Thu, Oct 13, 2022

IRS Tax Enforcement Funding and Potential Rise in Transfer Pricing Audits

The Inflation Reduction Act has allocated of billions of dollars to the IRS for tax enforcement, is a reminder that it is a good practice to stay abreast of current transfer pricing litigation and understand how it relates to your own transactions and fact patterns as a taxpayer.

The Inflation Reduction Act has allocated of billions of dollars to the IRS for tax enforcement may increase transfer pricing audits.

The Inflation Reduction Act allocations of fund to the IRS for tax enforcement reminds taxpayers to understand current transfer pricing litigation and how it relates to their transactions.

The Inflation Reduction Act (“the Act”) has allocated $80 billion (bn) to the IRS with more than half of the money going to enforcement. Should taxpayers be worried?

With increased tax enforcement listed in the Act as a revenue generator of $124 billion (bn) and the majority (60%) of the $80 billion expected to be spent on increased tax enforcement activities, multinationals and large corporations are likely to experience additional scrutiny of their tax returns, including scrutiny of their transfer pricing positions.

Insights on the specific ways the IRS will use the new budget is forthcoming. In August, in a letter to the IRS, United States Secretary of the Treasury, Janet Yellen (“Secretary Yellen”), asked the IRS to provide an initial spending plan in six months. For over a decade, the IRS has faced reduced funding and less staffing and had to face how the agency would ever do more with fewer resources.

Now, according to the Treasury Department's plan from May 2021, a majority of the budget may be used to hire up to as many as 87,000 new people over 10 years. A significant number of retirements or departures are also expected (approximately 50,000), which would mean a net number of new employees of 37,000. It is also important to note that it takes time to hire, particularly in a tight labor market, and time for new hires to become fully productive on the job. Additionally, the Congress may weigh in further over the ten-year time period and alter the appropriations ($13 billion is the 2022 allocation).

While we could see the IRS looking to hire more economists on staff or contract with external economists for projects, we may also see it looking to invest in data analytics or other assessment tools. Being able to harness the data collected from, for example, country-by-country reports and use it in transfer pricing risk assessments is something that the global tax and transfer pricing communities have been discussing for years.

The IRS could use its additional resources to examine both new transfer pricing issues and/or expand its number of cases. Remember, the IRS started its LB&I (Large Business & International) compliance campaigns several years ago in part in response to resource challenges. Whether it can expand the number of campaigns it plans to address or whether additional resources will allow them to look beyond the campaign topics will be something to watch for.

Audit Preparedness

This news is a reminder that it is good practice to stay abreast of current transfer pricing litigation and understand how it relates to your own transactions and fact patterns as a taxpayer. Transactions involving intangibles, services (especially high-value services) and financial transactions are anticipated to stay in the forefront. Speaking frequently with your advisors—whether economists or lawyers—or other in-house tax/transfer pricing professionals to understand current trends in your industry is also a good practice in a climate of potentially higher scrutiny. Sometimes working with advisors to revisit the risk level and risk ranking of transactions can be useful to make sure your transfer pricing house is in good order. If you have any transactions that may have been put on the "set it and forget it" compliance category, now may be the time to revisit these through the lens of the current and anticipated future climate.  For high-risk transactions, you may consider looking at results using different methods, including unspecified methods, beyond the one selected as the best method.

What Else to Look Out For

Being aware of what information is publicly available about your business and employees is increasingly important, particularly in the age of LinkedIn and other social media. How your internal facts and the external information available to anyone outside your organization, including tax authorities, do or do not align is something that taxpayers and advisors should look to understand as part of any audit preparedness.

Anticipate that there will be a shift away from all virtual to moving back to traveling for onsite interviews. As companies look to bring travel budgets back, tax departments may look to travel to confirm fact and circumstances in anticipation of additional scrutiny.

New resources to exam teams may mean a lack of knowledge of your business or industry during exam and lead to additional requests for information (higher volume of information document requests) and a need to educate the exam team more than usual as part of the process as the new members move up the learning curve. Tax departments may need to think about flexibility in having the resources available in-house, whether current staff or loan staff from outside firms, to respond in a timely fashion to more voluminous requests.

Conclusion

Now, with an increase in resources, the tax community will be waiting and watching over the next six months to see the IRS’ initial spending plan requested by Secretary Yellen. Our firm will continue to closely monitor any development, including those in the U.S. Congress. As ever, leaning into audit preparedness best practices is always a basis for readiness in a time of heightened scrutiny. 

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