INTRODUCTION

The Large Business and International Division of the I.R.S. ("LB&I") periodically develops international practice units ("I.P.U.'s") that serve as training material for international examiners. I.P.U.'s provide explanations of general tax concepts and information about a specific type of transaction. Because I.P.U.'s are not official pronouncements of law, they cannot be used, cited, or relied upon as authority. Nonetheless, they explain the general approach that will be followed by an LB&I examiner and are helpful when preparing for an I.R.S. examination of a multinational group.

In November 2017, the I.R.S. issued an I.P.U. entitled "Common Ownership or Control Under IRC 482 – Inbound." It serves as a primer for determining whether sufficient control exists between two parties to bring the arm's length transfer pricing rules of Code §482 into play.

On the same date, the I.R.S. issued a sister I.P.U. for outbound transactions, "Common Ownership or Control Under IRC 482 – Outbound." It is based on the same set of principles and is virtually identical to concepts of control for inbound transactions.

This article explains how the I.R.S. looks at the issue of control. How is it defined? In what fact patterns does it exist? In approaching these issues, this article focuses on the context of a non-U.S.-based group with operations in the U.S.

CONTEXT

The I.P.U. begins with the acknowledgement that a foreign-based group operating in the U.S. generally do so through a U.S. subsidiary. If the group sources its product outside the U.S. for sale in the U.S., the U.S. subsidiary generally is charged with the task of establishing a marketing plan and implementing that plan through a U.S. sales network.

The I.P.U. identifies the following types of transactions that often exist between the U.S. subsidiary and its parent or affiliates based abroad:

  • Loans
  • Leases
  • Sales
  • Licenses
  • Services

In comparison to business transactions entered into by unrelated parties, where each party is acting solely to increase its own economic goals, the I.P.U. expresses the view that related parties may take steps to price transactions based on other factors. Where that occurs, a U.S. taxpayer may underreport its U.S. taxable income and Federal income taxes.

To prevent tax slippage arising from related-party transactions, Code §482 authorizes the I.R.S. to conduct an examination and to reallocate income among related parties when necessary to reflect arm's length pricing. The purpose of Code §482 is to ensure that taxpayers clearly reflect income from "controlled transactions" and to prevent U.S. taxpayers from avoiding taxation by artificially shifting income.

However, the I.P.U. acknowledges that the mere fact that two parties are related does not create any presumption that intercompany pricing is other than arm's length.

A transaction is a controlled transaction if it occurs between two or more organizations, trades, or businesses that are either owned or controlled by the same interests. A controlled group of taxpayers is a group of taxpayers that are owned or controlled directly or indirectly by the same interests.1 Therefore, a controlled transaction is any transaction or transfer between two or more members of the same group of controlled taxpayers.

In contrast, an uncontrolled transaction is any transaction between two or more taxpayers that are not members of the same controlled group.2

Thus, the term "controlled" in the Treasury Regulations is a shorthand that generally refers to the concepts of both common ownership and common control, except where it is necessary to distinguish between those concepts.

The term "controlled" is defined as any kind of control (i) whether direct or indirect, (ii) whether or not legally enforceable, (iii) however exercisable or exercised, and (iv) including arrangements by which two parties act in concert or with a common goal or purpose.3 It is the reality of control that is the decisive factor and not its form or the mode through which control is exercised. Control is presumed to exist if income or deductions have been arbitrarily shifted between related parties.

Common ownership or control is determined at the time the parties agree to perform a transaction, even if the parties perform the transaction later.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.