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USA: IRS Guidance on taxpayer affirmative use of IRC 482 released

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Published on August 8, 2016
 

The Internal Revenue Service (IRS) Large Business and International division (LB&I) released an International Practice Unit (IPU) on May 12, 2016 outlining situations under which U.S. taxpayers with related party transactions may invoke Internal Revenue Code (IRC) 482 to make adjustments to income to reflect an arm's length result.

 

The IRS recommends that readers review the ”Three Requirements of IRC 482”, ”Arm's Length Standard”, ”Comparable Profits Method (CPM) Simple Distributor - Inbound”, and ”Best Method Determination for an Inbound Distributor” IPUs to fully understand application of this IPU.

It is also important to note that IPUs are intended as a general discussion of a concept, process or transaction and not official pronouncements of law or directives. Nevertheless, IPUs provide useful guidance on what the IRS is prioritizing and how IRS examiners will approach topics in an audit situation. An awareness of the topics, issues, technical foundations and conceptual approaches outlined in IPUs can assist U.S. taxpayers in structuring their intercompany transactions with foreign related parties as well as preparing for potential IRS examination of their Federal income tax returns.
 

Overview of IPU

IRC 482 focuses on the allocation of income and deductions among taxpayers. While adjustments can be made to both inbound and outbound transactions, this IPU focuses on inbound transactions from a foreign parent to a U.S. subsidiary. The IPU outlines the three situations under which U.S. taxpayers are allowed to invoke IRC 482:
  • On a timely filed U.S. income tax return, the taxpayer is reporting the results of a transaction which are different than the actual prices charged, but is doing so to clearly reflect an arm’s length result.
  • In appropriate circumstances, the IRS may permit amended returns that increase taxable income if the results are otherwise arm’s length.
  • A taxpayer can request a setoff when the IRS proposes an IRC 482 allocation. The setoff transactions must be between the taxpayer and the same controlled party involved in the proposed IRC 482 adjustment, be in the same tax year and follow certain procedural requirements.

 

Note that taxpayers are not allowed to file an untimely or amended return that decreases U.S. taxable income based on allocations with respect to controlled transactions.
 

Application of IRC 482

  • Self-Initiated Adjustment

    Many inbound transactions from a foreign parent to a U.S. subsidiary involve transactions based on fixed prices set at the start of a tax year. If at the end of the tax year the U.S. subsidiary determines that these prices have not produced an arm's length result, the U.S. subsidiary may increase or decrease its taxable income to reflect an arm's length result. The foreign parent's records must also reflect any adjustments made by the U.S. subsidiary.

    The U.S. subsidiary should then report the adjusted taxable income on its timely filed federal income tax return, including extensions. If a U.S. subsidiary does not timely file its federal income tax return, the U.S. subsidiary is not permitted to decrease its taxable income. The U.S. subsidiary may only make a positive adjustment to taxable income when filing an untimely or amended tax return.

    The IPU notes that the U.S. subsidiary is responsible for correcting its Customs Declaration Forms to reflect any adjusted prices. Additionally, the U.S. subsidiary should be prepared to support any adjustments to taxable income made using IRC 482 with transfer pricing documentation, research studies and/or pricing analysis and verification procedures.

 

  • Setoff Adjustment during IRS Examination

    If a U.S. subsidiary is under examination by the IRS and the IRS proposes an IRC 482 adjustment, the U.S. subsidiary may claim another IRC 482 adjustment to offset the IRS proposed adjustment. This setoff adjustment is required to be an adjustment to a non-arm's length transaction in the same taxable year between the same parties to the transaction in question.
    The U.S. subsidiary must adhere to the following procedures for the setoff transaction as outlined in Treas. Reg. 1.482-1(g)(4):
    • Documenting that the setoff transaction was not arm's length;
    • Establishing the amount of the appropriate arm's length charge;
    • Documenting all correlative adjustments resulting from the setoff; and
    • Timely notifying the IRS (within 30 days after the earlier of the Notice of Proposed Adjustment (NOPA) or Statutory Notice of Deficiency).

 

If the IRS agent is in agreement that the U.S. subsidiary has properly identified a setoff adjustment and followed the proper procedures, the IRS proposed adjustment will be amended to include the setoff adjustment.
 

Treaty Implication

The IPU warns that the taxpayer's allowed use of IRC 482 may result in double taxation. If an adjustment is made that results in double taxation, the taxpayer may have access to double tax relief under Article 25 of the U.S. Model Income Tax Treaty and the Mutual Agreement Process.
 

Conclusion

Controlled groups with U.S. subsidiaries entering into transactions with foreign related parties should consider the ability to adjust taxable income as necessary to reflect arm's length pricing on intercompany transactions as part of their global tax planning strategy. As noted above, the U.S. subsidiary should be prepared to support any adjustments to taxable income made using IRC 482 with transfer pricing documentation, research studies and/or pricing analysis and verification procedures.

 

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