Bloomberg Law Quotes Clark Armitage on IRS Using Economic Substance Doctrine

One of the IRS’s tools for pursuing companies in transfer pricing disputes is turning out to be harder to use than it looks.

Over the past couple of years, the agency has said it would use the economic substance doctrine — the idea that transactions must have a real business purpose to qualify for tax benefits — to press its case in litigation and audits over transfer pricing, or the way transactions between parts of the same company are priced and taxed.

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Typically, the IRS relies on Section 482, which governs transfer pricing, in examining companies’ related-party transactions. But the IRS wants its agents to think more broadly than that, said Caplin & Drysdale attorney Clark Armitage. “I think the IRS is saying, don’t limit yourself to transfer pricing analysis, think about alternatives.”

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Economic substance doesn’t seem to fit with the kinds of misdeeds that transfer pricing enforcers are looking for, some say. An economic substance argument is more likely to win in cases that look like “manufactured structured deals” with some tax objective that complies with the letter of the law but not the spirit, Armitage said, and “transfer pricing is not that.”

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