USA: Inbound distributor compliance campaign announced

Published on March 3, 2017

The Internal Revenue Service (IRS) Large Business and International division (LB&I) announced on January 31, 2017, thirteen corporate compliance initiatives being undertaken by LB&I to provide a more targeted approach to the issues identified. Included in the list is a campaign targeting U.S. inbound distributors.

The IRS noted historically that U.S. distributors of goods sourced primarily from foreign related parties have incurred losses or only small profits. In the IRS’s viewpoint, the returns earned are often times not commensurate with the functions performed and risks assumed by the U.S. taxpayer. The IRS believes that in many cases the U.S. taxpayer would be entitled to higher returns were similar transactions conducted with unrelated third parties. To support its agents in the field, LB&I developed a comprehensive training strategy for the campaign designed to assist revenue agents as they examine U.S. taxpayers with similar fact patterns and/or organizational structures.

Conclusion

The inbound distributor campaign implies an expansion of a project previously outlined by the IRS’s acting transfer pricing director, David Varley, in October 2015, which initially targeted taxpayers with assets between $10 million and $250 million and through a set of new filters developed by the IRS resulted in the initial identification of approximately 70 taxpayer returns for examination.

Our experience throughout 2016 and year-to-date 2017 reflects an increased focus by the IRS surrounding the examination of foreign-owned privately held middle market companies. In addition, due to staffing limitations within the IRS, transfer pricing examinations are more frequently being conducted by general revenue agents who have less experience with transfer pricing issues and thus, are taking more of a ”by the book” approach to these examinations. This has resulted in a more lengthy examination process which in addition to increasing the cost associated with the examination can increase the exposure that issues with a U.S. taxpayer’s transfer pricing policies will be identified by the IRS. This extended examination life cycle increases the likelihood of potential adjustments to a U.S. taxpayer’s taxable income being proposed and/or sustained.

We recommend that all U.S. taxpayers engaging in material intercompany transaction activity conduct a thorough review of their intercompany pricing policies and consider taking a proactive stance by preparing formal transfer pricing documentation that is in compliance with the U.S. transfer pricing rules to defend their intercompany pricing policies.
  
Preparing comprehensive transfer pricing documentation substantially mitigates the exposure to penalties that can be as high as 40 percent of the underpayment of tax for an adjustment to taxable income related to transfer pricing that is sustained during the course of an IRS examination. Having U.S. transfer pricing documentation in place is also helpful in assisting foreign multinational enterprises in complying with the transfer pricing documentation requirements outlined in the OECD´s final report on Action 13, Transfer Pricing Documentation and Country-by-Country Reporting (CbCR), under the OECD’s Action Plan on Base Erosion and Profit Shifting (BEPS), which was released in October 2015.