International tax disputes raise the stakes on the burden of proof considerably. The taxpayer may have the burden of proof to substantiate positions involving foreign transactions, transfer pricing, and cross-border arrangements. They often rely on records held abroad that are difficult to obtain and present before a U.S. court.
Next, let’s understand the burden of proof in producing foreign documents and how that affects the taxpayer’s case.
In tax proceedings, the taxpayer generally bears the burden of proof under Tax Court Rule 142(a). This rule generally applies to any taxpayer who is the petitioner in a U.S. Tax Court proceeding. This may include a U.S. person or a foreign person.
Under IRC § 982, Formal Document Requests (FDRs), failure to produce foreign-based documentation within 90 days may result in the taxpayer being barred from introducing that evidence (or related evidence) in court proceedings. This rule applies in any court with jurisdiction over a civil proceeding in which the tax treatment of the item under review is at issue. This may apply to all three courts: the U.S. Tax Court, the U.S. Court of Federal Claims, and the U.S. District Court.
The initial burden of proof is on the IRS to first show that the request for foreign documents is relevant to the audit and that it followed proper procedures.
Under Tax Court orders under § 7456, Courts can compel the production of foreign records held by entities under the taxpayer’s control.
In practice, failure to produce foreign records significantly weakens the taxpayer’s position and may lead courts to uphold the IRS’s adjustments under the presumption of correctness.
The IRS may issue a deficiency notice to the taxpayer based on a § 482 adjustment. Here, the taxpayer must show that its intercompany pricing satisfies the arm’s-length standard (Treas. Reg. § 1.482-1(b)). Also, the taxpayer bears the burden of proving that the IRS’s allocations are unreasonable.
Here, the term “taxpayer” may include any taxpayer, whether based in the U.S. or outside the U.S., whose transactions are challenged in U.S. tax proceedings.
The IRS’s determination in a notice of deficiency is presumed correct, and the taxpayer should rebut it with affirmative evidence.
Strong, contemporaneous documentation significantly strengthens the taxpayer’s ability to meet its burden.
Without adequate documentation, the taxpayer faces heightened difficulty in sustaining its position, increased penalty exposure, and a practical shift in evidentiary burden.
The Economic Substance Doctrine, found in IRC Section 7701(o), is a tax rule that prevents taxpayers from claiming tax benefits for transactions undertaken primarily to reduce taxes. Under the doctrine, the IRS may deny the tax benefits if a particular transaction has no real business purpose or meaningful economic effect other than saving on taxes. Generally, the burden of proving economic substance falls on the taxpayer.
When the IRS challenges a transaction for lack of economic substance, the taxpayer is required to demonstrate that the transaction meets these requirements.
Codified in 2010, the doctrine requires the taxpayer to prove that a transaction has both:
This applies to any taxpayer, whether U.S.-based or foreign, whose transactions are challenged in U.S. tax proceedings.
Failure triggers automatic application of certain penalties under IRC § 6662(b)(6), often incentivizing settlement over litigation.