The IRS has taken decisive steps to tighten compliance with transfer pricing regulations, capturing the attention of businesses operating within the U.S. Much like in The Good, the Bad, and the Ugly, strategy, timing, and alliances may determine who emerges unscathed.
Below we have summarized some of the key initiatives undertaken by the IRS :
| Key Initiatives by the IRS | Target | What This May Mean For Taxpayers |
| Compliance Alerts to Foreign-Owned Distribution Entities with Low Profits or Losses | Subsidiaries of foreign corporations with consistent losses or marginal profits. | Address misalignments in transfer pricing policies. |
| Guidance on Implicit Financial Support in Intercompany Loans | Multinationals with intercompany financing transactions | Assess intercompany financing arrangements to ensure compliance with arm’s length principle. |
| Stricter Enforcement of IRC Section 6662 for Transfer Pricing Adjustments | Taxpayers with documentation that is not contemporaneous, is deficient or there’s no documentation | Keep adequate, contemporaneous, robust documentation, with thorough and tailored data that supports the arm’s length principle. |
| Encouragement of Alternative Dispute Resolution Mechanisms | All taxpayers, but especially those with high-risk or complex TP positions | Though costly, these are valuable tools to provide certainty, resolve disputes and avoid tax litigations. |
- Issuing Compliance Alerts to Foreign-Owned Distribution Entities with Low Profits or Losses
Between November 2023 and January 2024, the IRS issued 180 compliance alerts targeting US subsidiaries of foreign corporations that consistently reported losses or marginal profits. These alerts, part of the IRS’s initiative focused on large foreign-owned corporations, stressed that distributors with limited functions, assets, and risks should generally not operate at a loss. Like “The Bad” lurking in the shadows, these alerts warn of potential audits that may arise and should be a call for companies to address misalignments in their transfer pricing policies.
- Guidance on Implicit Financial Support in Intercompany Loans
The IRS released AM 2023-008 in December 2023, whereby it addressed the impact of implicit financial support within corporate groups on intercompany loan interest rates. The guidance emphasizes that arm’s length interest rates must reflect terms a third-party lender would offer, factoring in both the borrower’s standalone creditworthiness and the overall credit standing of the corporate group. Much like “The Good” character in the classic film—who carefully evaluates the situation before taking action—taxpayers must diligently assess their intercompany financing arrangements to ensure compliance.
- Stricter Enforcement of IRC Section 6662 for Transfer Pricing Adjustments
The IRS continues to increase its application of penalties under IRC Section 6662 for insufficient or inadequate transfer pricing documentation. The IRS continues to scrutinize not just the quality of documentation but also the selection of transfer pricing methods to ensure they align with its expectations. There are “The Ugly” consequences to inadequate, non-contemporaneous, or insufficient documentation, so we recommend taxpayers to invest in rigorous documentation and to examine whether the selected method is truly the “best” (ok, not part of the movie but we couldn’t resist). As an important reminder, penalties can reach as high as 40% of the tax underpayment.
- Encouragement of Alternative Dispute Resolution Mechanisms
Despite its more stringent enforcement posture, the IRS remains committed to promoting collaborative resolution tools. These include advance pricing agreements (APAs), mutual agreement procedures (MAPs), and participation in the International Compliance Assurance Program (ICAP) to address disputes efficiently and foster global compliance consistency. In a scenario reminiscent of finding “the treasure,” these tools offer taxpayers an opportunity to resolve disputes and avoid costly litigation.
Future Evolution of the US Transfer Pricing Audit Landscape
Looking ahead, the US TP landscape may become more complex and demanding for taxpayers, although we have said that in prior years with little show for it.
Several key trends to look out for include:
- Greater Emphasis on Technology and Analytics
The IRS is expected to leverage advanced analytics, machine learning, and artificial intelligence to identify transfer pricing risks and flag non-compliance more effectively. This could lead to more targeted audits and higher expectations for robust, data-driven documentation from taxpayers.
- Focus on Economic Substance and Value Creation
The IRS will likely continue to scrutinize transactions involving intangible assets, intercompany services, and cost-sharing arrangements. Businesses will need to demonstrate economic substance and value creation in their transfer pricing strategies to withstand regulatory challenges.
- Evolving Penalty Frameworks
With the heightened application of IRC Section 6662 penalties, companies should expect more aggressive enforcement of penalty provisions. We hope the IRS continues to refine its penalty frameworks to incentivize voluntary compliance and early issue resolution.
- Adaptation to Changing Business Models
With the rise of digital services and remote work arrangements, we expect the IRS to continue adapting (albeit slowly) its transfer pricing guidance to address these new realities.
- Impact of the Return-to-Work Mandate for IRS Workers
Lastly, and likely the most talked-about as a result of the new Administration, the IRS’s return-to-work mandate for its workforce may impact the frequency and speed or transfer pricing audits. More agents returning to offices may result in an increase in audit activity and coordination among teams. Face-to-face collaboration may enhance the efficiency and depth of audit processes, enabling the IRS to tackle more complex transfer pricing issues. Additionally, the return to traditional workflows might expedite the resolution of existing cases and allow the agency to focus on emerging areas of concern, such as digital services and intercompany financing arrangements.
- From Global Harmony to America First II: A Policy Pivot
While the Biden Administration championed closer alignment with OECD initiatives (such as OECD’s Pillar I as close as a couple of days before leaving the Oval Office), the Trump Administration’s renewed “America First” approach will be starkly different, including a potential GOP-led tax retaliation against countries that adopt the OECD’s pillar I and II. This shift will likely significantly impact the international tax landscape, with an increasingly complex environment where domestic and global priorities are at odds.
Eduardo Emmerich – Partner – BaseFirma, Inc. – eduardo.emmerich@basefirma.com
Daniel Medvedovsky – Senior – BaseFirma, Inc. – daniel.medvedovsky@basefirma.com