23 April 2019Accounting & tax analysis

IRS launches captive campaign to ensure compliance with arm's length prices

The Internal Revenue Service (IRS) has launched a compliance campaign to ensure US multinational companies are paying their captive service providers no more than arm's length prices.

The captive services provider campaign was identified by the IRS Large Business and International division (LB&I), along with two others - the offshore private banking campaign and loose filed forms 5471.

An arm's length transaction refers to when both parties in a transaction are independent and on an equal footing.

The IRS stated that excessive pricing for captive services would inappropriately shift taxable income to these foreign entities and erode the US tax base.

In determining an arm's length price, actuarial analysis is an appropriate method to determine the premium required for insurance of a particular risk, the OECD has previously outlined.

"The section 482 regulations and the OECD Transfer Pricing Guidelines provide rules for determining arm’s length pricing for transactions between controlled entities, including transactions in which a foreign captive subsidiary performs services exclusively for the parent or other members of the multinational group," the IRS stated.

"The arm’s length price is determined by taking into consideration data available on companies performing functions, employing assets, and assuming risks that are comparable to those of the captive subsidiary."

The lead executives of the captive services provider campaign are Jennifer Best, director, Treaty and Transfer Pricing Operations; and John Hughes, director, Advanced Pricing and Mutual Agreement.

LB&I's goal behind these campaigns is to improve return selection, identify issues representing a risk of non-compliance, and make the greatest use of limited resources.