1. Global increase in transfer pricing audits – In 2009 the IRS hired scores of additional agents, particularly international examiners and economists, with the intention of expanding audits of large and mid-size corporate taxpayers – particularly those in the middle-market. The U.S. was not alone. Around the world, tax authorities increased their numbers of cross-border examiners in 2009 and beyond. Of the countries with the most aggressive additions of audit related personnel, key U.S.-trading partners Brazil, Mexico and China have signaled an increase in transfer pricing audits in the coming year. Multinational enterprises must anticipate that IRS initial documentation requests will include a request for transfer pricing documentation and be prepared to respond to such requests within 30 days of the request. Other countries will have similar, if not, shorter response times. Moreover, failing to respond in many cases is tantamount to being non-responsive. The days of “just-in-time” transfer pricing documentation are over.
2. Intellectual property and cost-sharing – On December 31, 2008, the U.S. Treasury released the new temporary cost-sharing regulations under Treas. Reg. §1.482-7T. The Temporary Treasury Regulations are hardly taxpayer-friendly and represent the increased scrutiny U.S. multinationals will face with respect to arrangements to share costs and the global structuring and alignment of intellectual property portfolios going-forward. In order to “grandfather” cost-sharing arrangements in place prior to the January 5, 2009 effective date, taxpayers had until July 6, 2009 to conform their existing cost-sharing arrangements to the requirements contained in the new temporary regulations with certain adaptations. The key for U.S. multinationals in 2010 is to remain vigilant with respect to existing cost-sharing arrangements and events that may trigger an arrangement – particularly important as M&A deal flow likely increases during the coming year in response to a (hopefully) reviving economy.
3. Codification of Economic Substance – The proposed bill codifying the Economic Substance Doctrine is still alive in the House and will likely find its way into law sometime in 2010 – either in the form of the ultimately enacted healthcare bill or in another piece of legislation. U.S. taxpayers must critically examine the transaction structuring and planning which has provided tax benefits and be prepared to produce documentation and other evidence showing the non-tax business purpose justifying the underlying transaction and attendant structuring.

The stakes are rising for multinational enterprises as the world is getting smaller and tax authorities are sharing information at unprecedented levels. Thus, the best defense is a well-crafted offense that is integrated contemporaneously with acquisitions, divestitures and/or restructurings. The days of operational autonomy for multinational enterprises are over.

At the recent LMSB Financial Services industry seminar in New York City, Kathy Robbins, LMSB field operations director (financial services industry) and Stuart Mann, Program Director for Withholding Taxes, noted that cross-border payments and compliance related to those payments will continue to be an area of emphasis and may well become a national program.

A subgroup of IRS personnel is working to develop a matching program for Form 5471 filings and annual Form 1042 filings to cross-reference this information to ensure that proper reporting with respect to Form 1042 has occurred. It also appears that the Form 5471 information will continue to be relevant in other areas as well, such as with respect to transfer pricing documentation. LMSB examiners have often found “gaps” in the information reported on Form 5471 and the taxpayer’s transfer pricing documentation under Section 6662. Thus, taxpayers and their advisors are well advised to review the content of their Forms 5471 filings with their Form 1042 filing and their transfer pricing documentation to ensure that there is consistency in this information.

Bear in mind that there are legitimate reasons for inconsistencies between amounts reported on Forms 5471 and Form 1042 and what is included in the taxpayer’s transfer pricing documentation. For example, transfer pricing documentation includes all intra-group transactions, not just U.S. sourced-fixed, determinable, annual or periodic income (“FDAP”) paid to non-U.S. persons – what is reported on Form 1042.

Given the IRS’ recent success with its withholding efforts and the fact that withholding is now a tier-I LMSB initiative, taxpayers and their advisors would be well advised to consider reconciling the information on Forms 5471/5472 with the information contained in their transfer pricing documentation, as unaccounted for items on Forms 5471/5472 may give rise to penalty exposure in the event of an adjustment on examination.

While the jury is still out on this matter (sorry, just couldn’t help myself), anecdotal evidence seems to suggest that if the IRS has its way the trend will be toward greater information sharing among the G20 tax authorities. So what, you ask? Well, think about this: IRS Commissioner Schulman is working diligently with the Leeds Castle Group to promote coordinated examinations of multinationals. If the IRS is successful in its bid to promote cooperation among the tax authorities of major U.S. trading partners, one of the likely outcomes will be increased scrutiny of cross-border planning and transactions, especially transfer pricing. Consequently, documentation of cross-border planning will need to be consistent among jurisdictions and will need to align more closely with business operations. Otherwise, there will be significant enterprise risk. While it remains to be seen if the IRS will be successful in its endeavors, early indications show that they likely have the momentum to succeed. If the global economy continues to contract, it seems probable that cooperation will increase among tax authorities if for no other reason than resource constraints. However, it’s not likely to take them long to conclude that, working collaboratively, taxpayer information can be leveraged across multiple jurisdictions to reduce the amount of time and effort required to audit a multinational enterprise. Only time will tell whether the cooperation seen in the UBS Case is an aberration or a paradigm shift.

- RBJ