Taxpayer Beware

Expect fewer tax audits of individuals and smaller companies and more audits of larger companies, says one observer, as the Internal Revenue Service goes after the ''low-hanging fruit.''

The tax man is knocking on doors. In June, the Internal Revenue Service informed Motorola that the global communications giant owed an estimated $500 million in back taxes due to transfer-pricing errors. The IRS is also taking a hard look at pharmaceuticals giant GlaxoSmithKline for alleged transfer-pricing problems. The agency says the London-based company owes the United States an estimated $5.2 billion (yes, with a “b”) in back taxes and interest on profits its U.S. unit earned between 1989 and 1996.

Is this a sign that the IRS is trying to make up for its own resource constraints by enforcing existing tax law more aggressively? Attorney Louis Marett thinks so. “They are looking for the low-hanging fruit,” says the chairman of the tax-practice group at Testa, Hurwitz & Thibeault LLP, in Boston. He expects the IRS to go where the money is, conducting fewer audits of individuals and smaller companies and more audits of larger companies.

In particular, says Marett, the agency will focus on tax shelters and transfer pricing. The IRS is making good on a May 2003 directive aimed at curbing transfer-pricing abuses. The practice, which involves the sale of goods from one business unit to another in a different country, is a notoriously gray area that has often confounded regulators. The agency has tried to address the issue at the pre-audit stage with its advance pricing agreement program, in which companies can agree with the IRS on appropriate pricing levels prior to filing their tax returns. Marett says “dozens and dozens” of companies are participating in the program.

In Motorola’s case, the IRS claim arose from a field audit of the company’s operations from 1996 to 2000. The agency argues that the company didn’t record enough of its profits in the United States during the period, and thus underpaid taxes on those proceeds. Motorola CFO David Devonshire calls the dispute routine. “Like all companies doing business internationally, we are audited each year covering many issues, including transfer pricing,” he says. He adds that the company resolved a disagreement arising from the same audit in the second quarter, which resulted in a $197 million addition to net income from reserves that had been set aside for tax adjustments. Motorola has said it intends to “vigorously dispute” the latest charge. (The IRS declined to comment.)

GlaxoSmithKline plans to contest the IRS’s claim, and says it expects a trial sometime in 2005 or 2006.

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