International Taxation

Problems Persist in Determining Tax Effects of Intercompany Prices Gao ID: GGD-92-89 June 15, 1992

During the 1980s, the amount of direct foreign investment in the United States rose dramatically--from $83 billion to $401 billion. The share of world manufacturing trade between related parties also increased significantly. Concerns have been raised in Congress about inappropriate transfer pricing practices. In 1986 foreign-controlled corporations--U.S. firms in which at least a certain percentage of voting stock is held by a foreign party--reported losses of about $1.5 billion, despite posting more than $540 billion in receipts that year. This report examines (1) whether foreign-controlled companies might have underpaid income taxes by improperly using transfer pricing; (2) what factors, if any, affected the Internal Revenue Service's ability to determine and recover any potentially underpaid taxes; and (3) what alternatives to dealing with transfer pricing existed.

GAO found that: (1) foreign-controlled companies often report lower gross profits, net income, and U.S. taxes as percentages of sales than their U.S. counterparts, but those statistics do not prove widespread impropriety; (2) the disparities in profits could result from lower sales prices to increase market share; (3) the tax value of transfer prices that IRS questioned could be significant; (4) IRS difficulties in recovering related taxes included the amount of research necessary to present Section 482 cases, problems in obtaining foreign tax records, staffing and management information limitations, a lack of appellate sustainment of examination findings, and decentralized IRS efforts on transfer pricing problems; and (5) there are various alternative methods for handling transfer pricing, all of which would aim to ease the present case-by-case approach, but each alternative has drawbacks.

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