The Internal Revenue Service lacks a strong operation to audit a critical international tax compliance area, according to a watchdog report released Thursday.
At issue is transfer pricing, a cost structure used by multinational companies to price goods and services they sell to subsidiaries in foreign locations.
The IRS requires businesses to report transfer pricing transactions because the practice can be used to deflate profits in the U.S., thereby avoiding high corporate taxes.
“The principal tax policy concern regarding aggressive transfer pricing is that it does not reflect an arm’s-length result from a related party transaction, causing multinational corporation profits to be intentionally inflated in low-tax countries and reduced in high-tax countries,” the Treasury Inspector General for Tax Administration (TIGTA) said in a Sept. 28 report made public Thursday.
The inspector general's findings follow a recent IRS announcement of collecting around $10 billion from more than 100,000 compliant taxpayers under its offshore voluntary taxpayer compliance program.
Transfer pricing reporting is also a key component in a major global tax compliance initiative led by the Organization for Economic Cooperation and Development (OECD) and G-20 countries.
The U.S. is among participating countries and Treasury Secretary Jacob Lew has been advocating for the initiative as a way developing countries can work together to crack down on multinational companies attempting to commit questionable tax practices.
However, the inspector general report said the IRS does not have a solid operation to audit transfer pricing transactions.
Among the major issues: a lack of communication between units in charge of transfer pricing information, adherence to an audit toolkit called a “roadmap” and rules within the operation.
The inspector general also found that some employees do not have access to a system called the specialist referral system, which generates 20 percent of the transfer pricing referrals.
The IRS agreed with most of TIGTA’s five recommendations in the report, including giving business taxpayers access to the “roadmap” when the agency is about to audit their transfer pricing report.
However, the IRS disagreed with the “roadmap” being used as the primary tool for reviewing cases.
"Each transfer pricing case is unique," Douglas W. O’Donnell, commissioner of the IRS's large business and international division, wrote in a Sept. 15 letter responding to the watchdog's findings.
In the same letter, O’Donnell also said the IRS disagreed with TIGTA that employees having access to the specialist referral system will improve the transfer pricing audit process. Instead, the agents in "geographic practice areas are responsible for making a referral for specialized review on cases with international aspects," he wrote.
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