IRS Considering Clarification on Pricing of Intercompany Debt:
Implications for Taxpayers
The Internal Revenue Service (IRS) is currently reviewing a critical issue related to the pricing of intercompany debt, specifically whether pricing should be solely based on the borrower’s credit rating or if a group approach should be used, taking into consideration the implicit support of the parent company.
The U.S. transfer pricing regulations do not currently support an adjustment for implicit support in intercompany debt pricing. The general provisions outlined in Treas. Reg. Section 1.482-1, which apply to all types of transactions, assume that arm’s-length conditions consist of uncontrolled transactions between uncontrolled entities. Similarly, Treas. Reg. Section 1.482-2, which governs financial transactions, does not include any specific exception for implicit support. This misalignment with the concept of implicit support has prompted the consideration of a potential clarifying regulation by the IRS.
Validation of Implicit Support for Services Transactions
Kate Kerrigan, IRS’s Office of the Associate Chief Counsel (International), highlighted that there is language in Treas. Reg. Section 1.482-9 that validates the concept of implicit support for services transactions but not for financial transactions. She suggested that a clarifying regulation could require taxpayers to account for a parent’s implicit support when determining the interest rate on an intercompany loan, similar to how a credit agency would rate a subsidiary borrower. This approach would align with the OECD transfer pricing guidelines, which recognize the potential impact of implicit support on credit ratings.
Consideration of Stand-alone Abilities
Implicit support can affect an affiliate’s ability to borrow or the interest rate at which a loan is extended. However, it was noted that this may not always be the case, as the likelihood of a parent or group supporting an affiliate may depend on the relative importance of the borrower within the group. Entities with a strategic position in the group, such as those operating in the core business, may have a higher chance of receiving support, while those not integral to the group’s identity or future strategy may be less likely to receive such support. In such cases, the OECD guidelines suggest evaluating the entity’s stand-alone abilities to repay rather than relying solely on the group’s support.
Clarification of the Regulation
In the same discussion, Kerrigan also clarified that the IRC Section 482 regulations already require considering all factors that impact the pricing of intercompany debt for transfer pricing purposes. Therefore, a potential future regulation accounting for implicit support would not introduce a new law but rather provide clarification of the existing law. Kerrigan further noted that if issued, she expects such a regulation would apply retroactively to all pre-existing intercompany debt or guarantees without any grandfathering.
The implications of a potential clarifying regulation on implicit support for intercompany debt pricing are significant. Taxpayers should closely monitor developments in this area, as it could impact their approach to pricing intercompany debt for transfer pricing purposes. Additionally, the potential retroactive application of the clarifications could raise conflicts with foreign jurisdictions that may not accept a new pricing approach for transactions already in place. It will be essential for taxpayers to remain aware of any changes in the IRS’s stance on this issue and carefully consider the potential implications for their transfer pricing practices related to intercompany debt.
It’s worth noting that in April 2022, the IRS changed its policy to no longer require IRS executive approval before raising the economic substance doctrine in audits. That November, the IRS warned that taxpayers should expect more penalties to be asserted in transfer pricing cases. An IRS official said the agency is continuing to review cases more closely, including those with transfer pricing documentation, to determine if penalties are warranted and that they hope the increased penalties will result in taxpayers providing better transfer pricing documentation reports.
If you have any questions about this issue, do not hesitate to reach out.
Jason Rauhe, CPA is a Principal in the firm’s Global Business Services practice and is responsible for assisting clients and adding depth in all areas of the firm’s international tax consulting services including transfer pricing, and the firm’s compliance expertise.
Rauhe previously served as Director of International Tax at a Top 100 CPA Firm, where he was responsible for the firm’s international tax division and major industry alliance networks.