(Reuters) – The Internal Revenue Service is staffing up with high-powered talent to crack down on companies shifting profits from country to country to lower their tax bills, a hot strategy the agency has targeted before with only limited success.
The IRS showed its elevated concern on the issue, known as “transfer pricing,” last May by hiring Samuel Maruca to fill the newly created post of transfer pricing director.
He has since brought aboard specialists from Big Four audit firms KPMG KPMG.UL and Ernst & Young ERNY.UL, as well as law firm Mayer Brown and boutique consultancy Horst Frisch.
Maruca, who came from law firm Covington & Burling, is still recruiting. He told Reuters the agency previously had “had a difficult time attracting and retaining economists.”
Now, he said, the IRS’s international group “has significant external hiring authority.”
Transfer pricing is a booming field of global tax law. It involves multinational corporations that are constantly moving goods, services and assets from one subsidiary to another in different countries, and how they account for these “transfers.”
By carefully manipulating the pricing of such moves, companies can effectively shift profits to low-tax countries from high-tax ones, lowering their overall tax costs.
Many governments in the developing and developed world, many of them faced with crushing deficits, are working to curb transfer pricing because it reduces their corporate tax revenues.
IRS Commissioner Doug Shulman made changes at the agency in mid-2010 that set the stage for bringing in Maruca, who has filled 40 positions so far and plans to bring on up to 60 more staffers.
The IRS, which employs 90,000 people, saw its budget cut by 2.5 percent by Congress for fiscal 2012 to $11.8 billion.
UNDERPAID AND OUT-GUNNED
Federal agencies often struggle to keep up with higher-paid private-sector professionals. The IRS is no exception, and there is some skepticism about Maruca’s chances.
“The economic crisis allowed the IRS to attract talented, experienced industry professionals who might not have been available previously,” said ex-deputy IRS Commissioner Michael Dolan, now director of KPMG’s Washington national tax practice.
“The $64,000 question is, what will Maruca be able to do … and will he really have enough resources to change the game?” Dolan said.
To curtail tax avoidance through transfer pricing, governments seek to limit corporations’ ability to manipulate the transfer prices. National laws, though variable from country to country, generally call for “arms-length” pricing.
In theory, that means corporations must set transfer prices that are at or near market level, not artificially raised or lowered. But enforcement is complex, especially for intangible assets, such as search-engine algorithms or trademarks.
“The valuation problems are insurmountable,” said Edward Kleinbard, a professor at the University of Southern California and former chief of staff at the Joint Committee on Taxation, which analyzes tax policy for the U.S. Congress.
“There are billion-dollar disputes on just the arms-length transfer pricing of intangibles” he said.
By one measure of transfer pricing enforcement, the IRS lags behind tax treaty partners. In fiscal 2011, 85 percent of transfer pricing audit adjustments were initiated by a foreign country, rather than by the IRS, according to IRS statistics. That was up from 77 percent in fiscal 2010.
Two major transfer pricing court decisions went against the IRS in 2009 and 2010.
“Clearly, the IRS is trying to figure out what to do next on its litigation strategy in these important transfer pricing cases,” said Eric Solomon, a director at Ernst & Young, who called Maruca’s group a “SWAT team.”
As the IRS raises its game, the pharmaceutical and high-tech sectors can expect close scrutiny, tax professionals said.
Businesses are sure to fight back. The IRS has ruffled feathers on transfer pricing before with limited results.
“Anybody who thinks the IRS can ultimately enforce transfer pricing is either an eternal optimist or delusional,” said Richard Harvey, a tax professor at Villanova University and former senior adviser to the IRS’s Shulman.
The staff changes and hiring at IRS “will help them on the margins,” Harvey said. “But they’re still fighting a very difficult battle where the deck is stacked against them.”.