IRS corporate enforcement focused on int’l issues 

The IRS has been forthcoming about the fact that it will be focusing its new funding received under the Inflation Reduction Act of 2021 (IRA) to increase audits of large corporations and partnerships and high net worth individuals. A recent news release and a district court victory in Liberty Global, Inc. v. United States make it clear that international tax issues will be a major component of the IRS’ enhanced enforcement efforts.

Increased enforcement of international tax issues

The recent IRS news release describes how the IRS will increase its focus on international tax issues as follows:

• Increased compliance activity around transfer pricing of U.S. subsidiaries of large foreign corporations. The IRS stated that it would be sending compliance letters to 150 subsidiaries of large corporations “to reiterate their U.S. tax obligations and incentivize self-correction.” The IRS stated that these letters began going out in October.
• Expansion of the Large Corporate Compliance (LCC) program to include cross-border issues. The IRS will be starting an additional 60 LCC audits, and review of cross-border issues and corporate planning will be part of the audit selection process. The LCC program covers large corporations with average assets of more than $24 billion and average taxable income of approximately $526 million per year.
• Increased scrutiny of IRC Section 199 claims. Buoyed by its recent win in BATS Global Markets Holdings, Inc. v. Commissioner, the IRS said it would continue the Large Business & International Division campaign to increase scrutiny of claims for refund based on the IRC Section 199 domestic production activities deduction, which was repealed by the Tax Cuts and Jobs Act of 2017.

Crowe observation

The fate of IRS funding is still uncertain. Significant cuts could impair the IRS’ ability to significantly increase audits of complex international transactions.

Liberty Global

The IRS had a major win in which a district court found that a cross-border transaction lacked economic substance. That case, Liberty Global, Inc. v. United States, involved a taxpayer that filed its 2018 return consistent with temporary regulations issued in 2019, which resulted in the taxpayer recognizing $2.4 billion in gain from the sale of a controlled foreign corporation without an offsetting IRC Section 245 deduction. Subsequently, the taxpayer filed an amended return requesting a refund of $95,783,237, claiming that the temporary regulations did not apply and that it is entitled to the IRC 245A deduction. The taxpayer then filed suit in federal court for the refund.

In its refund suit, the taxpayer challenged the validity of the temporary regulations, arguing that the IRS failed to follow the notice and comment requirements under the Administrative Procedure Act (APA). On April 4, 2022, the court agreed with the taxpayer and invalidated the temporary regulations.

The taxpayer’s win on the APA issue, however, was not enough for it to prevail in its claim for refund. On Oct. 31, the district court held that the taxpayer was not entitled to the IRC Section 245A deduction because the transaction generating the deduction lacked economic substance under IRC Section 7701(o).

In addition, on Oct. 7, 2022, the U.S. Department of Justice took the unusual step of suing the taxpayer for tax and penalties related to the transaction without first issuing a notice of deficiency. The taxpayer filed a motion to dismiss the case, which the court denied. This case is still pending.

Looking ahead

The increase in enforcement funding and the IRS’ focus on international tax issues should put multinational corporations on notice that the likelihood of international tax issues being audited has increased. Moreover, the IRS’ recent success in Liberty Global signals an increase in its willingness to use the economic substance doctrine under IRC Section 7701(o) to challenge complex international transactions.