IRS requests for third-party transfer-pricing information.

On April 6, 1994, Tax Executives Institute submitted the following comments to the Internal Revenu IRS requests for third-party pricing information in connection with the examination of the tax liabi competitors, customers, and vendors. The comments took the form of a letter from TEI President Ralph Assistant Commissioner (Examination) John J. Monaco. The comments were prepared under the aegis of t Administrative Affairs Committee, whose chair is Robert D. Adams of Halliburton Company, and its Int Committee, whose chair is Lisa Norton of Ingersoll-Rand Company.

In recent weeks, a number of TEI members have brought to the Institute's attention requests that IRS personnel have made that a company provide pricing information in connection with the examination of the tax liability of the company's competitors, customers, or vendors. The requests have come both from Regional Counsel (in respect of a docketed Tax Court case) and from International Examiners (in respect of the audit of unidentified companies in the recipient companies' industry).

As you know, Tax Executives Institute is loath to become involved in specific cases. That is not our intention here. Rather, our goal is to ascertain whether the IRS has embarked on a general course of action in section 482 cases that taxpayers would be interested in learning more about and, if so, to suggest that the IRS would be well served by better articulating the reasons for its actions and the potential consequences to the affected companies.

Beginning in February, our members began receiving received requests from Agatha Vorsanger, North Atlantic Regional Counsel, in connection with Nestle Holdings' pending Tax Court case. The letter states that "[w]e believe that your company may have information which is relevant to the royalty and research and development fee issues in these cases." The letter proceeds to detail five areas in which the IRS is seeking information (including whether the company has ever entered a licensing agreement with Nestle or any related entity, whether the company has ever solicited non-Nestle related entities for the licensing of its trademarks and tradenames, and whether the company has ever purchased any trademarks, tradenames, or brand names). The letter concludes: "We would like to know the answers to these questions and, if available, review any documents addressing these matters as soon as possible."

In addition to the requests expressly related to the Nestle case, other TEI members have received more generalized requests for information concerning unrelated parties. For example, a taxpayer in the St. Louis District received a request from a Nashville-based International Examiner. The letter states that "[i]t is possible that your activities in ... [a specified industry] may be comparable to the activities of the company currently under examination. If this is true, any information that you provide may be used to establish an arm's length charge for any similar activity." The letter also states:

I am not conducting an examination of your company. I am requesting this information under the authority of section 7602 of the Internal Revenue Code.

Attached to the letter from the Examiner was a detailed, four-page questionnaire that the Examiner asked be completed within 33 days.

Although the Institute is generally aware (e.g., through the involvement of many of its members in the Commissioner's Advisory Group section 482 initiatives) of the IRS's efforts to collect third-party data, these taxpayer contacts concern us for a number of reasons:

* First, absent some general

announcement of IRS policy,

the affected companies properly

wonder why they are being

singled out for information

unrelated to their own

liability.

* Secondly, the letters are

drafted in such a way that a

company may reasonably

view itself as compelled to

answer. In this regard, we

are particularly concerned

about the reference in the

Nashville-St. Louis letter to

section 7602, which is the

general summons provision.

It seems unlikely to us that a

summons could properly be

issued under that section for

the requested information--information

unrelated to the

tax liability of, or transactions

with, the party being

summoned.

* Thirdly, we believe the letters

lay an inadequate foundation

for their request. That

is, the letters generally do

not explain why the request

is being made (other than

"because we need the information").

Not all the requests that have been brought to our attention, however, have been deficient. A letter from an International Examiner in the New Orleans District contains the following paragraph:

Your cooperation will be appreciated

and a response

whether negative or positive

would also be appreciated. In

an effort to establish a reasonable

basis for transfer

prices using transactions between

related parties, we are

obliged to contact companies.

The absence of meaningful

comparable data has led to

misunderstandings on transfer

pricing in the past.

This letter makes it clear the taxpayer is not required to respond (though it requests at least the courtesy of a negative response) and, more important, points out that the IRS has an obligation to seek third-party information in order to test the acceptability of a given taxpayer's pricing.

John, the fact that some requests are more complete, or better balanced, than others underscores the need for National Office oversight and leadership on this issue. We urge the IRS to consider some type of taxpayer outreach initiative in this area. As in the past, TEI would be pleased to open up the pages of The Tax Executive to you, or Regina Deanehan (or Lou Carlow), or whomever you designate. You could write an article that discusses how the IRS is responding to the criticism it has received in section 482 cases, and how taxpayers can assist the IRS's efforts. We believe the tax system as a whole would benefit from a bit more "sunshine."

Among other things, more openness should result in greater consistency and should allay certain companies' concern that they are being unfairly targeted. In this regard, you should be aware that some tax practitioners are reacting very negatively toward the request for information concerning the Nestle case. One law firm memorandum we have perused advised taxpayers to consider the following in evaluating the IRS's request:

"1) That the I.R.S. has no right

to obtain information in this

way;

"2) This information can be used

against you later;

"3) Unless there is a clear benefit

to a company, it should not

volunteer this sort of information;

"4) Any information you provide

in this manner could quickly

become public; and

"5) Telling the taxpayer against

whom I.R.S. says it will use

this information what the

I.R.S. is doing."

The memorandum then concludes: "I.R.S.' discovery powers are limited once the I.R.S. has completed their audit. There is no need for taxpayers to let themselves be bullied into volunteering information that may later be used against them."

Whether the statements in the memorandum are correct (or skewed) is irrelevant; the perception clearly exists that the IRS is up to something nefarious. Indeed, although our members may find the law firm memorandum unduly adversarial, the absence of any balanced IRS counterpoint understandably leaves them reluctant to respond to the IRS requests. By forthrightly announcing what the IRS's information-gathering procedures (and goals) are--and clarifying the potential consequences (including the lack of any sanction for a company's choosing not to respond to. the request)--you can help remedy the situation, dissipate the distrust, and strengthen the taxpayer-IRS relationship.

If you wish to discuss this matter, please do not hesitate to call either Timothy McCormally, the Institute's General Counsel and Director of Tax Affairs, at [phone] or me at [phone].