Internal Revenue Service examiners confront some steep barriers when trying to audit the transfer pricing strategies used by multinational corporations to reduce their taxes, according to a new report.

The report, from the Treasury Inspector General for Tax Administration, found that some IRS employees may not be consistently following the IRS's Transfer Pricing Audit Roadmap, which the IRS developed to provide its examiners with a set of audit techniques and tools to help them do examinations of multinational transfer pricing. The IRS also doesn't have a process in place to make sure all transfer-pricing issues are identified for specialized review by IRS experts.

Transfer pricing is used to set a price for goods or services that are sold between two parts of the same multinational company. However, such pricing might not reflect the result of an arm’s length transaction. Instead it's really more like a related-party transaction and may allow the profits of a multinational corporation to be inflated in low-tax countries and reduced in high-tax countries.

IRS audits of transfer pricing transactions aim to improve taxpayer compliance. However, employees in the IRS's Transfer Pricing Practice don't have access to a Specialist Referral System to deal with such complex transactions and they need to rely on managers within the IRS's International Business Compliance function to share any transfer pricing referrals with them.

TIGTA also found that the rules of engagement between the TPP and the IBC function are not always being followed for working on transfer pricing-related examinations. There are no separate performance measures to weigh the success of the IRS’s transfer pricing efforts.

For the report, TIGTA tried to quantify the ultimate impact of the IRS’s transfer pricing compliance efforts. But the IRS does not track the amount of proposed transfer pricing adjustments or the outcomes of transfer pricing issues.

As part of the audit, TIGTA identified all of the cases from 2012 through 2014 that included at least one transfer pricing issue with appealed adjustments. It found that, out of about $10.5 billion in proposed adjustments, the IRS Office of Appeals reduced the original proposed adjustment amounts by $8.5 billion. In the end, only about $321 million was ultimately assessed on those taxpayers for transfer pricing and other tax issues.

In its report, TIGTA recommended the IRS make sure its employees follow the Transfer Pricing Audit Roadmap, and include it as part of the quality review process. The IRS should also ensure that TPP employees have full access to the Specialist Referral System, TIGTA suggested, and the agency should also ensure that TPP and IBC function employees follow the rules of engagement, and include it as an attribute of the quality review process. The IRS should also develop a formal transfer pricing strategy, the report suggested, and implement a post-mortem review of examinations with transfer pricing issues that went through the Appeals process.

“International tax noncompliance is an area of strategic focus for the IRS,” said TIGTA Inspector General J. Russell George in a statement. “By improving the efficiency of its transfer pricing examination process, the IRS can make important progress in achieving its goal of reducing the international Tax Gap.”

The IRS agreed with some of the recommendations, but disagreed with others. IRS management said they specifically track and monitor transfer pricing examinations and adjustments, but identifying the assessment results of compliance efforts by issue would require modifying several existing systems and require a substantial expenditure of funds from the budget-crunched agency. However, TIGTA pointed out that in a response to one of its previous reports, a manager of the IRS's Large Business and International Division agreed to provide compliance results by issue from the Issue Based Management Information System for use by the practice areas in the development of campaigns.

In response to the new report, Douglas W. O'Donnell, commissioner of the IRS's Large Business and International Division, agreed that transfer pricing compliance is a major problem.

“Transfer pricing is a significant compliance issue facing the IRS,” he wrote. “Indeed, as noted in your report, transfer pricing issues account for a significant percentage of international issues being worked and a substantial portion of potential dollar adjustment. And, while cross-border trading between related parties and foreign investments by U.S. persons continue to increase over the last several years, our enforcement resources for dealing with any inappropriate or aggressive transfer pricing issues resulting from these transactions continues to decrease, effectively limiting the amount of United States revenue that the IRS can ultimately protect.”

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