IRS Faces Big Decisions to Update the 482 Transfer Pricing Rules
It has been over a year since the Tax Cuts and Jobs Act ("TCJA") was enacted. The transfer pricing rules set forth in the treasury regulations with respect to IRC Sec. 482 ("the Section 482 regulations") have remained relatively unchanged since 1986. Nonetheless, multinational corporations doing business within the United States have had to ensure that their transfer pricing strategies are compliant with the TCJA.
A critical issue that affects multinational corporations is the TCJA's updated and expanded definition of intangible property, which is defined in IRC Sec. 367(d)(4). The definition of intangible property has been expanded to explicitly include "goodwill, going concern value, or workforce in place." Temporary Regulation Section 1.482-1T, issued September 2015, attempted to aggregate transactions as necessary to reflect "all value provided between controlled taxpayers in a controlled transaction.” The IRS has struggled to use aggregation or realistic methods to defend its intangible valuation methods in court. Due to the definition of intangible property, the IRS has met many challenges when trying to enforce the Section 482 regulations in cases involving high-profit intangible property transfers. The IRS will likely face more challenges due to the updated and expanded definition of intangible property under the TCJA. Certain intangible assets that do not fall under the broad definition are transferrable free of charge.
The 2017 case of Amazon.com v. Commissioner was a significant case involving intangible property and cost sharing. Amazon.com transferred property to its European affiliate and agreed to share future intangible development costs. The court debated the proper amount of the European affiliate's buy-in obligation with respect to the transferred property (including technology, trademarks, and customer information) for income tax purposes. It was such a notable case that, following the settlement of the case in favor of Amazon, the TCJA replaced IRC Sec. 936(h)(3)(B) (which allowed transfers of intangibles to be treated as sale of property) with a new definition under IRC Sec. 367(d)(4) that includes goodwill, going concern value, and workforce in place. This new definition signifies a larger scope of intangible property that may be taxed and brings into light how intangible property will be transferred between multinational corporations and their respective affiliates. The question now becomes whether the post-TCJA definition of IRC Sec. 367(d) intangibles overrides the tax court ruling siding with Amazon in its application of the cost-sharing methods. As a result, in April 2019, the IRS began appealing the case in attempt to re-assess the valuation of the intangible property at the center of this case.
In addition to reconciling the post TCJA changes to IRC Sec. 367(d) with IRC Sec. 482 concepts under cost-sharing, other challenges have arisen from updating the U.S. transfer pricing regulations. One such challenge is revising the regulations so that they align better with the Organisation for Economic Co-operation and Development ("OECD") transfer pricing guidelines on certain low value adding services. The OECD transfer pricing guidelines provide a simplified method involving safe harbor rules for low value adding services, while the U.S. transfer pricing regulations simply provide the services cost method ("SCM") as a means of regulating the low value adding services. One proposed method suggests utilizing a safe harbor markup rate and a materiality threshold for the low value adding services that would reduce compliance costs and enable taxpayers to focus their analysis on the cost base. In turn, this would allow the IRS to better prioritize its enforcement resources.
There are many arguments on the interpretation of the impact of the TCJA on the transfer pricing regulations. The transfer pricing regulations are based upon the concept of searching for and applying the best method to define the appropriate arm's length intercompany policy. As the transfer pricing regulations have been fundamentally the same since 1986, the IRS is in urgent need to update the Section 482 regulations in light of TCJA and alignment with the OECD guidelines. According to the IRS guidance plan, the IRS is working on "regulations addressing the changes to [Sections] 367(d) and 482" as part of its ongoing TCJA implementation effort. The regulations will presumably reflect the TCJA's expanded definition of intangible property under IRC Sec. 367(d)(4) and amended IRC Sec. 482, which now explicitly authorizes valuation of intangible transfers on an aggregate basis or use of realistic alternatives to the transaction. Whether more fundamental changes are forthcoming is unclear, but IRS officials have in the past pondered the need for a rewrite in response to the IRS's poor litigation record and practitioners have suggested there is ample room for improvement. In light of these expected future changes to the Section 482 regulations, multinational corporations should (at a minimum) assess their current transfer pricing positions and take into account the potential implications of the post-TCJA definition of IRC Sec. 367(d).