Printer Friendly

Improving the process for conducting the international segment of an IRS audit.

Improving the Process for Conducting the International Segment of an IRS Audit

At a pre-audit meeting, the Internal Revenue Service and Weyerhaeuser Company focused on the international audit process and agreed on improvements that should significantly reduce staff time for both. This article summarizes the process by which the improvements were developed, agreed to, and implemented.

BACKGROUND

The international portion of Weyerhaeuser Company's 1983 to 1985 U.S. tax audit took several months longer than the domestic examination to complete. This delayed closing the overall audit and had Weyerhaeuser management and IRS officials alike asking "why?" Although the International Examiner was based in San Francisco and the domestic examination conducted from Seattle, there was no inherent reason for the international segment to take so long. There was one unagreed technical issue, but this was identified early in the examination and did not appear to be the principal cause of delay. Much of the examination consisted of documentation of foreign tax credits and earnings and profits, and reviewing the technical aspects of Subpart F computations. The review of foreign source income, section 861 expense allocations, and DISC and FSC commissions was fairly routine.

Before completion of the audit, the IRS notified Weyerhaeuser that it was planning to assign an additional international examiner (IE) to Weyerhaeuser's next audit cycle. The new IE would be from Seattle and work under the supervision of a more senior IE from San Francisco. In conjunction with the pre-audit planning for the new audit, Weyerhaeuser and the IRS agreed to explore ideas for improving and expediting the international audit process.

In preparation for the meeting, Weyerhaeuser thoroughly reviewed the previous audit, including the scope of the examination, the time needed to gather information and respond, and the level of adjustments proposed. Most of what the company learned came as no surprise. But there were some revelations.

Weyerhaeuser knew that it was taking longer to prepare and respond to Information Document Requests (IDRs) than it would like, but was not sure why. On average, the company was responding in 129 days, whereas it generally considers 60 days to be a reasonable target. Two primary causes surfaced for the delay:

* The company was spending enormous amounts of

time documenting small withholding taxes on royalties

and other relatively small foreign tax credits.

The IRS and Weyerhaeuser agreed they both

were responsible for the disproportionate amount

of time spent on de minimis adjustments. Although

the IRS had requested documentation of

all foreign tax receipts, the company wanted all

adjustments made when the receipts were presented.

* Many of the IDRs were issued during the peak of

Weyerhaeuser's tax accrual and return preparation

cycle when its staff was substantially focused

on those activities.

The IRS advised the company that its review disclosed that computations with respect to which there was no substantive disagreement were taking too much time. After discussion, it appeared the problem was attributable to insufficient communication between the IRS and the company at critical times during the report-writing phase. Weyerhaeuser and the IRS agreed this could be corrected by more extensive use of the facsimile machine and greater on-site involvement as the examiner's report is being prepared.

OBJECTIVES

The IRS and Weyerhaeuser agreed to three objectives for the next audit cycle:

* Finish the international examination no later than

the domestic audit.

* Make the most effective use possible of staff time

(for both Weyerhaeuser and the IRS).

* Ensure that the complexity of the international

tax law does not cause inordinate delays in the

audit.

PROPOSALS

During the meeting, the IRS and Weyerhaeuser discussed three proposals to accomplish their mutual objectives: (1) setting the scope of the audit, (2) developing scheduling efficiencies, and (3) improving communications.

A. Setting the Scope of the Audit

The IRS and Weyerhaeuser agreed that the scope of the examination should cover only areas with significant revenue potential and that Weyerhaeuser should make presentations to assist the IRS in coming up to speed in complex areas. Obviously, sampling techniques could also be employed to verify compliance in de minimis areas. The IRS and the company focused on the following areas for improvement:

1. Documentation of Withholding Taxes

In prior examinations, the IRS had requested 100-percent documentation of foreign tax credits claimed. Weyerhaeuser has numerous small dollar royalty arrangements and documenting foreign withholding taxes consumes an incredible amount of time. Royalties and the corresponding withholding taxes are accrued and the documentation is on a paid basis. To reconcile the two requires poring over files to determine to which accounting period the withholding tax payment relates. The IRS and the company agreed that no documentation would be requested for small withholding taxes below a threshold level, since the amounts are recorded in the Weyerhaeuser's general ledger and there have been few adjustments in the past and then only in de minimis amounts.

2. Documentation of Indirect Foreign Tax Credits

Weyerhaeuser receives some relatively small dividends from controlled foreign corporations (CFCs) that have correspondingly small amounts of indirect foreign tax credits and gross up. The time required to document and review these credits and earnings and profits is just as great as for a CFC with a large dividend and credits. The potential for revenue recovery is minimal and does not merit either party spending valuable staff time. Consequently, the IRS and Weyerhaeuser agreed that no documentation would be requested for indirect foreign tax credits below a threshold level since the company's U.S. accounting records reflect adjustments to tax expense. (At worst, there could be a small timing difference between years.) The IRS and the company also agreed that this would not preclude the IRS from testing Subpart F of some CFCs even though there was less than the agreed level of foreign tax credits involved.

3. Scope of Review of Foreign Source Income

Weyerhaeuser is in a substantial excess foreign tax credit limitation position. The Tax Reform Act of 1986 contained numerous provisions that could potentially bog the company and IRS down without materially affecting the company's tax liability, e.g., separate baskets, "look through" rules, and new complex expense allocation and apportionment rules for interest and other expenses. A high-level review will be performed of Weyerhaeuser's tax return workpapers. Weyerhaeuser believes this should be sufficient to show there is no revenue potential and the area would not merit a detailed examination. After the company makes presentations to the IRS to provide it with an overview of the company's methodology and accounting records, the IRS will test check areas of key revenue potential.

