Bruce Givner Taxation Law Blog on Lawyers.com

Transfer Pricing: Does The IRS Have Too Much Power

Monday, May 7, 2012 by Bruce Givner

The IRS wants to be sure that related parties
engage in transactions on terms that are similar to those that would be reached
between independent parties. Otherwise, the two related parties might
arrange their affairs so as to minimize income taxes. For example, a U.S.
parent corporation might pay a higher price to its Irish subsidiary corporation
because the Irish subsidiary corporation is subject to very low tax rates in
Ireland. So the deduction against the U.S. tax shifts wealth, within the
corporate structure, to the lower taxed subsidiary.

Due to that type of concern, the IRS is active in
what is referred to as “transfer pricing.” This involves situations where
2 related parties make a deal. The IRS highlights the primary difference
in the deals that controlled and uncontrolled parties make involve manipulating
the prices of the deal to find ways of structuring the deal to have less tax in
high tax jurisdictions.

Consider the example:

US Parent Company X, has a new product which it
expects will be a blockbuster. It wants to minimize the taxes that will
be imposed on future income from the product. Therefore, it sells the
patent and licenses it to one of its subsidiaries in a low tax jurisdiction,
Subsidiary Y. Subsidiary Y is able to sell this product at a high profit
and the profit will be kept in the low-tax jurisdiction, thus avoiding the
higher taxes that the Parent Company X would have to pay in the U.S.

However, IRS has virtually unlimited power, through
Code Section 482 and the related Treasury Regulation section 1.482, to adjust the incomes of both
controlled parties to make them more in-line with what they “should” have been.
The IRS would make Subsidiary Y pay the U.S. parent an amount
“commensurate with the income attributable to the intangible”. That would make
this kind of deal structuring much less favorable for both parties.

The authority granted to IRS under code section 482
is particularly troubling because the IRS has the benefit of hindsight and the
power to impose,
retroactively, new terms to the contract deal. The IRS looks back at the income
attributable to the deal and taxes the parties based on this income. The IRS uses
figures that “could” be off by as much as 20% up or down.

So when your company engages in transfer pricing
agreements with a related party, be aware that the IRS can restructure the deal
if not made under terms those that “uncontrolled” parties would make.

Before you engage in transfer pricing, consult the
expert tax attorneys at Givner & Kaye. We have over 35 years experience in
complex tax matters (310) 207-8008

Posted at 15:04 PM

Topic: Taxation