Intercompany transfer pricing is an IRS enforcement priority, and can result in significant tax liabilities and higher penalties than in many other situations. Federal tax laws provide avenues to reduce or eliminate the enhanced transfer pricing penalty, and there are additional approaches under tax treaties and IRS guidance that are intended to provide companies with certainty in their commercial transactions. The following provides a short list of actions any company can take to improve their transfer pricing approach and expected tax results.
US companies can be assessed with massive tax liabilities and penalties related to their transfer pricing policies and transactions with non-US affiliates. Most tax penalties imposed under US federal tax law are limited to around 20 percent of the amount of tax at issue. In the transfer pricing context, however, gross over- or under-valuations used in intercompany transactions can lead to penalties of up to 40 percent of the tax liability. Further, the cost of defending against an assessment and penalties can be astronomical. The Amgen case (referenced in prior articles) illustrates this point; it will likely take years (and an army of lawyers) to resolve Amgen’s transfer pricing dispute.
Amgen isn’t alone. In late 2021, Zimmer Biomet settled a $209 million transfer pricing assessment. These cases go to show that well-informed, well-funded, and “buttoned-up” taxpayers are susceptible to tax adjustments and penalties on transactions with overseas affiliates. Imagine the tax adjustments, penalties, and legal fees if Amgen, Zimmer Biomet, or your company were not well-informed, well-funded, and buttoned-up!
As any tax enforcement agency will explain, tax compliance is not optional. In some cases, particularly for mid-market companies without a significant track record of overseas operations, it can be a matter of corporate survival. Even if a transfer pricing dispute does not result in a colossal tax liability, the mere risk of potential adjustments and penalties can turn an otherwise attractive acquisition target into a time bomb, and blow up a potential acquisition or company sale.
There are a number of steps you can this year to increase the certainty of your company’s tax positions and reduce the risk of incurring tax and penalties on intercompany transactions with affiliated companies:
- Adopt an appropriate transfer pricing strategy that takes into account the operations and risks undertaken by each of your company’s affiliates;
- Prepare internal transfer pricing documentation in accordance with regulatory requirements;
- Ask a professional to review your transfer pricing documentation and give pointers on how to improve your approach;
- If preparing transfer pricing documentation sounds daunting, hire a tax professional to do it for you;
- Ensure your intercompany agreements actually comply with (or at least don’t contradict) your transfer pricing policies and strategies;
- Obtain legal opinions with respect to tax positions on transactions and transfer pricing documentation;
- Seek an advanced pricing agreement with the IRS, essentially blessing your company’s approach to its intercompany transactions for a relatively long time period (often five to ten years); and/or
- Seek a bilateral advanced pricing agreement with the IRS and the taxing authorities of the nations in which your company’s affiliates operate.
Although intercompany transfer pricing is an enforcement priority and carries the risk of significant penalties, it is not something that only the largest multinational conglomerates should consider. With a little planning and some thoughtful analysis, any US taxpayer can obtain certainty, reduce risk, and improve their financial viability.