4. Scope of Review of FSC Qualification Requirements

A high-level review will be performed on foreign sales corporation (FSC) qualification requirements, including foreign management requirements, foreign sales activities test, and the foreign cost tests. This is an area with numerous procedural and accounting requirements that has absolutely no revenue potential unless a taxpayer is extremely careless. The IRS and Weyerhaeuser agreed that the company will present an overview and some key documents to establish the existence and qualification of the FSCs, thereby eliminating the need for detailed review. They also agreed this would not preclude the IRS from a more detailed examination of areas it believed questionable.

5. FSC Commission

With regard to the FSC commission, which is an area with revenue potential, Weyerhaeuser agreed to make one or more presentations to the IRS explaining the company's accounting system, tax adjustments, methods, and assumptions in making expense allocations and apportionments. The IRS will test check key areas. This should rapidly increase the IRS's understanding of Weyerhaeuser's accounting treatment and computation methodology and allow both parties to reduce the time involved in reviewing this area.

B. Scheduling

With two IEs assigned to the Weyerhaeuser audit, there were questions related to how they will divide audit areas, when they will be available to conduct the audit, and whether this time frame would correspond with the availability of company personnel. There are certain periods such as the year-end closing of the books and the last three months of tax return preparation when Weyerhaeuser's tax staff availability is extremely constrained.

Weyerhaeuser is in a better position to work with the IRS from February through June, and October through December than during other times of the year. Accordingly, the IRS and the company agreed on the following scheduling principles (with details to be agreed on at a subsequent meeting):

* Audit one area at a time. Both IEs would concentrate on the same area

until it is finished. Although this is a general goal, an exception will be

made for areas that require little time to review. At such times it will be

necessary to review more than one issue concurrently to make the most

effective use of both IEs.

* Agree on the sequence of issue review. The examination will start with

FSC issues, which will be the most time-consuming area.

* Commit a heavy amount of time at the front end of the examination.

* Keep open communications on other commitments, e.g., other audits,

training, vacations. This was an important agenda item. The International

Supervisor indicated the senior IE on the Weyerhaeuser examination

(from San Francisco) would be heavily involved on another assignment

through June. If that IE were not available to join the Weyerhaeuser

audit until after June, the IRS and the company's mutual objectives

would be jeopardize. After further discussion, the Supervisor offered to

schedule the San Francisco IE for at least one week per month through

June and to assign the Seattle IE to the audit on a full-time basis.

C. IDRs and PAFs

The IRS and Weyerhaeuser agreed that the IRS will issue all Information Document Requests (Form 4564) and Preliminary Audit Findings (Form 5701) through the Team Coordinator. The Team Coordinator will maintain a log, thereby giving the Case Manager better control of the audit process. Weyerhaeuser agreed to designate one person to receive and log-in and log-out all such forms (for both domestic and international issues).

D. Communications

The IRS and the company agreed that they must both work harder at improving communications. It is anticipated that this will go much smoother with a full-time IE assigned from Seattle who has been designated as the principal contact for the IRS. The IRS and the company plan to have weekly meetings to review the status of IDRs, any open issues, and the schedule for remaining examination items. The concern raised by the IRS concerning computations of agreed adjustments taking too long would be corrected by having face-to-face discussions and resolving any discrepancies at that time and by making more extensive use of the facsimile machine when Weyerhaeuser and the IRS cannot meet.

CONCLUSION

The stage is set for a successful audit. The IRS and Weyerhaeuser fully anticipate accomplishing all of their objectives and completing the audit in a timely manner without burning out either staff.

A critical element in the development of the audit plan was that both the IRS and the company identified early on that their objectives were identical - that is to say, the completion of a quality audit with a minimum expenditure of scarce resources. After the audit, the IRS and the company will meet and review data on how successfully they followed their plan, the benefits of having done so, and opportunities to further improve the process.

R. DOUGLAS KYLE is a Manager, International Taxes for Weyerhaeuser Company in Tacoma, Washington. Mr. Kyle joined the company in 1968 after receiving his J.D. degree from George Washington University Law Center. (He earned a B.A. degree in Accounting (cum laude) from the College of Idaho.) Mr. Kyle has been a member of Tax Executives Institute since 1978, and has served as President of TEI's Seattle Chapter and as a Regional Vice President of the Institute. He currently is a vice chair of TEI's International Tax Committee.
COPYRIGHT 1990 Tax Executives Institute, Inc.
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1990, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

Article Details
Printer friendly Cite/link Email Feedback
Author:Kyle, R. Douglas
Publication:Tax Executive
Date:Sep 1, 1990
Words:1963
Previous Article:Comments on capitalization of interest in the foreign context.
Next Article:Status report on IRS offset program.
Topics:


Related Articles
What to do when facing a substantial tax deficiency.
CEP's silver anniversary: IRS and taxpayers working together.
Draft IRS report on International Enforcement Program - Key Performance Indicators.
IRS serious about market-segmented audits.
Update on MSSP audits.
Improving the audit process: a cooperative venture.
The audit lottery, or preparing for the TCMP audit - again!
How should a tax practitioner complain about an IRS agent's conduct?
Recommendations for CEP process improvements involving specialists.

Terms of use | Copyright © 2017 Farlex, Inc. | Feedback | For webmasters