For companies with operations in the United States, there are new developments in the area of US taxation that you should know about.
The US federal tax collectors, the Internal Revenue Service (IRS), have focused on what they believe to be the massive under-reporting of profits in the US by multinational corporations with separate operations in the US and other countries. They believe that these multinationals are allocating billions of dollars of profits away from US collection by adjusting prices when they transfer goods between their affiliates in such a way as to short-change the US taxing authorities. A multinational company which hasn't planned carefully how to deal with this newly modified US tax law can find itself subject to very large US tax payment adjustments and 20 or 40 per cent penalties for under-reporting. In addition, if the company has not considered its position carefully from a customs, anti-dumping and antitrust standpoint as well as a tax standpoint, it can bring further substantial problems upon itself.
New Tools To Fight Under-Reporting
The IRS' way of trying to discover and recover the tax on these profits for the US is by proceeding under newly revised penalty legislation and intercompany pricing regulations adopted under section 482 of the US Internal Revenue Code. This legislation is designed to enable the IRS to obtain reallocation of revenues and expenses between corporations and their US and non-US subsidiaries.
These rules require the use of certain specified methods of establishing intercompany accounts for reporting taxes. The regulations also require the preparation of proper documentation for the method selected. Furthermore, this documentation must be completed by the time of filing of the company's US tax return.
While the documentation for the method selected must be available for IRS review, a company working with its outside attorneys and with experts retained by them can very likely keep confidential strategic analysis of the potentially very different alternative methods under consideration before a final choice of method is made. This confidentiality is possible under the privilege which applies between a client and its attorney and under the privilege which applies to attorney work product.
The techniques for achieving this confidentiality include having the law firm itself retain separate experts for the strategic analysis work and using experts' input in their legal analysis. Under this technique, one expert is used by the law firm for the strategic planning and legal advice; the second is used for implementation of the chosen plan and preparing the documentation supporting the selected method, for disclosure to the IRS, if required. The key point is that using outside counsel early one can assist in the best choice of method and in preserving confidentiality of the strategic analysis of alternative methods, including especially the disadvantages of those alternative methods to the company.
Selection of Comparables
Part of the process of choosing and supporting a best method calculation of the transfer price involves the selection of so-called comparables; prices charged by independent sellers to independent purchasers of a product comparable to the product transferred intra-company. These comparables are used to help establish the appropriate transfer price for the intra-company transfers. Here also, the use of outside attorneys can be very helpful to avoid possible antitrust questions which might arise if the company were to attempt itself to gather comparable current or recent-past price information from its competitors.
Likewise, coordination of customs and transfer pricing reporting can save large sums by avoiding situations in which, for example, an attempt to set transfer prices in a way to minimize customs duties may create a much larger disadvantage for the company on the tax side. Similar coordination on the anti-dumping side is important in situations where dumping issues can arise.
In short, a carefully planned and coordinated policy on the multinational corporation's part to deal with these new US transfer pricing rules can save a tremendous amount in adjustments, penalties and litigation costs.
It is also helpful to know that the IRS has been working with the OECD, the intergovernmental organization representing the Group of 25 principal industrialized countries, to harmonize US transfer price regulations and OECD Transfer Pricing Guidelines. While the regulations and guidelines are not identical, careful planning with good legal advice can, again, help to harmonize tax planning across multiple jurisdictions.
The bottom line is that the multinational which has intercompany transfers can benefit from careful legal planning of its transfer pricing as never before, and now is the time to do the planning.