How is a transfer pricing dispute resolved with the IRS?

A transfer pricing dispute can be resolved in several ways. A U.S. company may choose the approach that best fits its circumstances. For example, a U.S. company may use a mutual agreement procedure to address double taxation for its foreign-related companies.

The following are some of the ways to resolve a transfer pricing dispute with the IRS.

Resolution during IRS Examination

The dispute may be resolved directly with the examination team. This may happen if the taxpayer’s additional documentation or analysis persuades the IRS to drop or reduce the proposed adjustment. This is generally the fastest and least costly outcome, and it avoids escalating the matter to Appeals or court.

Resolution through Appeals Settlement

If the case goes to the IRS Independent Office of Appeals, the taxpayer and the IRS may agree on a settlement after considering the strengths and weaknesses of both sides and the risks of taking the case to court.

However, settling the dispute with the IRS does not automatically resolve any tax issue in the foreign country. The same income could still be taxed by the foreign tax authority, potentially resulting in double taxation.

Mutual Agreement Procedure (MAP)

The Mutual Agreement Procedure (MAP) can be particularly important when a transfer pricing adjustment creates double taxation in the U.S. and the foreign country.

For example, suppose the IRS increases a U.S. company’s income by $10 million because it believes the company paid too much to its foreign affiliate. If the foreign country does not make a corresponding adjustment to the affiliate’s income, the same $10 million may effectively be taxed in the foreign country as well. This may result in double taxation.

Resolution through MAP is usually provided under the U.S. tax treaties. If an applicable U.S. tax treaty provides MAP protection, the taxpayer may request assistance from the U.S. competent authority.

The U.S. competent authority handles transfer pricing MAP cases through the Advance Pricing and Mutual Agreement (APMA) Program. The procedures for requesting assistance from the U.S. competent authority are generally set out in Revenue Procedure 2015-40.

MAP is a government-to-government process. The taxpayer does not directly negotiate the case with the foreign tax authority, but remains involved by providing information, explaining its position, and responding to requests from the competent authorities.

MAP may result in full or partial relief from double taxation. However, there is no guarantee that the competent authorities will reach an agreement.

Taxpayers should consider MAP early before an IRS Appeals settlement, court decision, or other action. This is because it may affect the taxpayer’s ability to obtain relief from the competent authority. Some U.S. tax treaties also contain mandatory arbitration provisions for certain MAP cases when the competent authorities cannot reach an agreement.

Litigation in U.S. Courts

If a transfer pricing dispute cannot be resolved through the IRS examination process, Appeals, MAP, or another administrative process, the taxpayer may consider litigation.

If a transfer pricing dispute reaches the litigation stage, the taxpayer generally has two main options, which are as follows:

• Challenge before the U.S. Tax Court
  The IRS may issue a Notice of Deficiency to the taxpayer, determining additional tax due because of a transfer pricing adjustment. In this case, the taxpayer may file a petition with the U.S. Tax Court. The taxpayer can generally challenge the proposed additional tax in Tax Court without paying the disputed amount first.

• Challenge before the U.S. Court of Federal Claims or U.S District Court
  Alternatively, the taxpayer may pay the additional tax resulting from the transfer pricing adjustment. They may file a refund claim with the IRS. If the claim is denied, the taxpayer may bring a refund lawsuit in the U.S. Court of Federal Claims or U.S. District Court.

Transfer pricing litigation is usually complex and fact-intensive. Courts may consider the following factors:

• The functions performed, assets used, and risks assumed by each related party;
• The transfer pricing method selected under the best method rule;
• The reliability of comparable companies or transactions;
• The valuation of intellectual property and other intangible assets;
• Intercompany agreements and the actual conduct of the parties; and
• Expert economic evidence.

Litigation can take years and can be expensive. It can also make the dispute public. As a result, taxpayers often consider administrative and treaty-based resolution options before going to court.

Next, let’s look at some recent high-profile transfer pricing disputes in the United States involving multinational companies and understand how these disputes can have a significant financial impact on the companies involved.