X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
Did you know you can bargain with the Internal Revenue Service about your taxes? There is a little-known program that can help many companies, both small and large. While I was acting director and branch chief of the IRS Advance Pricing Agreement program, I saw the benefits firsthand. If it is right for your company, the program can bring helpful certainty to a complex area. If yours is a multinational company that buys or sells goods or services among controlled parties (i.e., two or more corporations or partnerships owned or controlled directly or indirectly by the same interests), you face a high probability of an audit in the United States or abroad. The IRS requires companies that engage in these related party intercompany transactions to maintain documentation through a Transfer Pricing Study. To avoid penalties, a properly done Transfer Pricing Study is essential for establishing that the transactions are conducted at arm’s length. But you can help protect your company even further from both the cost of an audit and the associated uncertainty of possibly having to pay taxes retroactively. The solution is to get an Advanced Pricing Agreement in place, now. Here are reasons why you should consider using such a program. AUDITS AND YOU You may think the risk of an IRS audit is low. But before you count out the IRS, consider that audits of larger corporations have rebounded significantly to 20 percent from only 12 percent just two years ago. Audits of small businesses organized as corporations also increased after years of decline. This trend is expected to continue as the deficit grows and thus demand increases for all possible tax revenue. Even if you are right about the IRS, have you thought about the country on the other side of the transaction? You should know that in 2004 the number of foreign-initiated tax adjustments was greater than the amount coming from the United States. Mexico and Canada are dedicating more resources to transfer-pricing audits. The European countries, Japan, and Korea continue to engage in audits, and China is targeting foreign-owned entities that don’t report profits. Companies can no longer assume they can fly below the radar. Midsize companies are vulnerable to transfer-pricing audits, and the IRS scrutinizes these companies just as much as the Fortune 500 ones, despite less money being at stake. If a transfer-pricing audit is inevitable, prepare and hope for the best, right? Maybe there’s a better way. PRE-EMPTING AN AUDIT One such better way might be to use an Advanced Pricing Agreement to help pre-empt an audit. The APA program is a voluntary program available to taxpayers as a form of pre-emptive alternative dispute resolution. The idea is to use a cooperative process to resolve difficult problems before the taxpayer implements an unacceptable solution. An APA is a prospective agreement between the taxpayer and the IRS that binds the taxpayer to a defined transfer pricing methodology for a period of years that ensures arm’s-length pricing among the controlled parties. In return for the taxpayer’s entering into the agreement, the IRS will not challenge the methodology on audit if the conditions of the agreement are satisfied. Why would a company volunteer for the program? In general, the APA process typically allows for more flexibility and creative solutions than an audit. More specifically, consider these reasons why an APA may be the right choice. First, the agreement provides a fresh look from a neutral source. Consider your relationship with the company’s IRS field team. If, for whatever reason, a poor relationship exists, an APA is an excellent way to remedy that or at least add a neutral party into the mix. The APA team leader is a lawyer from the IRS chief counsel’s office, a neutral party who will manage the case, give it a fresh look, and assess the situation. Part of the APA process is ensuring the taxpayer gets a fair and impartial hearing. If you feel that getting an impartial hearing from the field team in the audit process might be a challenge, it might be a good idea to seek an APA. Second, more creativity is allowed. An audit and any resulting assessment of tax are often by the book. In contrast, an APA provides an opportunity to find a creative solution. For instance, if your industry is in a recession, causing the company to earn significantly lower profits for a couple of years, an audit might easily result in an assessment of additional tax. But maybe the company’s profits for the two years before and the two years after the recession are exceptionally good. An APA might consider the results for the overall six-year period and find them acceptable. A thoughtful proposal will likely not be rejected out of hand. Third, the program can help your company avoid paying too much tax. The tendency among some is to think that many companies aren’t paying their share of U.S. tax. But what if your organization is paying too much? This could put the company at risk in the other country if the overpayment to the United States results in an underpayment in a foreign jurisdiction. Although paying too much tax in the United States won’t bring the IRS banging down your door, the other country just might come calling. If