--Tech firms getting flagged for overseas transactions
--Transfer pricing can help limit a firm's overall tax bill
--The IRS has sought to crack down on transfer pricing abuse
By John Letzing
SAN FRANCISCO (Dow Jones) -- The global reach of U.S. technology giants has helped fuel impressive growth, but it is also causing conflicts with the U.S. Internal Revenue Service over transactions involving overseas subsidiaries.
A growing number technology firms has disclosed disputes with the IRS related to transfer pricing, which refers to how much a domestic company and its foreign units charge each other for goods and services. Some of the potential liabilities are sizable.
Amazon.com Inc. (>> Amazon.com, Inc.), for example, has said the IRS has proposed a $1.5 billion tax increase related to transfer pricing over a seven-year period starting in 2005.
AOL Inc. (>> AOL, Inc.), Adobe Systems Inc. (>> Adobe Systems Incorporated), Hewlett-Packard Co. (>> Hewlett-Packard Company), Juniper Networks Inc. (>> Juniper Networks, Inc.), Microsoft Corp. (>> Microsoft Corporation) and Yahoo Inc. (YHOO) in recent months have disclosed disputes or inquiries over related issues.
Companies often use transfer pricing as a way to maximize their tax liabilities in countries with relatively low corporate tax rates, minimizing the recognition of profits in countries like the U.S. that have stiffer corporate taxes. But companies can get flagged by the IRS if, for example, prices charged to a foreign unit are deemed different than what would have been charged to an unaffiliated firm.
It's not a new issue, but the IRS has stepped up its enforcement activity, tax experts say, often focusing on the pricing of intangible property such as patents in addition to manufactured goods or other tangible property.
"There's been more of a focus on intangibles" such as patents, said Brian Gleicher, a Washington-based partner with White & Case LLP. That in turn can contribute to disagreements over valuing what are basically intellectual concepts. "As a result there's a little bit more of a susceptibility to an adjustment," Gleicher said.
David Blum, a Chicago-based tax attorney with Levenfeld Pearlstein LLC, said growing IRS scrutiny of transfer pricing comes as cash-strapped governments of all types seek to shore up tax revenue. "I've seen an aggressiveness in the past 12 to 18 months that I've never seen in my career," he said.
In a speech delivered last week, IRS Deputy Commissioner of Service and Enforcement Steven Miller said that as of January an estimated 19% of issues disclosed by the nearly 2,000 large corporations that had filed returns with so-called uncertain tax positions were related to transfer pricing.
Last year, The IRS appointed Samuel Maruca as its first director of transfer pricing. Maruca's team operates within the IRS's large business and international division, where a great deal of transfer pricing expertise has been consolidated.
The division had "International" tacked onto its name in 2010.
"That's not just a buzz word," Gleicher said. "There truly was a desire to focus on international issues including transfer pricing."
Of the large tech companies reporting issues, Amazon disclosed the biggest specific liability. The online retailer, which has disclosed the issue in filings over the past year, has said it disagrees with the IRS proposal and plans to contest it.
An Amazon spokesman declined to comment, and an IRS spokesman declined to comment about specific companies.
Most of the other companies disclosing transfer pricing disputes haven't quantified their exposure. H-P, however, noted in a filing that its existing unrecognized tax benefits may be reduced by up to $238 million within the next 12 months because "it is reasonably possible that certain federal, foreign and state tax issues may be concluded." The issues involve transfer pricing and other matters, the company said.
An H-P spokesman declined to comment.
Yahoo said in a February filing that during the final quarter of last year, the company began talks with IRS appeals division to settle adjustments to its tax bills from 2005 and 2006 related to transfer pricing, which had been contested.
Microsoft disclosed in a January filing that late last year the IRS issued proposed adjustments for the software giant's tax liability that are "primarily related to transfer pricing and could have a significant impact on our financial statements."
Representatives from Yahoo and Microsoft declined to comment.
Though large by most measures, the proposed $1.5 billion tax bill for Amazon would be a relatively small percentage of the nearly $48.1 billion in sales it reported last year. Like other firms, Amazon is able to help maintain its healthy financial profile through transfer pricing and an effective jiggering of its tax liabilities.
Though the U.S. corporate tax rate is 35%, Amazon's effective tax rate has been lower in recent years. The company said in regulatory filings that it has lowered its tax bill partly by recognizing profits through its European headquarters in Luxembourg. Luxembourg has a tax rate of roughly 22%, according to the Organisation for Economic Co-operation and Development.
As companies find themselves in the IRS's crosshairs, they are hiring staff capable of overseeing complex transfer pricing issues. Last year, for example, Amazon hired Michelle Garcia as director of transfer pricing. Garcia previously worked at firms including consultancy AFE Consulting Inc. and KPMG LLP.
"A multi-billion dollar proposed adjustment from the IRS obviously is unusual," University of Southern California law professor Edward Kleinbard said of Amazon's disclosed transfer pricing issue, "but it's not unprecedented."
Kleinbard said Amazon's dealings with the IRS appear to still be at an early stage, based on language used in its filings. He added that it's difficult to estimate what portion of the $1.5 billion reported by Amazon it may ultimately be liable for. There's "no rule of thumb at all," he said.
-By John Letzing, Dow Jones Newswires; 415-765-8230; [email protected]