IRS Continues Crackdown on Transfer Pricing Compliance, Enforcing Steep Fines

At a glance

• The main takeaway: The IRS continues to more strictly enforce compliance and penalties related to transfer pricing documentation.
• Impact on your business: Going forward, multinational companies with intercompany transactions will be under more scrutiny and should prioritize strong, well-documented transfer pricing policies.
• Next steps: Companies should assess internal transfer pricing policies against IRS standards and consult with a transfer pricing advisor to ensure appropriate compliance.

The full story:

Multinational companies should take steps now to shore up transfer pricing policies and documentation or risk becoming one of the latest targets of a compliance crackdown. As evidenced by increased issuances of compliance letters to taxpayers, a surge of transfer pricing cases in the US Tax Court, and a hiring boom in the IRS transfer practice, the agency will only continue to ramp up scrutiny of multinational companies for potential transfer pricing violations. To avoid penalties, companies should proactively assess internal transfer pricing policies against current IRS standards, especially for documentation.  

The IRS continues to be transparent in its refocus on transfer pricing documentation-related penalties

The IRS announced its intention to refocus efforts on transfer pricing compliance last year, explicitly stating plans to assess more penalties for inadequate documentation. This increased scrutiny is not indicative of the agency creating or imposing new rules; instead, it is a renewed effort to enforce the standards that already exist.

These efforts began with a round of letters mailed to taxpayers characterized as “inbound distributors[1]” the agency suspected of underreporting and underpaying taxes. These alerts provided taxpayers with the opportunity to take corrective steps, such as amending previous returns or filing for an advance pricing agreement, or to submit rebuttals defending their compliance. Taxpayers who did not respond to these compliance alerts would be referred for examination and could face extensive penalties under Internal Revenue Code (IRC) Section 6662, which authorizes accuracy-related penalties for substantial valuation misstatements on income tax returns.

To support the renewed enforcement of transfer pricing compliance, the IRS also announced plans to hire 70 new agents and specialists, including experienced professionals in economics, tax, and transfer pricing, as well as inexperienced hires who will be trained in-house. 

Increased scrutiny and penalties are reflected in recent Tax Court cases

Two recent transfer pricing court cases exemplify these trends, including Newell Brands v. Commissioner and Airbnb v. Commissioner. In both cases, the IRS determined the taxpayer underpaid millions of dollars in taxes ($90 million for Newell and over $1 billion for Airbnb) and owed millions more in penalties, while the taxpayers asserted their transfer pricing positions were accurate and documented accordingly. 

Both cases reflect the IRS’s new enforcement policy of asserting Section 6662 penalties for undervaluation, underpayment, and insufficient documentation. As stated in Section 6662, a misstatement on tax returns could result in penalties of 20% or 40%, meaning the stakes are incredibly high for improperly calculated taxes or insufficiently documented transfer pricing policies.

What steps multinational companies can take to prepare

One upside to the transparency the IRS has offered in their rewed compliance enforcement is that it provides companies the opportunity to prepare and reinforce their transfer pricing methods and documentation. Taking a few steps in preparation now could potentially save millions in adjustments and fines.

1. Assess internal transfer pricing policies against current IRS standards. Multinational companies can perform a self-assessment to determine whether the currently selected transfer pricing methods and documentation practices are still appropriate, especially in light of IRS enforcement trends. Some multinational companies may not even be aware they need a transfer pricing policy, which would make this step even more pressing.
2. Critically evaluate transfer pricing documentation. Not all transfer pricing documentation is created equally and just the existence of documentation will no longer be enough to ward off an audit or potential penalties; the IRS will be reviewing multinational companies’ transfer pricing positions alongside prepared documentation and will make assessments based on the adequacy and reliability of that documentation. Taxpayers should consult the FAQs compiled by the IRS to better understand documentation standards and best practices.
3. Partner with a knowledgeable tax advisor specialized in transfer pricing policies. Enacting an appropriate transfer pricing policy may be an important piece of tax compliance, but it is also one of the most important tax planning tools for multinational companies. When developed strategically, transfer pricing can be highly effective in helping businesses manage their cash flow and tax burden. A tax advisor specialized in transfer pricing can help companies optimize their taxable position while maintaining the highest possible level of compliance with evolving IRS standards.

The bottom line

Transfer pricing policies and documentation are critical tools for multinational companies trying to maintain compliance and avoid future penalties. While the IRS standards for the policies have remained fairly consistent over the years, the IRS’s enforcement of those standards has varied. The current trends suggest that the IRS will continue to crack down on enforcement, especially related to adequate transfer pricing documentation, and will levy the maximum penalties when applicable.

To avoid paying potentially millions of dollars in fines, any multinational company with intercompany transactions needs to conduct an immediate evaluation of internal transfer pricing policies. To ensure your transfer pricing methods and documentation are adequate, consult with a knowledgeable transfer pricing tax advisor. Aprio’s transfer pricing advisors can help identify strategies to mitigate tax impacts while maximizing compliance.

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[1] Defined as foreign headquartered companies with US related parties importing goods into the US for further distribution. These are typically characterized as “limited risk distributors” that should be earning a routine return for their distribution activities.