IRS Announces Campaign to Audit Transfer Pricing for Intercompany Services

Thoughtware Alert Published: Apr 25, 2019
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On April 16, 2019, the IRS Large Business and International (LB&I) Division released three new compliance campaigns, all of which focus on offshore activities of U.S. taxpayers. In particular, one of the newly announced compliance campaign areas focuses on transfer pricing between U.S. taxpayers and their offshore, related-party captive service providers.

The three new campaigns bring the total number of compliance campaigns to 53 since the compliance campaign-based approach to auditing commenced on January 31, 2017. The IRS said the compliance campaigns are designed to move toward “issue-based examinations and a compliance campaign process in which the organization decides which compliance issues that present risk require a response in the form of one or multiple treatment streams to achieve compliance objectives.” The LB&I’s goal is to improve return selection, identify issues representing a risk of noncompliance and make the greatest use of limited resources.

Many multinational enterprises establish offshore captive service providers that provide services to their parent company or other related parties. These entities solely perform services for related parties, hence the term “captive.” Examples of such services are shared service centers that provide management and administrative services, contract research and development, contract manufacturing, financing entities, etc. For example, the transfer pricing arrangements between an entity in India that provides contract software development services on an exclusive basis to its U.S. parent company would be targeted by the IRS. The IRS wants to ensure that U.S. taxpayers employ arm’s-length prices with their related-party captive service providers. According to the LB&I directive, “Excessive pricing for these services would inappropriately shift taxable income to these foreign entities and erode the U.S. tax base. The goal of this campaign is to ensure that U.S. multinational companies are paying their captive service providers no more than arm’s length prices.”

U.S. taxpayers with related-party captive service providers should ensure their intercompany pricing is arm’s length and their transfer pricing documentation is current to avoid potential adjustments to taxable income, penalties and interest, which the IRS could impose. For more information, contact Will or your trusted BKD advisor.

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