IRS Holding Up Transfer-Pricing Deals For Years

The Internal Revenue Service has fallen behind on agreements made with companies wanting to avoid a surprise audit of their intercompany transactions.
Sarah JohnsonApril 9, 2012

Senior finance and tax executives may well be wondering whether their companies should work with the Internal Revenue Service on transfer-pricing agreements after learning about the agency’s latest progress report. Last week the IRS revealed that it processed fewer Advance Pricing Agreements (APAs) last year, and the average time the IRS takes to process such deals rose to 40.7 months last year from the 37.2 months reported in 2010.

In other words, companies that have turned to the IRS to bring certainty to their intercompany transactions for a five-year period or longer may have to wait three and a half years or more to get an answer. “Taxpayers, advisers, and governments, as well as the IRS, have become frustrated with how long these cases can take,” says Rocco Femia, a partner at law firm Miller & Chevalier.

Thus, the IRS received only 96 new applications last year — a 33% decline from its all-time high of 144 applications in 2010. Moreover, the IRS finalized fewer agreements last year: the agency completed 42 APAs, which is below its average of 48 each year between 1991 and 2010. David Canale, Americas director of Ernst & Young’s transfer-pricing controversy services, says the IRS’s processing has experienced a “severe slowdown” over the past year and a half.

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While working with the IRS on such agreements may seem odd, many companies go through the trouble for the very purpose of avoiding an unexpected visit from IRS auditors. After all, transfer pricing, or the pricing of sales and services between a company’s subsidiaries, can be so complicated and subjective that corporations work with the agency to get on the same page for a few years at least.

The theory is that companies can avoid the uncertainty that can come with these arrangements. Indeed, the IRS noted in its latest status report that “transfer pricing issues by their nature are highly factual and have traditionally been one of the largest issues identified by the IRS in its audits of multinational corporations.”

The deals among corporate taxpayers, the IRS, and, occasionally, other tax authorities come at a cost, however. Large companies pay a $50,000 fee and share tax information directly with authorities in exchange for an APA. The process can be time-consuming for tax directors as well as other support staff, such as the human-resources department. The application alone can fill several binders.

The latest status report from the IRS could make companies question whether the outlays of up-front time and money are worth the risk of an audit that may never come. However, experts note, transfer pricing is low-hanging fruit for U.S. and international tax authorities seeking new sources of revenue in recent years.

Without the government’s go-ahead, companies may try to do the right thing, with proper due diligence and planning, but still find themselves in the crosshairs of tax authorities that disagree with their transfer-pricing judgments. “There’s no guarantee, even if the taxpayer is very responsible in determining the right price, that tax authorities will agree to that [determination],” says Femia.

Part of the reason for the holdup of such cases at the IRS (it had 445 pending cases as of the end of 2011) is other governments’ involvement. Just about 80% of the companies that filed applications last year sought bilateral agreements. In such arrangements, the IRS and another tax authority agree on final terms, providing more certainty to corporate taxpayers but adding to turnaround time. Many other jurisdictions lack resources, tax experts say.

Moreover, the IRS has slowed down its sign-offs in an effort to make its decisions more consistent among companies within the same industry. Simpler cases have often been put on hold while the IRS waited for other, more complicated ones to work their way through the system for comparison, according to Canale.

For companies on the fence about whether to enter into an agreement with the IRS, the answer comes down to risk tolerance, experts say. “The cost is an up-front commitment to proactively resolve an issue that might not otherwise arise,” Femia says.

For its part, the IRS reorganized earlier this year, merging the Office of the U.S. Competent Authority, which handles transfer-pricing cases with foreign jurisdictions, with its APA Program and hiring new employees. “Any changes that reduce the amount of time agreements are processed — whether because of an increase in staffing or better execution — I think it would be beneficial to the taxpayer,” says Femia.

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