Clark Armitage Talks to Tax Notes on IRS's New Transfer Pricing Regulatory Projects
Although transfer pricing regulatory projects have become a recurring part of the IRS's annual priority guidance plans, the latest plan refers to a series of new projects that suggest more far-reaching changes could be coming.
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Another, very different, possibility is that the amendments could create a regulatory safe harbor allowing U.S. multinationals to comply with the OECD inclusive framework on base erosion and profit shifting's pillar 1 agreement, according to J. Clark Armitage of Caplin & Drysdale. Although the prospects of ratification for a multilateral convention amending the nexus, profit attribution, and transfer pricing articles of all of the United States' bilateral tax treaties are unclear, the large U.S. multinationals that fall within the scope of pillar 1 will still be taxable on amount A in most other countries, Armitage said. Under the approach to pillar 1 accepted by 137 of the 141 members of the inclusive framework and approved by the G-20, multinational groups with more than €20 billion in global revenue and pretax profit that exceeds 10 percent of revenue will be required to allocate 25 percent of the profit in excess of that threshold to market jurisdictions.
“If these 100 taxpayers are in 150 jurisdictions and the only country that hasn’t adopted amount A into its law is the U.S., then that’s the law. Short of that, there's going to be double tax,” Armitage said.
To avoid subjecting these multinationals to double taxation if the pillar 1 multilateral convention is not ratified in the United States, Treasury and the IRS could create a safe harbor for companies that allocate profit in accordance with pillar 1, according to Armitage. Such a safe harbor would essentially accept pillar 1's profit allocation rules as the best method for section 482 purposes and forego the right to make transfer pricing adjustments concerning the multinational group's allocation of income from intangibles, Armitage said. The planned amendments to the section 482 regulations' provisions on risk allocation and periodic adjustments could also be elements of a pillar 1 safe harbor, he added.
"Maybe what this is is a regulatory project set up in anticipation that the OECD pillar 1 work will be finalized and agreed, and then [implemented]. They could say, 'Here's how we'll make that happen: We’ll do it by treating [pillar 1] as a de facto best method in connection with the allocation of intangible profits from marketing and distribution, and in order to do that we’ll need more discretion about how we view and think about the allocation of risks,'” Armitage said. “And then we may dispense with periodic adjustments if you’ve come in and taken that deal, so it’s a carrot-and-stick approach to getting the authority to agree with other countries on implementation of pillar 1 through a dispute resolution mechanism.”
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The planned amendments on risk allocation could simply comprise refinements to reg. section 1.482-1(d)(3), which provides that controlled taxpayers' contractual allocation of risk will be respected unless it is inconsistent with economic substance and establishes the criteria for assessing substance. The amendments also could, as proposed by Armitage, represent another piece of a safe harbor designed to accommodate pillar 1, or they could be part of the fundamental redefinition of the arm's-length standard suggested by Avi-Yonah.
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The last of the three sets of amendments deals with periodic adjustments, although the priority guidance plan says nothing at all about what the amendments might be intended to achieve. If they are not part of a reformulation of the arm's-length standard or a quid pro quo for opting to adhere to pillar 1, they could simply be intended to clarify a vague provision, according to Armitage. In a provision that purports to implement the "commensurate with income" standard added to section 482 by the Tax Reform Act of 1986, reg. section 1.482-4(f)(2) generally allows the IRS to make adjustments based on the profit actually realized in an intangible transfer if the realized profit deviates from the profit projected at the time of the transfer by more than 20 percent.
“Particularly for younger, smaller companies with less predictable cash flows and no really good comparables, you basically have perpetual uncertainty because your transaction could always be subject to adjustment,” Armitage said. “And to give more guidance on what's required for periodic adjustments not to apply would be extraordinarily helpful for taxpayers, so to give a little more architecture to that might be a sensible thing.”
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