More States Tooling Up for Transfer Pricing Audits

May 17 — Multinational corporations should expect plenty of new transfer pricing audits from state revenue departments in response to perceived revenue losses and new tools for sharing audit information, two senior EY LLP tax practitioners said.

In addition, the practitioners warned of heightened scrutiny by revenue authorities in developing nations that previously lacked the sophistication to pursue complex transfer pricing audits.

Jeff Saviano, EY's Americas Tax Innovation Leader, said state revenue departments have become increasingly frustrated by multinational taxpayers’ use of tax havens and income shifting strategies. With the exception of California and a few other large states, Saviano said most revenue departments simply don't have the sophistication to handle complex transfer pricing audits.

But Saviano said that environment is shifting quickly, due in part to new tools that will become available from the Organization for Economic Cooperation and Development's base erosion and profit shifting action plan.

“You can see this train coming down the tracks. It is motivated by OECD and BEPS. It is motivated by loss of revenue,” Saviano said May 17 during EY's Domestic Tax Conference in Chicago. “I think this is going to stick.”

MTC Initiative

More importantly, Saviano pointed to the Multistate Tax Commission’s recently approved Arm's-Length Adjustment Service (ALAS). The service is intended to support states’ tax compliance efforts in circumstances where corporate taxpayers engage in improper income shifting (24 Transfer Pricing Report 1579, 4/14/16).

Only six states have committed to the ALAS process—Alabama, Iowa, Kentucky, New Jersey, North Carolina and Pennsylvania—but Saviano predicts that more will join shortly.

“I think more states are going to fund it,” he said. “I think you will see more audits and attacks on your transfer pricing than you have in the past. I think that is virtually guaranteed.”

Saviano also warned of state-level activism with regard to purported tax havens after nearly a dozen states enacted laws to address the problem in the past year .

“There were five states in 2014 and 15 states last year,” he said. “This is reaching a tipping point.”

Saviano said the state statutes feature either a “facts-and-circumstances” approach, or a “blacklist” approach. State laws featuring such blacklists generally require the corporate taxpayer filing a combined return to include the taxable income and apportionment of unitary affiliates incorporated in jurisdictions purported to be tax havens. The approach has been controversial in some states. Connecticut, Oregon and the District of Columbia attempted to implement blacklists in their statutes, but later repealed such provisions.

Developing Nations

Michael Mundaca, co-director of EY's National Tax Department, said multinationals should prepare for potential transfer pricing audits by revenue agencies in developing nations.

“It is an issue in developing countries where they do not have the resources to make these sophisticated transfer pricing analyses,” Mundaca said. “But with the increased information reporting available in country-by-country reports, by other BEPS-related initiatives, I do think those countries will—even with lesser resources—be more aggressive in transfer pricing.”

Mundaca said the scrutiny from these jurisdictions could come quickly.

“I think very soon we will see the first wave of information requests as well as enforcement,” he said.

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bna.com

To contact the editor responsible for this story: Ryan Tuck at rtuck@bna.com