Inbound distribution companies: It's Casablanca redux

The film Casablanca gave rise to several famous phrases. “Round up the usual suspects” was spoken by Claude Rain’s character at both the beginning and end of the movie and even became the title of another famous 1995 film. In the movie, and now in general usage, it refers to people habitually suspected of or arrested for a crime. Those “rounded up” are generally scapegoats rather than the actual perpetrators of the crime in question.

Earlier this year, the IRS Large Business and International Division announced 13 campaigns in their movement toward issue-based examinations. Among these campaigns is an initiative to examine inbound distribution companies, or shall we say, to round up the usual suspects.

Why inbound distributors?

The IRS has stated that the goals of its campaigns are to identify high risk areas in order to best use limited resources. Given the high U.S. corporate tax rate compared to the rest of the world, multinational corporations have a natural incentive to limit their taxable income in the United States. By keeping U.S. taxable income low, these corporations can keep money overseas and out of the U.S. economy. With this in mind, the IRS may view inbound companies as a low-hanging fruit to identify non-compliance and increase tax revenues.

If your business doesn’t have a transfer pricing document in place, consider reaching out to an international tax specialist to understand your potential exposure.

Representatives from the IRS have noted that the program will differ from past programs, and it won’t simply target the largest companies. Even if a company has minimal intercompany activity, it may still be subject to scrutiny. The IRS has noted that taxpayers selected as a part of the campaign will be notified through normal audit procedures, and taxpayers are permitted to ask if they've been selected as a part of the campaign.

How can taxpayers prepare for a potential audit?

As with any potential audit risk, taxpayers should prepare to handle possible questions with proper documentation to support their positions. In this case, the IRS will most likely request an up-to-date and accurate transfer pricing study. The study should accurately address the intercompany transactions that are occurring in the ordinary course of business, particularly as they relate to U.S. activity.

If your business doesn’t have a transfer pricing document in place, consider reaching out to an international tax specialist to understand your potential exposure and how to correct it going forward.