The Internal Revenue Service reports that U.S.-based corporations more than tripled foreign profits, from $89 billion to $289 billion between 1994 and 2004, with 58% of the earnings recognized in low-tax or no-tax jurisdictions. More important, the globalization trend is not slowing. In fact, the IRS has stated publicly that it will ramp up enforcement efforts in several key areas, including transfer-pricing transactions.
The increased scrutiny of transfer pricing (the strategy by which multinational corporations move income among related subsidiaries in search of a low-tax jurisdiction within which to recognize revenue) has also elevated the issue from a back-office compliance exercise to an audit-committee priority requiring “active” management participation, says Steve Snyder, a director at Navigant Consulting. He cites temporary Treasury Department rules, an Obama Administration tax plan, and two recent court cases as other reasons why CFOs will feel transfer-pricing pressure in 2011.
Temporary rules issued by Treasury in 2009 are still in effect. They addressed how cost-sharing arrangements for intangible assets are valued when an owner-developer sells the rights to use the asset to an overseas subsidiary.
The rules are controversial because the guidance they provide regarding how companies should measure the level of risk held by the so-called controlling corporation often results in more taxable income shifting to the original developer. An Obama Administration tax proposal will, if accepted, broaden the definition of intangible property and tax “excessive returns” when intangibles are transferred from the United States to a related subsidiary in a low-tax jurisdiction.
There is a bright spot for corporations, says Snyder. Two recent tax-court decisions related to transfer-pricing issues went against the IRS and in favor of corporate taxpayers. In a case involving Veritas Software, the court took a “narrow” view of intangible property, and made a distinction between preexisting intangible property and intangibles developed under a cost-sharing agreement, handing a victory to the software maker. Similarly, the tax court sided with Xilinx Inc. when the engineering design firm took a deduction for employees’ stock options related to the research-and-development staff working under a cost-sharing agreement.
New sales-tax laws, written to catch up to the realities of e-tail, could haunt online sellers in 2011. For the most part, online retailers aren’t required to collect sales tax from buyers when the sellers don’t have a physical presence (nexus) in the state where the buyers make purchases. But that competitive advantage for Internet retailers could disappear this year if more states follow New York’s so-called Amazon law, says Tracey Sellers, a managing director at True Partners Consulting.
Passed in 2008, the legislation takes its nickname from Amazon.com, the most prominent of the 30 or so online marketplaces that the law targets. The law establishes nexus for online retailers in New York if they have what is known as a sales affiliate in the state that generates at least $10,000 in annual revenues for the retailer. These affiliate programs are a prominent feature of Amazon.com, eBay, and other online retailers, and describe an arrangement whereby the e-tailer acts as an Internet storefront for a business that may be located in New York State. If the affiliate is based there, any sales generated by a “click through” to Amazon is taxed by the state.