On January 31, 2017, the Internal Revenue Service (“IRS”) Large Business and International Division (“LB&I”) announced the identification and selection of 13 campaigns that will be the focus of the agency’s enforcement efforts. These campaigns were identified through extensive data analysis by LB&I, suggestions from IRS compliance employees and feedback from the tax community. LB&I’s goal is to improve return selection, identify issues representing risk of non-compliance and make the greatest use of limited resources.
It should come as no surprise that two of the identified campaigns, the Related Party Transaction Campaign and the Inbound Distributor Campaign, focus on cross-border controlled transactions. Below are IRS’ stated purposes and goals for these campaigns:
- Related Party Transactions Campaign: “This campaign focuses on transactions between commonly controlled entities that provide taxpayers a means to transfer funds from the corporation to related pass through entities or shareholders. LB&I is allocating resources to this issue to determine the level of compliance in related party transactions of taxpayers in the mid-market segment. The treatment stream for this campaign is issue-based examinations.”
- Inbound Distributor Campaign: “U.S. distributors of goods sourced from foreign-related parties have incurred losses or small profits on U.S. returns which are not commensurate with the functions performed and risks assumed. In many cases, the U.S. taxpayer would be entitled to higher returns in arm’s-length transactions. LB&I has developed a comprehensive training strategy for this campaign that will aid revenue agents as they examine this IRC Section 482 issue. The treatment stream for this campaign will be issue-based examinations.”
These statements leave no doubt as to whether IRS believes mid-market companies have an enhanced likelihood of being non-compliant in their pricing of controlled transactions, especially mid-market companies that function as inbound distributors. While it is possible that taxpayers fitting this profile do indeed maintain an increased risk profile, one cannot help but wonder if inbound distributors are being targeted simply because IRS can (and has) standardized the process field agents can follow to evaluate whether transactions common to an inbound distributor are priced appropriately (e.g., purchase of tangible goods, receipt of support services). Whatever the reason may be, in this time of heightened focus by IRS on transfer pricing it is critical that taxpayers confirm that their existing transfer pricing policies remain reasonable and cover all transfers of value between entities of a controlled group. From a risk management perspective, ensuring that intercompany transactions among entities in a given group are priced appropriately (i.e., at arm’s length) and that such pricing has been adequately documented is simply a “must-do” in today’s regulatory environment.