Managing risks in international tax engagements.

• Author: Soltis, Sandy
• Position: The Risk Management RESOURCE

Provided by Aon Insurance Services

U.S. tax laws are complex. Because of that complexity, tax practitioners need to be knowledgeable about both the tax laws and what their clients are doing. This is even more important when your client is doing business overseas. Not only does the tax practitioner need to understand U.S. tax laws, he or she also needs to know how to advise the client on the tax considerations of its overseas operations, both in the U.S. and the foreign country. International tax is not an area for dabblers. Tax practitioners can be sued for failing to advise about international tax issues, tax filing requirements of foreign countries, or reporting foreign income on U.S. tax returns. Some allegations of omission can be as simple as failure to advise clients about water's edge elections available in some states.

Some of the major considerations include:

Transfer Pricing

When a U.S. company buys or sets up an entity in a foreign country, there are generally several types of transactions that occur between the entities. These include purchasing or selling a tangible product, providing intangible assets to the foreign entity for use in its operations, and assistance from the head office in the U.S. for administrative functions, among others.

The price paid, or "transfer price," for each of these activities may be challenged by the U.S. The transfer price must be at arm's length to be accepted for U.S. tax purposes. In general, an arm's length price is the amount that would be charged to an unrelated party for the same or similar transactions under similar circumstances.

There has been an increase in transfer pricing regulations and enforcement. Tax authorities generally require a transfer pricing study to support cross border transactions and agreements between entities within a global organization. Significant penalties can apply if the taxpayer cannot support the transfer price charged to a related party. To avoid the imposition of a penalty, a U.S. taxpayer must maintain contemporaneous documentation to establish the transfer price, and must produce such documentation to the IRS within 30 days of its request during an audit.

Failure to comply with the documentation requirement can result in a penalty on any tax underpayment due to IRS adjustments. The penalty is 20% or 40% of the tax underpayment, depending upon the amount of the adjustment.

In addition to U.S. transfer pricing rules, many developed foreign countries have had...