Business-owning clients may need to pay more attention to the audit risk of a long-time accounting practice.
Transfer pricing in accounting is how one division in a company charges another division, such as a subsidiary or affiliate. Corporations often flex pricing to trim profits of a division in a high-tax area and increase the profits of divisions in low-tax areas, often internationally. Tax authorities frequently challenge transfer pricing methods.
Advisors warn that this is something tax planners and clients need to be aware of in light of stepped up tax enforcement on the federal level.
The Inflation Reduction Act of 2022, signed into law in August, provided $80 billion for the IRS over 10 years. More than half of that money will go toward strengthening tax enforcement, including by hiring.
“This new staff group is expected to include more economists and attorneys, which indicates that more complex audits—such as those covering transfer pricing topics—will remain a top priority,” said Erin Alexander, director of transfer pricing and the economic group at Mazars in New York City.
“Several areas that have been overlooked by the [IRS] is the complex matter of transfer pricing,” added Chris McMahon, CEO of Aquinas Wealth Advisors in Pittsburgh. “Often the IRS has come to rely most exclusively on the transfer pricing studies that [companies] have drafted by their CPA firms. The IRS is going to dig in now to see if their modeling is correct.”
“I think that the IRS will allocate more resources to scrutinize cross-border payments for intercompany transactions,” said Henric Adey, director and the national leader of the transfer pricing practice at Eisner Advisory Group in Iselin, N.J. “A lack of contemporaneous documentation of your current transfer pricing position can lead to protracted audits.”
Audits can cause a ripple effect that impacts other areas of a client's tax planning, advisors said.
“Transfer pricing audits are time-consuming and expensive,” Alexander said. “They can also create a domino effect, as transfer pricing adjustments may affect the calculation of U.S. state taxes, the tax paid by the foreign related party, and customs valuations, to name a few. Transfer pricing documentation that is well done and complete will protect a taxpayer.”
Documentation should include intercompany agreements and ensuring that the facts and circumstances of the business agree with those in the documentation, Alexander said. “If a taxpayer has taken a risky transfer pricing position, it may also be a good time to consider the tax dispute resolution tools that are available,” she added, “including the International Compliance Assurance Program, advance pricing agreements and mutual agreement procedures.