Brief commentary on recent cases, rulings, notices, and related federal tax guidance.
Like clockwork, Americans greet each new year with soon-forgotten resolutions and unfounded predictions for the upcoming year. In keeping with that fine tradition, we’ve compiled three not-so-crazy predictions for tax trends and developments in 2023.
Prediction #1: Rising interest rates contribute to changes in acquisition structures
First, rising interest rates and the limitation on interest expense deductions are likely to dissuade the use of debt to finance acquisitions. Fewer attractive options for debt financing, coupled with general economic uncertainty, will likely lead to a slow-down for acquisition volume in 2023. But, we may also see an increase in equity-based consideration in deal structures, as buyers attempt to reduce out-of-pocket costs and sellers seek tax-free or tax-advantaged exit opportunities. This could lead to more equity-based acquisitions, tax-free reorganizations, and potentially a shift in the way companies finance their growth.
Prediction #2: IRS increases scrutiny of cross-border transactions
Second, IRS budget increases in the Inflation Reduction Act and a heavy focus on increased enforcement are likely to lead to more audits. Comments from Secretary of the Treasury, Janet Yellen, indicate that enforcement initiatives will likely center on ‘large’ taxpayers and areas of traditional noncompliance. One such area relates to cross-border transactions and profit-shifting activities. Transfer pricing (referring to the prices charged for goods and services between related parties) is an area of particular emphasis. Given the IRS’ ongoing focus on transfer pricing and an increase in enforcement resources, businesses would do well to recall that the IRS unit hosting the transfer pricing division is responsible for enforcement and collections for businesses with as little as $10 million in assets. Even better to recall that there is no statutory or regulatory floor on transactions subject to transfer pricing, and nearly any taxpayer that has commercial transactions with related parties should be aware of the application of the IRS transfer pricing authority.
With the IRS receiving additional funding, we can expect to see an increase in transfer pricing audits as the agency looks to ensure that these prices are being set at arm's length and not being used to shift profits to lower-tax jurisdictions.
Prediction #3: Governments adopt new ways of taxing the digital economy
The OECD's Base Erosion and Profit Shifting (BEPS) initiative is in part a response to a widespread view that governments need to adapt the norms of international taxation to an increasingly digital economy. Part of the BEPS initiative relates to the reallocation of authority to impose taxes (“Pillar 1” of the BEPS framework), and the establishment of a global minimum tax to prevent tax base erosion (“Pillar 2”).
Although there is an increasing sense of consensus in the international community relating to the propriety of Pillars 1 and 2, there are differing views on how to implement these initiatives. Without agreement, we can expect to see a patchwork of different approaches to taxing the digital economy and cross-border transactions involving intellectual property. We saw examples of such unilateral actions in 2021 and 2022, as countries imposed their own taxes on digital services (such as those passed in France, the United Kingdom, and Italy). A continued divide will create further complexity, and require companies to monitor developments across the globe and be strategic in their planning to minimize potential tax liabilities.
Overall, 2023 is shaping up to be an interesting year, with a number of trends that taxpayers should keep on their radar. It will be important to stay up to date on these developments and to work with a tax professional to ensure that companies are in compliance and taking advantage of any available tax planning opportunities.
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This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.