International Taxation

This report provides information on the Internal Revenue Service's (IRS) enforcement of section 1059A of the Internal Revenue Code, which deals with transfer pricing regulations. Section 1059A was meant to prevent the federal government from being whipsawed by an importer, on property acquired from a related party, who claims a low valuation for customs purposes and a higher valuation for tax purposes. GAO discusses IRS' difficulties in applying the section and a July 1992 IRS legal opinion on the applicability of section 1059A to transactions between a U.S. parent firm and its Mexican related parties. GAO also discusses proposals to reconcile differing IRS and U.S. Customs Service valuation rules that affect the use of section 1059A.

GAO found that: (1) IRS has included section 1059A issues in nine tax audits since 1986; (2) the July 1992 IRS technical advice memorandum stated that IRC section 1059A could not be used to prevent a U.S. taxpayer from including certain expenses in the taxpayer's cost for tax purposes; (3) although U.S. parent companies pay certain expenses on behalf of their foreign-related parties, these expenses are not subject to customs duties because they are not included in duty valuation; (4) U.S and Mexican federal tax revenues decrease 2 percent and the parent and related companies' combined net income increases 3 percent when U.S. taxpayers pay related parties' expenses; (5) it could not estimate the total tax revenue losses attributable to U.S. parent companies paying related parties' expenses because of the few cases audited and the unknown extent of the practice in countries other than Mexico; (6) IRS has ceased implementation of section 1059A in situations involving direct payments on behalf of foreign-related parties since it issued its technical advice memorandum; (7) the inconsistency in IRS and Customs' valuation definitions can be resolved by a multilateral renegotiation of the Customs Valuation Code of the General Agreement on Tariffs and Trade (GATT) or a unilateral congressional amendment of either IRC section 1059A or section 402 of the customs legislation; (8) IRS believes that the issue should be resolved by amending customs law; and (9) Customs and private sector representatives believe that the two legislative options will violate GATT and lead to retaliation by other GATT members.