First let’s start with IRC 482. IRC 482 allows the IRS to make allocations to ensure that taxpayers clearly reflect income attributable to controlled transactions and to prevent the evasion of taxes. This refers to both domestic and international transactions that relate to transfer pricing between two related entities. In order for IRC 482 to even apply, three requirements have to be met:
- There must be two or more organizations, trades or businesses; AND
- There must be common ownership or control, either directly or indirectly of such entities; AND
- The IRS must determine that an allocation is necessary either to prevent evasion of taxes, or to clearly reflect the income of any of those entities.
We are going to focus on #2 above assuming that prerequisite #1 has already been met.
IRC 482 gives a broad definition of what constitutes control. Of these, they include, direct, indirect, legally enforceable or not, two or more taxpayers acting in concert, reality of the control is decisive and form of the control is not decisive. Basically saying…they can look at any kind of control.
You would think control would be one of those easy things to define and show, but it is not always that clear and just going by ownership (Stock) percentage is not always the case. So if you honestly don’t know who has control, ask yourself some of the following questions:
- Do you have actual or practical control in the other party to the transaction?
- Do you have two independently owned companies acting in concert with each other?
- Do you have income or deductions that have been arbitrarily shifted?
- Does one individual or party have enough control or influence to move the party in question to act as instructed?
- Who is the single largest shareholder?
- Do some parties have the same board of directors?
- Is there a management agreement that gives specific authority?
If you ask yourself any of these questions and you or the IRS come up with an answer of “yes there is common control”, then the IRS can move on to prerequisite #3 and look to make sure allocation is done according to control and ownership. They can then make allocations if they feel that the transactions were executed in a way that did not properly reflect an arm’s length transaction and hence create a case in which one person, or entity, did not pay their full share of tax due.
These rules are very complex and control can be an easy or difficult item to prove. If you have any questions or if the above information relates to you or your company, you should consult a tax adviser to reassure yourself that your related transactions are in compliance and the allocations fairly represent the control or power for each party involved.
By Chris Morrison, CPA