On March 1, 2017, the Internal Revenue Service (IRS) released a new International Practice Unit (IPU) summarizing foreign and domestic loss impacts on foreign tax credits (FTC). The IPU provides a summary of the law regarding worldwide taxation and FTC limitations, followed by explanations and analysis for IRS agents examining FTC issues. As we have noted previously, this high-level guidance to field examiners signals the IRS’s continued focus on international tax issues.
The Internal Revenue Service has made available unofficial but detailed and instructive guidance on the application of Social Security and Medicare taxes (FICA) to wages paid to employees working abroad. The new November 14, 2016, International Practice Unit (IPU) makes clear that both US citizens and resident aliens (green card holders) remain subject to payment of FICA taxes despite the fact the services are performed outside of the United States, in those instances where the employer is an American employer, certain foreign affiliates thereof, or a foreign person treated as an American employer. The IPU notes that an important exception to the general rule of FICA application is where the IRS has entered into a Totalization Agreement, a type of FICA tax treaty, with the country where the services are performed and the requirements of the Totalization Agreement have been met.
On June 14, 2016, the Internal Revenue Service (IRS) published an International Practice Unit (IPU) on the monetary penalty for failing to file Form 926, Return by a U.S. Transferor of Property to a Foreign Corporation (available here). Under IRC section 6038B(a)(1)(A), a US person who transfers property to a foreign corporation in an exchange described in IRC sections 332, 351, 354, 355 or 361 is required to file Form 926 and accompanying information with the IRS. The Form 926 and accompanying information must be filed with the US person’s income tax return for the taxable year that includes the date of the transfer.
Failure to comply with the reporting requirements (e.g., failure to timely file a Form 926 or providing false or inaccurate information) can result in a penalty equal to 10 percent of the fair market value of the transferred property for which there was a failure to comply, up to $100,000. However, the penalty is not limited if the failure to furnish was due to intentional disregard. The penalty may be waived if the US person demonstrates that the failure to comply was due to reasonable cause and not to willful neglect. If there is a failure to comply, the statute of limitations on assessment of tax for the year of noncompliance potentially remains open until three years after the date on which the required information is provided.
The IPU contains detailed instructions to IRS revenue agents for purposes of examining this issue and determining whether to assert a penalty. In our experience, the IRS in recent years has been more aggressive in asserting penalties for failure to comply with information reporting requirements and has imposed a heavy burden on taxpayers to demonstrate that the reasonable cause exception applies. This IPU states that additional IPUs on information reporting penalties in other situations (e.g., failure to file Form 5471, issues associated with offshore bank accounts and check-the-box rules for foreign entities) will be forthcoming. Given the increased focus on penalties in this area and statute of limitations issues, taxpayers subject to these information reporting requirements should ensure that they are complying with the IRS rules in this area.
On March 7, 2016, the Internal Revenue Service (IRS) released a new International Practice Unit (IPU) on a specific transfer pricing method—the residual profit split method (RPSM). The IPU explains to IRS examiners how to determine if the RPSM is the “best method” under Section 482, and if so, how to apply such method between a US parent and its controlled foreign corporation in a transaction where intangible property is employed. As stated in a previous post, IPUs generally identify strategic areas of importance to the IRS but they are not official pronouncements of law or directives and cannot be used, cited or relied upon as such. However, taxpayers should benefit from reviewing IPUs, as they reflect the current thinking of the IRS on pertinent issues, and therefore allow taxpayers to structure and document their transfer pricing arrangements in a manner that is consistent with such thinking, as noted in a prior post available here.
Section 482 was designed to prevent the improper shifting or distorting of the true taxable income of related enterprises. Section 482 accomplishes this by requiring that all transactions between related enterprises must satisfy the arm’s length standard. That is, the terms of intercompany transactions generally must reflect the same pricing that would have occurred if the parties had been uncontrolled taxpayers engaged in the same transaction under the same circumstances. One of several possible transfer pricing methods for determining whether a transaction meets the arm’s length standard is the profit split method. One specific application of the profit split method is the RPSM. This IPU focuses on the application of the RPSM as it applies to outbound transactions involving intangible property.
The IPU outlines four steps for IRS examiners to follow in determining whether the RPSM is the best method to evaluate a controlled transaction and if so, how to apply the RPSM to that particular transaction.
- Identify the routine and nonroutine contributions made by the parties. The IPU cautions that if there are no nonroutine contributions, or if only one controlled taxpayer is making nonroutine contributions (most commonly of intangibles), then the RPSM should not be used. The IPU provides three examples of when the RPSM may be used: (a) a tangible goods sale if the seller uses nonroutine manufacturing intangibles to make the goods, and another controlled party purchases and resells the goods using its nonroutine marketing intangibles; (b) a licensing transaction where one controlled party licenses nonroutine manufacturing intangibles to a second controlled party, who then manufactures goods using those manufacturing intangibles and sells the goods using its own nonroutine marketing intangibles; and (c) a commercial sale of software product, if two controlled parties each contribute nonroutine software intangibles to manufacture the product, and the controlled parties share the revenue from the sales.
- Determine if the RPSM is the best method. The RPSM is the best method only if it provides the most reliable measure of an arm’s length result. The IPU cautions that the RPSM should [...]
As we noted in our initial post, the Internal Revenue Service (IRS) began publishing job aids and training materials developed by its International Practice Units (IPUs). On April 6, 2016, the IRS released another IPU on section 482, available here. The most recent IPU covers the three requirements under section 482: (1) two or more organizations, trades or business; (2) common ownership or control (direct or indirect) of the entities; and (3) the determination that an allocation is necessary either to prevent evasion of taxes, or to clearly reflect the income of any of the entities.
The most recent IPU takes a broad view of the application of section 482 and looks at the substance of transactions. Regarding the first requirement, the IPU instructs examiners that organizations can include almost any type of entity and that a trade or business means a trade or business activity of any kind, regardless of place of organization, formal organization, type of ownership (individual or otherwise) and place of operation. On the common control requirement, the IPU emphasizes that the form of control is not decisive and that the reality of control governs. It also notes the presumption of control if income or deductions are arbitrarily shifted. Finally, the reallocation to clearly reflect income requirement notes that an IRS allocation will be upheld unless the taxpayer can provide that the IRS determination was arbitrary and capricious. Moreover, the IPU provides examples of circumstances that indicate the presence of arbitrary shifting of income, including when the net income of the foreign affiliate is high compared to the net income reported by the US company. Of course, it may be appropriate for the foreign affiliate to have higher net income.
The IPU contains instructions on initial factual development of the requirements and provides references to resources that an agent should consult, including internal IRS resources, IRS guidance and case law. It also identifies the types of documents that should be requested and reviewed during the examination.
As demonstrated by the large number of high-profile transfer pricing disputes currently pending in the courts, the IRS is taking a strong stance on the application of section 482. Moreover, as demonstrated by this IPU, the IRS wants examining agents to be aggressive in identifying circumstances where there may be noncompliance with section 482. Taxpayers with transfer pricing issues may benefit from reviewing all IPUs on section 482, both in documenting their transfer pricing activities and upon commencement of an examination to ensure that they have the documentation that the IRS will request.