the APA involves the tax authorities in the foreign jurisdiction (which I explain below), an APA can correct this situation before it’s a problem. TESTING THE WATERS If you think an APA may be right, but you need some additional assurance, it is available for the asking. Taxpayers can request a pre-filing conference, to meet with the APA staff and solicit their informal views about issues. These issues can include the covered transaction, the proposed transfer-pricing method, and the probability of agreement among competent authorities. This meeting is also a time to clarify the process. The best part is that the taxpayer can remain anonymous for the pre-filing conference, if desired. But before you’re ready for a pre-filing conference, there are some questions to consider ahead of time. First, will the agreement with the IRS be unilateral or bilateral? Although a company can request a unilateral APA (an agreement between the company and the IRS), a bilateral one is often the best choice. A bilateral APA (an agreement among the company, the IRS, and the other country where the goods and services are bought or sold) places the company and the IRS on the same side of the table in negotiating against the other country. Sometimes, an audit that might have been contentious could turn into a cooperative bilateral APA when the APA team assesses its negotiating position with another country. A bilateral APA also avoids an audit in both jurisdictions and the possibility of a double tax. Second, which transactions should the APA cover? An APA doesn’t need to cover all entities or all transactions. Maybe your company has three product lines and engages in business with five countries. You may not need five APAs covering three product lines. Don’t make the process longer or more difficult than necessary. Maybe one product line is the most problematic, such as a transfer from a semiconductor company that is suffering a downturn and is creating lower profits in the short term. This may be the company on which an audit would most likely focus, especially if the company suffers a loss or if its profits are significantly lower than normal. One country might create more problems than another. For instance, Canada may be planning an audit claiming the royalty your Canadian subsidiary is paying to the U.S. parent is too high. In a previous IRS audit, the royalty may have been considered too low. A bilateral APA with Canada now might avoid a crisis next year. TIME AND MONEY No decision is complete without considering the time and expense. A unilateral APA likely will take approximately 12 to 18 months to complete. A bilateral APA generally will require an additional year because of the added complexities of negotiations between countries to reach agreement. But the time to reach bilateral agreements has ranged from as short as three months to as long as four or five years. Even if longer, the wait for a bilateral agreement might be worthwhile because the avoided audits might have taken much longer. Requesting an APA requires payment of a user fee of between $22,500 for a small-business APA to a maximum of $50,000 for a larger company covering several transactions or different countries. Generally, a company will engage professionals, including lawyers, accountants, or economists, to develop or review its APA request. But the major part of the submission is the taxpayer’s Transfer Pricing Study, which is necessary regardless of whether a company gets an APA. When considering the cost you should remember the objective. Once you’ve completed an APA, the transfer-pricing policy is accepted for the duration of the agreement (generally five years). Also, the cost of negotiating an APA is likely to be less than the costs of defending an audit, especially if you challenge the international examiner’s proposed adjustment. This would involve meeting with an appeals officer and even the possibility of needing help from the U.S. competent authority to avoid the possibility of double tax. Money spent planning is often better spent than money spent reacting to an audit. If you think an APA may be the answer for your company, get the advice that gives you the best advantage. As early as the pre-filing conference, you want an expert adviser who knows the APA program from the inside and knows what’s possible. Someone with an APA background can steer you around any pitfalls, can know when to push further with the government, and can provide a realistic view of the process. This will help your company achieve the best possible results. The U.S. economy is suffering through a severe government deficit. The IRS promised to increase the number of transfer-pricing audits. Small and large companies alike will feel the impact. Countries besides the United States are aggressively targeting review of company transfer-pricing policies. The pieces are all in place. It is not whether multinational companies will have an audit, but when. For that reason it is critical that companies take the appropriate steps now to be adequately prepared. An APA may not be for everyone, but for some taxpayers, it is a great opportunity.
Mindy Piatoff is special counsel in the D.C. office of Sheppard, Mullin, Richter & Hampton.

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.