Financier Worldwide Indepth Feature: Global Tax 2024

Clark Armitage offers insights in Indepth Feature: Global Tax 2024 for the June 2024 issue of Financier Worldwide Magazine.

Q: Could you outline what you consider to be the key developments relating to tax regulations that you have seen in your country of focus over the last 12-18 months?

Armitage: In December 2023, the Internal Revenue Service (IRS) published a general legal advice memorandum (GLAM), which took the position that the interest rate on related-party borrowings must be adjusted to account for implicit support. The GLAM provides an example: if a group member would pay 10 percent interest based on its standalone credit rating, but a third party would lend to the subsidiary at 8 percent based on an expectation that the group parent would not allow the subsidiary to default, the arm’s-length rate on related-party borrowings is then 8 percent. In practice, IRS audit teams have recently been using the parent or group’s credit rating to determine the interest rate on subsidiary debt. The GLAM makes clear that this is not the appropriate analytical approach. Instead, an implicit support adjustment should consider the borrower’s role, level of integration within the group and implicit support from affiliates. According to the GLAM, the parent could have borrowed at 7 percent rather than 8 percent. As with all things transfer pricing (TP)-related, the facts matter. Defending an audit of the issue requires drawing out those facts.

Q: What factors are driving the political agenda on tax-related decisions? Does there seem to be a motivation to get tougher on tax enforcement, for example?

Armitage: The 2021 Inflation Reduction Act awarded the IRS additional funding of $80bn over 10 years. The IRS published a strategic operating plan indicating that it would dedicate $46bn of that to increase and improve enforcement. The IRS identified key areas of focus, including increased numbers of audits of large corporations, large partnerships and high net worth individuals, better use of data to risk-assess and select returns for audit, and identifying high-risk issues, such as complex and emerging issues and issues likely to involve low rates of voluntary compliance. An overall goal of these enforcement initiatives is to increase fairness through a balanced approach. In reality, much of the expanded budget has not become available to the IRS due to later legislative developments, and it is not clear that there have been substantial increases in audit rates.

Q: To what extent is transfer pricing a key challenge for multinational enterprises? Are too many companies underestimating the importance of compliance and risk management in this area?

Armitage: TP has long been a key area of focus for the IRS. Many of the large dollar tax cases in litigation involve TP adjustments, including multibillion adjustment cases involving Coca-Cola, Microsoft, 3M, Eaton, Medtronic, Facebook and others. The IRS recently signaled a reduced interest in TP. It will no longer always request TP documentation at the start of an audit. We have seen this occur in practice, but only for companies that seem to have addressed their material TP situations, such as through advance pricing agreements (APAs). Tax directors should thus continue to focus attention on TP and consider use of APAs to mitigate audit risk.

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