Under the new regulations, taxpayers have great latitude in establishing transfer prices. IRS’ Examination, Appeals, and Litigation Experiences With Section 482 Were Mixed

IRS’ international examiners continued to propose substantial adjustments to the taxable income of FCCs and USCCs in fiscal years 1993 and 1994, although the total dollar value of the adjustments in 1993 was $1.3 billion less than in 1994. As it was, taxpayers were already using transfer pricing methods other than the three formerly most well-defined methods for a large proportion of their transfer pricing activity reviewed by IRS, including that in APAs. The Majority of FCCs and USCCs Paid No U.S. Income Tax

In each of the 5 years studied, FCCs were less likely than USCCs to pay U.S. income tax, as shown in figure 2 and appendix V. In 1991, 73 percent of FCCs paid no U.S. income tax compared with 62 percent of USCCs. So, the 38 percent of USCCs that paid U.S. income tax in 1991 held 80 percent of the assets and generated 81 percent of all gross receipts. Objectives, Scope, and Methodology

As mentioned earlier, our objectives for this report were to provide information and analysis to update our 1993 work on (1) IRS’ recent experience in dealing with transfer pricing issues through its examinations, appeals, and litigation functions; (2) IRS’ use of available regulatory and procedural tools; and (3) the extent to which USCCs and FCCs did not pay U.S. income taxes. Finally, we researched 1993 and early 1994 court cases involving transfer pricing issues. IRS’ Use of Certain Procedural Tools

IRS used certain new and existing procedural tools—designated summonses, formal document requests, additional penalties, simultaneous examinations, and arbitration—sparingly. However, advance pricing agreements (APA) were increasingly used. But the very small number of large nontaxpaying corporations accounted for a disproportionately large share of total corporate assets and receipts. Comparing the types of industries represented by the largest foreign- and U.S.-controlled corporations may explain some of the differences between them.
Why GAO Did This Study

Pursuant to a congressional request, GAO provided information regarding transfer pricing issues and foreign-controlled corporations' (FCC) and U.S.-controlled corporations' (USCC) tax compliance, focusing on: (1) the Internal Revenue Service's (IRS) handling of transfer pricing issues through its examinations, appeals, and litigation functions; and (2) IRS use of available regulatory and procedural tools.

What GAO Found

GAO found that: (1) recent IRS experiences with transfer pricing cases have been mixed; (2) although there were as many regulatory violations in 1993 and 1994 as in previous years, the value of the 1994 adjustments increased $1.3 billion over 1993 adjustments; (3) a large number of the 1993 and 1994 cases involved pricing methods other than the three methods specifically described in earlier IRS regulations; (4) the outcomes of IRS appeals and legal processes for the 2 years were similar to those in 1987 and 1988, with a sustention rate of about 30 percent of the proposed adjustments' value; (5) IRS has used certain procedural tools, such as simultaneous examinations and arbitration, as effective deterrents to abusive transfer pricing practices; (6) IRS expects to increase its use of advanced pricing agreements; (7) the success of the new transfer pricing regulations remains to be seen; (8) about 75 percent of FCC and 60 percent of USCC paid no U.S. income tax between 1987 and 1991; (9) the corporations that paid U.S. taxes in 1991 held 80 percent of FCC and USCC assets and generated 81 percent of their receipts; (10) the largest nontaxpaying corporations accounted for most FCC and USCC assets and receipts; and (11) factors other than transfer pricing abuse may contribute to the differences in tax amounts paid by FCC and USCC.