The practice of shifting income to jurisdictions with low tax requirements, often possible through transfer pricing, is under scrutiny in both the United States and Europe.  Now there may be a role for whistleblowers to prompt regulatory action.

A transfer price is the price of goods, services or other intangibles that a company pays to an affiliate.  Major multinational corporations have been known to manipulate transfer pricing to avoid taxes in countries where corporations have substantial trading operations.  To ensure intercompany transactions are fairly-priced, regulators ask whether the results would have been the same had two non-affiliated taxpayers engaged in the same transaction.  Governments are now ramping up their auditing mechanisms to ensure they are not losing tax revenues because of transfer pricing abuses. 

Glaxo dispute over transfer pricing

In 2006, the US Internal Revenue Service (IRS) successfully resolved a major transfer pricing dispute with Glaxo SmithKline Holdings Inc. & Subsidiaries.  The company paid the IRS approximately 3.4 billion dollars as part of an agreement to resolve the parties’ long-running transfer pricing dispute for the tax years 1989 through 2005. 

After reaching that settlement, and until recently, the IRS has been relatively inactive in auditing transfer pricing.  With the US government’s focus on deficit reduction, the IRS is running a Transfer Pricing pilot programme to improve its effectiveness in transfer pricing audits.  The programme involves test audits in which the IRS provides comprehensive transfer pricing scrutiny. 

IRS steps up a gear

In May 2011, the IRS charged a highly decorated transfer pricing lawyer, Sam Maruca, to serve as the first Transfer Pricing Director in the Large Business and International Division of the IRS.  Discussing the steps in the IRS’s efforts to improve the agency’s international operations, IRS Commissioner Doug Shulman stated that improving “how we manage transfer pricing compliance and continuing to develop our capacity to coordinate effectively with our treaty partners is ever more critical to our job.” 
“These latest changes move forward to fulfilling one of my top priorities -- meeting the challenge of tax administration in a global economy, ” he added.

Global revamp

In the UK, Her Majesty’s Revenue and Customs (HMRC) introduced the Transfer Pricing Group (TPG) in April 2008 to beef up enforcement against malicious transfer pricing practices.  In 2009, TPG argued successfully in a landmark case against DSG Retail Limited’s transfer pricing policy, forming new law in the UK that has a major impact on the country’s multinational companies. 

China has also revamped its transfer practice enforcement in the past few years.  In 2010, the tax authority of the Hunan Province finalized a major transfer pricing investigation of a joint venture established by a Canadian parent company.  The parties settled the case with an adjustment to taxable income of approximately US $15.7 million, covering the period from 2001 to 2008.  Overall, China retrieved approximately US $398 million of tax dollars after 178 investigations of transfer pricing in 2010, a 24 percent increase from the previous year.

OECD enters the fray

Last year, the Organisation for Economic Co-operation and Development (OECD) issued a report in which it analyzed the administration methods that 33 countries have developed in the transfer pricing area to help inform OECD and non-OECD economies on ways to simplify the administration of transfer pricing.  Considering the depressed European Economy, the OECD expects its constituents to police transfer pricing abuse.  Many non-OECD nations have mirrored the OECD’s regulation guidelines.

Calling on all whistleblowers

One way economies can battle the exploitation of transfer pricing is by incentivizing employees to blow the whistle on such practices.  US Senator Chuck Grassley has expressed frustration with the IRS whistleblower office for their inadequate processing of whistleblower information and untimely compensation of whistleblowers.  The Government Accountability Office (GAO) reported that an average of two-thirds of the companies operating in the US paid no federal corporate income tax from 1998 – 2005.  That trend certainly continues today.  Focus on transfer pricing violations can not only invigorate the IRS whistleblower office, but also increase tax revenue.  This is a viable solution for all governments contesting transfer pricing abuse.