New IRS Audit Campaigns Target International Companies

By Kristin Maeckel, partner; Robert Verzi, partner; and Philip Brudney, manager

The IRS’s Large Business and International (LB&I) division recently detailed the top 13 issues it will be targeting for audit campaigns. Several of the issues relate to international tax compliance. Companies with potential exposure in these areas should examine their compliance and how to reduce their tax risk going forward. Two of the specific areas are:

1. Form 1120-F Non-Filer Campaign: Foreign companies doing business in the U.S. are often required to file Form 1120-F. LB&I has data suggesting that many companies are not meeting their filing obligations. In this campaign, LB&I will use various external data sources to identify these foreign companies and encourage them to file their required returns. The treatment stream for this campaign will involve soft letter outreach. If companies do not take appropriate action, LB&I will conduct examinations to determine the correct tax liability. The goal is to increase voluntary compliance by foreign corporations with U.S. business nexus.

Aprio commentary: Form 1120-F is filed by foreign companies to report and pay tax on income effectively connected with the conduct of a U.S. trade or business, including income attributable to a U.S. permanent establishment. Form 1120-F must be timely filed in order to claim credits and deductions against gross income. If the IRS later determines a Form 1120-F should have been filed and if no return was previously filed, then the company loses the right to deduct expenses against its U.S. income. We recommend that any foreign company with U.S. operations file a protective Form 1120-F to preserve its right to take deductions and credits.

2. 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.

Aprio commentary: U.S. distributors should earn an arm’s-length return based on U.S. transfer pricing regulations. When distributors do not prepare adequate documentation, the IRS can easily impose its own interpretation of the situation and require a transfer pricing adjustment. By preparing thorough transfer pricing documentation and maintaining intercompany agreements, U.S. distributors can support their intercompany pricing and reduce the likelihood of adjustment if examined by the IRS.

For questions about Form 1120-F or U.S. transfer pricing, please contact Kristin Maeckel at kristin.maeckel@aprio.com or Robert Verzi at robert.verzi@aprio.com.

Any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or under any state or local tax law or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein. Please do not hesitate to contact us if you have any questions regarding the matte