US Tax Newsflash

The Inflation Reduction Act of 2022 that was passed in August 2022 authorized nearly USD 80 billion of additional funding to the Internal Revenue Service (“IRS”). Amongst other uses, the funding is intended to help the IRS bolster tax enforcement.

Equipped with these additional resources, the IRS has been ramping up efforts to strengthen tax enforcement. In the past year, increased efforts have focused on high-income, high-wealth individuals who do not pay overdue tax bills and complex partnerships. On October 20, press releases issued by the US Department of Treasury and IRS announced new initiatives to ensure large corporations pay taxes owed.

The press release specifically states:

• The IRS is increasing compliance efforts on the US subsidiaries of foreign companies that distribute goods in the US and do not pay their fair share of tax on the profit they earn of their US activity. These foreign companies use transfer pricing rules year after year to report losses that are engineered through the improper use of these rules to avoid reporting an appropriate amount of US profit. To crack down on this strategy, the IRS is sending compliance alerts to approximately 150 subsidiaries of large foreign corporations to reiterate their US tax obligations and incentivize self-correction.

In a typical transaction, a China corporation (“China Co”), directly or through some other non-US subsidiary, will produce goods for ultimate sale to the US market. As an alternative to selling goods to US consumers directly from China, China Co will sell the finished good to a wholly owned US corporate subsidiary (“US Co”). US Co then sells the finished good to the ultimate US consumers. As part of this arrangement, the goods may be sold to US Co at a price that results in US Co generating a nominal amount of taxable income or, in some cases, a tax loss. The IRS is concerned that there is an inappropriate transfer price on the sale of goods from China Co to US Co, with the result that US Co is underreporting taxable income. In this regard, US transfer pricing rules require transactions entered into by and between related parties (e.g., China Co and US Co) be transacted on an arm’s length basis.

This development should be viewing in connection with the IRS Large Business & International (“LB&I”) Division’s existing “campaign” program that was announced in January 2017, the goal of which is to improve tax return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources. LB&I is a Division within the IRS that is responsible for tax administration activities for US and non-US businesses with a US tax reporting requirement and assets equal to or exceeding USD 10 million. Amongst the current list of 49 active campaigns, several are specifically related to non-US corporations with US operations, including the following:

• Verification of withholding tax related to non-US corporations claiming a tax refund associated with filing Form 1120-F (US Income Tax Return of a Foreign Corporation);
• Delinquent filing of Form 1120-F by a non-US corporation that has an obligation to file such form (e.g., as a result of having a US trade or business); and
• Non-filing (even if on a protective basis) of Form 1120-F by a non-US corporation that has an obligation to file such form.

In conjunction with, or in addition to these Campaigns, the LB&I Division will address taxpayer non-compliance related to unreported income, undisclosed assets, or any other tax avoidance scheme.

All China-parented corporate groups with US subsidiaries should pay attention to this development, even if they do not receive a compliance alert from the IRS. This development should be viewed as an incentive to review the tax model of US subsidiaries and operations, with a particular focus on ensuring transfer pricing policies are up to date and compliant with current law.

^{Tax Newsflash is published for the clients and professionals of Deloitte Touche Tohmatsu. The contents are of a general nature only. Readers are advised to consult their tax advisors before acting on any information contained in this newsletter.}
 

For further information, contact any of the China-based US tax professionals listed below or your regular Deloitte contact:

Hong Kong

Candy Chan
Tax Partner
+852 2852 5886
cancha@deloitte.com.hk

Edmond Lam
Tax Director
+852 2238 7564
elam@deloitte.com.hk

Rita Leung
Tax Director
+852 2109 5358
rleung@deloitte.com.hk
 

Shanghai

David Allgaier
Tax Partner
+86 21 6141 2788
dallgaier@deloitte.com.cn

Judy Xie
Tax Partner
+86 21 2316 6602
judxie@deloitte.com.cn

Beijing

Joyce Song
Tax Director
+86 10 8520 7760
joysong@deloitte.com.cn