IRS Wants Your Euros

Last week IRS Commissioner Doug Shulman spoke to the attendees of George Washington University's annual conference on Current Issues in International Taxation. Shulman's focus on just two areas during his prepared remarks is telling. He singled out foreign asset disclosure and transfer pricing as the only two topics for his talk.

Both of these are relevant to sections of our client base so I took particular note of Shulman's published remarks on IRS' website. They signal where IRS is focused on developing new regulations and procedures to enforce existing tax law.

Foreign Asset Disclosure

IRS has long sought to close the loopholes and wiggle room that might allow US residents to send assets overseas without reporting the income earned by those assets. Earlier this year there was the much publicized case of UBS handing over the names and account details of its US customers to IRS. Several of those account holders were prosecuted on April 15, an irony not lost on the American public.

Here is the deal. If a US resident owns foreign bank accounts and an account balance exceeds $10,000 at any point during the year the resident has to report the account to IRS on an annual informational filing. IRS does this to make sure that any interest or other income from these offshore accounts is making its way onto the taxpayers income tax return each year.

IRS received broader powers this year under the Foreign Account Tax Compliance Act, but most of those provisions will not be enforced until 2012.

For law abiding US residents the moral is this. If you have relocated here from your home country to manage a subsidiary of a foreign company you may now be a US tax resident (regardless of your immigration status). If you have a bank account back home you need to let IRS know about it. While it's true that you are a small fish and that you may have nothing like the evil intent exposed in the UBS case the penalties are just too stiff to risk (up to 50% of the account value). The same goes for foreign corporations doing business in the US. Earnings from your offshore accounts may be subject to US tax and the accounts themselves may be subject to annual information disclosures.

Transfer Pricing

Transfer pricing is a completely unrelated but increasingly critical matter. Related corporations that do business with one another across borders are subject to the transfer pricing rules. Basically, transfer pricing works like this. You need to make sure that you are selling and buying goods and services from foreign related parties at prices that are similar to what an arm's length (unrelated) buyer or seller would have to pay.

These rules exist to keep corporations from gaming the tax systems in different jurisdictions. Picture a manufacturing company in India producing parts that are assembled and sold by a sister company in the United States. If India has a really low tax rate and the US has a really high tax rate there is an incentive for the Indian company to charge an exhorbitant price for the parts. This would produce bumper profits in India and only marginal profits in the US thereby reducing the combined companies' total taxes. Transfer pricing exists to prevent such arrangements.

For businesses that are either US subsidiaries of foreign parents or who have foreign subsidiairies themselves the lessons are clear:

1. Document how prices between related parties are set and update the documentation every time the pricing changes.


2. Change pricing to reflect market conditions. A transfer pricing arrangement that hasn't changed in ten years is ripe for audit.


3. While transfer pricing audits are usually reserved for larger companies greater efficiency in this area means IRS will be able to do more audits. Smaller companies are less likely to invest in the documentation process and are more likely to fall prey to audit adjustments.


4. Transfer pricing isn't just a concern for large, multi-national manufacturers. An area that has been getting increasing scrutiny is the fees companies charge one another for intellectual property. Knowledge based small businesses like software developers and professional services providers need to pay attention to their transfer prices with overseas sister, child or parent companies.

Over the last few years it has been hard to divine the direction of tax policy, but at least in this case IRS is giving us a glimpse of its enforcement playbook. Companies of all sizes would do well to pay attention.