February 12, 2024
United States | IRS sending out more letters regarding transfer pricing compliance
EY is aware that the IRS is continuing to send letters to certain US-based subsidiaries of foreign-owned corporations asking about their intercompany transaction pricing. The letters (Letters 6607 and 6608) have gone out mostly to corporations that distribute goods in the United States, and in limited instances, to corporations that manufacture goods in the United States. These letters stem from the corporations' alleged use of certain transfer pricing strategies that the IRS may deem improper.
Based on press reports, the IRS has sent out about 180 such letters since November 2023.1 IRS Commissioner Danny Werfel said in a recent interview that addressing these transfer pricing strategies is a "high priority."2
The IRS had announced (IR-2023-194) on October 20, 2023, that it planned to send letters to approximately 150 US-based subsidiaries (see Tax Alert 2023-1907). The IRS updated this number to 180 in January 2024.
The letters respond to information reported on Form 1120, U.S. Corporation Income Tax Return, and Form 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade of Business, when taxpayers report losses or low margins for tax years 2017—2021. The letters say that losses or low margins indicate that the intercompany transaction pricing may not comply with IRC Section 482.
Letter 6607 instructs taxpayers to evaluate their transfer pricing policy, intercompany agreements, financial results, and Form 1120 to confirm they have complied with IRC Section 482, and then complete and submit "Response to Letter 6607" and return it with the applicable attachments by a designated date. Taxpayers that do not return an adequate response by the due date may be referred for examination. Letter 6608 has similar instructions but requires a response only if the taxpayer determines it did not comply with IRC Section 482 and files an amended return.
Taxpayers should consider responding to these IRS compliance letters to avoid potential examinations and engage with the IRS proactively. In addition, taxpayers should also consider doing a health check on their intercompany transaction pricing, confirming that their internal workpapers support accurate and robust transfer pricing documentation.
The IRS has been asserting penalties more frequently for taxpayers' not maintaining sufficient documentation to meet the reasonableness standard under Treas. Reg. Section 1.6662-6(d)(2)(iii).