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As part of the IRS’ Large Business and International Division (“LB&Is”) move towards issue-based examinations, it recently announced the rollout of 13 campaigns. These campaigns and were identified by LB&I to use its resources most efficiently and identify issues representing risk of non-compliance. It is expected that additional campaigns will be launched in upcoming months.
Three of these campaigns deal specifically with related party transactions, including cross-border transactions:
Inbound Distributor Campaign
From a cross-border transfer pricing perspective, the Inbound Distributor Campaign is expected to impact a large number of U.S. taxpayers who are subsidiaries of foreign parent companies. Many Canadian companies who export to the U.S. through related party distributors will be affected by this campaign, which is targeted at U.S. subsidiary distributors of foreign parent companies. The campaign is intended to address improper transfer pricing practices that result in losses or minimal U.S. profits that are not commensurate with the functions performed and risks assumed by the Distributor. To support the campaign, which will be driven by issue-based examinations, the LB&I has rolled out a training initiative for agents to support their examinations of the transfer pricing issues associated with inbound distributors.
Inbound distributors can expect a higher probability of audit, and those with insufficient contemporaneous transfer pricing documentation will be at significant risk of adjustments and potential penalties, especially if they are in a loss position.
Micro-Captive Insurance Campaign
This campaign is targeted at the inappropriate use of “micro-captive” insurance structures and resulting transactions that are inconsistent with arm’s length transactions. The use of such micro-captives were identified as transactions of interest (i.e. a potential tax avoidance transaction) in Notice 2016-66, especially in the context of related party transactions. Under Notice 2016-66, these transactions must be disclosed or be subject to penalty provisions.
An “abusive” form of a micro-captive structure may involve the creation of a captive insurance company that sells insurance policies to related parties for “esoteric, implausible risks for exorbitant ‘premiums’, while the insureds continue to maintain their far less costly commercial coverages with traditional insurers.”
Because the captive can elect to exclude up to $1.2 million ($2.2 million for tax years beginning after December 31, 2016) of its net premium income per year under section 831(b), the IRS notes that the total annual premium amounts are often equal to $1.2 million to take full advantage of the premium exclusion provision, without any actual actuarial analysis to substantiate the premium amounts. The IRS has previously described certain micro-captive structures as a “Dirty Dozen” tax scheme and indicated in Notice 2016-66 its intention to examine the non-tax business purposes for establishing the captive structures in the first place.
The campaign will be rolled out through issue-based examinations, which is also supported by agent training. Taxpayers employing these kinds of structures may be at risk if the insured risks are uncommon and / or premium payments are not supported through actuarial analyses.
Click here for more information on the campaigns.
Related Party Transactions Campaign
This campaign is focused on transactions between commonly controlled entities that provide a means to transfer funds from a corporation to shareholders via pass-through entities. The LB&I is devoting resources to determine the level of compliance specifically with mid-market taxpayers.
How MNP Can Help
If you are a Canadian company with a US subsidiary distributor, we can help review your transfer pricing policies and existing documentation to determine any areas of exposure and create an action plan to mitigate these exposures.
For more information, contact Melinda Nguyen-Raybould, MBA at 416.596.1711 or [email protected]
Related Topics:U.S. Tax; Tax Controversy
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