tax on certain payments made by corporations in the United States to related foreign recipients. The tax only applies to US corporations with more than $500 million in gross receipts and a base erosion percentage of 3 per cent or higher.
In addition, the TCJA added a tax on global intangible low-taxed income (GILTI) and another on foreign derived intangible income (FDII). The higher and lower tax rates of GILTI and FDII were designed to provide a disincentive and an incentive, respectively, to US corporations moving their assets and activities to lower-tax countries. GILTI applies to all US corporations with foreign subsidiaries, while FDII may potentially apply to any US corporation with foreign sales. All of these provisions can apply to the same taxpayer in the same tax year, and are, at least to some extent, intended to supplement the traditional transfer pricing rules.
The United States supports the introduction and implementation of the OECD's Pillars One and Two. That said, because different jurisdictions will take varying approaches in enacting top-up taxes under Pillar Two, the OECD/G20 Inclusive Framework recommendations are likely to result in a significant increase in double taxation, at least initially.
The goal of the foreign tax credit regime is to relieve the effects of more than one country taxing the same income. The IRS and Treasury recently issued new foreign tax credit regulations, however, that have caused concern among many taxpayers that it will be more difficult to claim a credit against their US tax liability for foreign taxes paid on the same income.
Taxpayers facing double taxation involving a treaty partner may seek relief through the mutual agreement process. Taxpayers can also apply for an advance pricing agreement, which may help avoid or relieve double taxation.
Outlook and conclusions
Transfer pricing remains a primary area of IRS enforcement focus. Large audits continue. Cases will continue to wind their way through the administrative process and litigation in the coming years. Taxpayers would be well advised to pay close attention to their intercompany transactions and pricing. They should view audits as potential preludes to litigation and proceed with caution and prudence. The TCJA and Pillars One and Two will further complicate matters. Taxpayers should also continue to look to utilise the mutual agreement process and advance pricing agreements to avoid double taxation when feasible and to monitor changes to the wider international taxation regime, both domestically and globally, to ensure that their behaviour is both tax efficient and in line with domestic and global norms.
