USA: Potential increase in penalties given by IRS for tansfer pricing

published on 17 November 2022 | Reading time approx. 2 minutes

IRS officials in 2022, has stated that the IRS expects to see an increase in the amount of penalties asserted to companies in trasfer pricing cases. Holly Paz, acting commissioner of the IRS Large Business and International Division ("LB&I") recently stated at the American Institute of CPAs National Tax Conference on November 1 that the IRS "will continue to look more closely at cases, even those with transfer pricing documentation, to determine when it's appropriate to assert penalties." This follows the statement made by other individuals in LB&I in September 2022 stating that "more penalties will be asserted in hopes of receiving better documentation." It is expected that taxpayers should be prepared to receive higher scrutiny on their transfer pricing policies and practices with the potential risk of a penalty.

IRS Increasing Scrutiny on Transfer Pricing Cases

According to Tom Greenaway of KPMG LLP, the "IRS previously has had a very poor track record on transfer pricing litigation." Penalties were not being assessed to taxpayers in transfer pricing cases mainly because the IRS were not "winning those cases" according to Greenaway. But with the IRS becoming more thorough about the cases it selects, the IRS is beginning to have a better track record in court according to Greenaway. As a result, more penalties being assessed to taxpayers are expected in the future.

Currently, the Internal Revenue Code Section 6662 imposes two types of transfer pricing penalties:

a "transactional" penalty, which applies if the taxpayer's price in a transaction is considered too high or too low than the IRS-determined "correct" price
a "net adjustment" penalty, which applies if the net increase in taxable income from a transfer pricing adjustment exceeds a certain threshold.

Each type of penalty can result in either a 20 per cent or 40 per cent increase in tax liability that depends on how "off" the transfer pricing was from the IRS's "correct" transfer pricing.

The main defense for any potential transfer pricing penalties is for the taxpayer to use a a regulatory-specified method with proper documentation to support the selection of the price. If a taxpayer is selected for examination, it is expected that the transfer pricing documentation is delivered to the IRS within 30 days of the requset. With the IRS focusing more on Section 6662 penalties, it is imparative for taxpayers to revisit their transfer pricing documentation and check that the documentation is robust and fully compliant with Sections 482 and 6662.

Increased scrutiny of transfer pricing documentation is expected to be a large topic of discussion for the IRS moving forward. The rise in penalties as a result of the increase scrutiny of transfer pricing highlights the importance for taxpayers to have proper transfer pricing documentation prepared in defense of an IRS examination.