A recent article in Accounting Today investigates a study on reporting practices by multinational companies, and seems to question the intentions of these filers.  Specifically, the report (conducted by the Government Accountability Office) concludes that current rules “influence company decision about how many workers to employ and how much to invest in particular activities and locations.”

One noteworthy comment from the article comes from GAO Chairman Max Baucus (D-Mont.):

I’ve said before that we will tackle tax reform in 2009 and this report underscores the need to review business taxes as part of our tax reform efforts in the next Congress. Simply put, I do not intend to allow U.S. multinationals to sidestep their fair share of taxes by moving income offshore.

This viewpoint may be grounded in sound information from the report, but reform is not necessarily the answer — the best recourse may simply be to clarify and better enforce the rules that exist.

Currently, the US has one of the highest corporate tax rates of any developed country in the world.  As a result, corporations looking to cut costs often determine where to set up business operations by looking to income tax rates as well as payroll and other costs associated with various jurisdictions.

But taking that measure does not exploit a loophole.  The Internal Revenue Code currently has significant rules that are specifically enacted to reduce the possibility of US taxpayers shifting income to foreign jurisdictions.  These include, but are not limited to, Subpart F rules, Transfer Pricing Rules and IRC Section 367, which governs transfers of property from the US to other countries.  Despite Senator Baucus’s quote, these rules make it very difficult for corporations to merely “sidestep their fair share of taxes by moving income offshore.”

That said, the rules are so complex that they are most likely applied differently by different corporations, depending upon how they interpret the rules relevant to their own particular fact pattern.

Back to the solution, then.  One thing the IRS could do is to provide better guidance as to how the rules should be applied.  A second thing would be to step up enforcement of reporting requirements currently in effect.  Proper reporting would provide the IRS with better information as to whether the rules were being applied properly.

Within the past month, the IRS has indicated they will start penalizing corporations for failure to file the necessary information returns.  Penalties have been applicable for many years, but have rarely been assessed.  Better enforcement could be the best way to help prevent any tax avoidance and clear up misunderstandings as to whether taxpayers are shifting income offshore to avoid taxes.

Business is global – and so are taxes. Companies that are connected by common control and share resources across borders need to ensure they address transfer pricing when goods or services change hands. We wanted to share some expertise in this area through this Q&A, and you can also view an educational webcast on where transfer pricing may come into play and the best methods to use for different scenarios.

Q. What is transfer pricing?

A. Simply put, if income or deductions shift between taxpayers in different tax jurisdictions, transfer pricing comes into play. The goal from the perspective of the IRS and other tax authorities is to prevent companies from shifting income between entities in a way that may evade taxation.

For companies that have operations in different regions – whether as part of the core organization or through subsidiaries – transfer pricing is an important piece of tax law. In basic terms, transfer pricing is the determination of the price or compensation for transactions conducted between separate taxpayers based on similar arm’s length transactions with third parties. They can be directly owned companies, affiliates, brother or sister companies or entities under common control, and they can be in different parts of the U.S. or operating across international borders.

Q. How do I know if transfer pricing applies to me?

A. If you and another company have common ownership or are under common control and are transacting business together, you’ll want to be very aware of transfer pricing. A couple examples are:

A U.S.-based company with an R&D subsidiary in Israel

Here’s a case in which the level of activity abroad is a big factor in determining transfer pricing. The higher the level of risk, assets and functionality, the higher the pricing will be.

A UK company with a sales outlet in India

Again, this is not just a U.S. initiative – tax authorities worldwide consider transfer pricing a hot area. The transfer pricing level is driven by the level of operations within each jurisdiction and between such taxpayers, with slightly different rules amongst different global jurisdictions.

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