By Craig A. Sharon, Esq.
Bingham McCutchen LLP, Washington, DC
As I write this commentary, I just finished my first year at Bingham after leaving the IRS Advance Pricing Agreement (APA) Program, where I served for six years, including the last three years as APA director. For readers who previously served as managers in the IRS, you know that the one-year mark is a watershed event under the IRS ethics rules, which, among other things, impose on higher-level managers a one-year ban on appearing before the IRS. The good news is that now I am "legal."
The first anniversary after leaving the government is also a good time to gather one's thoughts and make some observations, because one year of private practice necessarily involves some change in perspective, but is not enough time to have forgotten the challenges (and joys) of the other side. Don't worry, this commentary is not an introspective, fluff piece about the great friends and colleagues that I left behind (many), the great satisfaction derived from public service (best job ever), or the moral challenges that arise when moving over to the "dark side," as many in the IRS call the private sector (in jest, of course). Instead, it highlights my most notable impressions about U.S. transfer pricing enforcement from my new perch on the outside, looking in.
I do not represent that these observations are particularly keen or insightful, but they do reflect a "half-in, half-out" mentality that manifested itself, for example, in my repeated use of the royal "we" when talking about the IRS during the year. It took me at least nine months to break that habit. Indeed, at an early tax conference, I agreed to buy the audience one drink for each time I referred to the IRS as "we." I still owe that audience six drinks.
In no particular order of importance, I'd highlight the following:
In short, over the past year the TPP director was promoted to "General" and given an army to fight with.
Because the IRS views the Veritas decision as turning on the specific facts of the case, IRS exam teams are now focusing like a laser on factual development in all sorts of transfer pricing audits. In theory, this new focus should be welcome news to taxpayers, which have been arguing for case-specific factual analyses for years. In reality, though, this concentration has led to increasingly detailed, overly broad, and burdensome requests for information, employee interviews, and site visits, which taxpayers are increasingly resisting, which, in turn, has led to increasing IRS threats to summons withheld information. A new balance is needed here - the latest incarnation of an age-old problem. I am partial to Sam Maruca's formulation that the factual development should focus on the IRS's "hypothesis" of the case. This approach provides some framework for discussing the proper scope of an inquiry.
Implementation of this concept can be difficult in practice, however, with exam teams continuing to insist, at least initially, on very broad, almost hit-or-miss fact-finding efforts.
The TPP has stated its intention to develop more sophisticated criteria for selecting cases and issues for audit. That's great - and a big challenge - but there is a flip side to case selection that has been mostly overlooked or at least under-estimated. That is, it's probably harder for the IRS to halt a "bad" case (i.e., a proposed audit of a low-risk taxpayer or issue) than it is to identify and pursue a "good" case. Neither is easy to do, but internal dynamics make it harder to kill the bad cases. If the decision becomes a confrontation between the national office and a local exam team that feels strongly (as they often do) about pursuing a case, it's far easier to let the exam team go about its business to preserve the long-term relationship. My impression is that the TPP is already learning this the hard way. If the TPP is serious about focusing its resources on the highest-risk cases, it will need to develop tools that improve its visibility into the Field, establish rules of engagement that give it final case-selection or at least issue-pursuit authority, and then use that authority to de-select the low-risk cases/issues chosen for audit by exam teams.
I have other items on my "observation" list - such as my perception about the effect of Mayo on the final cost-sharing regulations (explains, e.g., the more aggressive Preamble language) and why individual taxpayers get so impatient with the delays in APA case processing (because they only have one case to worry about) - but the above items seem most significant to me. Of greatest importance to the U.S. transfer pricing system, the TPP is off to a hopeful start. For sure, significant implementation challenges remain, but there is reason to be optimistic that the IRS is heading in the right direction (finally). It will take time, though, so taxpayers will need to be patient - admittedly, easier said than done.
This commentary also will appear in the April 2012 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Maruca and Warner, 886 T.M., Transfer Pricing: The Code, the Regulations, and Selected Case Law, Levey, Carmichael, van Herksen, Patton, Levi, Krupsky, and Kellar, 890 T.M., Transfer Pricing: Alternative Practical Strategies (Chapter 8, Advance Pricing Agreements, and Chapter 9, Cost Sharing Arrangements), Gleicher, 892 T.M., Transfer Pricing: Competent Authority Consideration, and Cole, Kawano, and Schlaman, 940 T.M., U.S. Income Tax Treaties - U.S. Competent Authority Functions and Procedures, and in Tax Practice Series, see ¶3600, Section 482 - Allocation of Income and Deductions Between Related Taxapyers, and ¶7160, U.S. Income Tax Treaties.
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