April 2023 / United States

The Internal Revenue Service (IRS) released its Inflation Reduction Act Strategic Operating Plan that focuses spending on enforcement and operations. The Plan further outlined how the IRS will use USD 80 billion in funding it received from the Inflation Reduction Act through fiscal year 2031.

The 150-page plan specifically highlighted the following as priority spending items:

• improvement to taxpayer services;
• efficient resolution of taxpayer issues;
• expanding enforcement on taxpayers with complex filings and high-dollar noncompliance;
• delivery of more effective technology and analytics; and
• attraction and retention of the agency's workforce.

The Plan's spending was segmented into:

• USD 45.6 billion for enforcement;
• USD 25.3 billion for operations support;
• USD 4.8 billion for the business system modernization; and
• USD 3.2 billion for taxpayer services.

The operating plan has 42 initiatives designed to achieve agency goals and outlines 190 key projects and more than 200 specific milestones. The IRS stated that it will identify additional projects and milestones as its work continues.

The plan emphasizes that IRS will be working to ensure fair enforcement of the nation's tax laws and compliance with existing laws while respecting taxpayer rights. The IRS will focus on identifying compliance issues involving large corporations, larger partnerships and high-wealth individuals. The plan additionally states that, in accordance with Treasury Secretary Janet Yellen's directive, its audit rates will not increase on small businesses and households earning USD 400,000 or less per year.

On 3 April 2023, the IRS released Notice 2023-31 notifying taxpayers of their intent to extend the transition period for an exception to pay foreign royalty withholding taxes once proposed Treasury Regulation (issued 21 November 2022) is finalized. The Internal Revenue Service (IRS) extension period - from 17 May 2023 to 180 days after the date the proposed regulations are finalized and filed with the Federal Register – would apply to the Foreign Tax Credit (FCT) proposed single-country exception, issued as part of the IRS's 21 November 2022 proposed regulations.

Under these proposed regulations, a royalty withholding tax would qualify as an FTC if the company has a licensing agreement in a given country to use the intellectual property that generates the royalty, and as long as the IP is used only in that country. To qualify for the proposed single-country exception, taxpayers may need to revise existing license agreements to satisfy the above documentation requirement. Rather than having to revise licensing agreements that will allow taxpayers to meet the single-country exception by 17 May 2023, the proposed Treasury Regulations would give taxpayers additional breathing room. They will now have at least 180 days after the date final regulations are filed with the Federal Register.

Otherwise, taxpayers may rely on Notice 2023-31 for foreign taxes paid in taxable years beginning on or after 28 December 2021 and ending before the effective date of the final single-country exception rule, provided the foreign tax is otherwise eligible for the exception.

Note: The Treasury and the IRS in 2021 issued FTC regulations providing that foreign withholding taxes on royalty payments are creditable only if the foreign law treats royalties as taxable income based upon the place of use, or the right to use, of the intangible property, consistent with how the Internal Revenue Code (IRC) imposes taxes on royalty income. Royalty withholding taxes were of particular concern to taxpayers, as many countries use rules to demand withholding taxes on royalty payments that are different from those that the US adopts. The result is that, absent a specific exception, many taxpayers would face ineligibility of foreign withholding taxes to qualify as FTCs. The above proposed regulations address this issue.

On 29 March 2023, the Internal Revenue Service (IRS) released Announcement 2023-10, which featured the 2022 Announcement and Report Concerning Advance Pricing Agreements (APA Report) providing that fewer APAs were executed with longer periods of time to completion than in 2021. The Report summarizes APAs by industry, transaction category, transfer pricing method selected, and profit-level indicator used for the APAs executed for the 2022 calendar year.

According to the report, only 77 APAs were executed in 2022, compared to 124 in 2021. The 2022 percentage of APA renewals executed was reduced to 55%, compared to 63% in 2021, and the median completion time for an APA in 2022 increased to 43.4 months, compared to 35.1 months in 2021.

However, the number of applications filed in 2022 increased to 183, compared to 145 filed in 2021. Additionally, the comparable profits and transactional net margin methods were selected in more than 75% of all covered transactions, with more than half of the APAs executed in 2022 involving transactions between non-US parents and US subsidiaries. Although most of the 2022 transactions covered in APAs executed in 2022 involved the sale of tangible goods or the provision of services, approximately 22% involved the use of intangible property.

IRS representatives attribute the decrease in the number of executed APAs to the fact that the APA Program was able to close its pre-pandemic cases and routine APAs during 2021, leaving more complex cases and newer APAs for 2022, which are more time consuming to complete. Further, the need for virtual meetings delayed the advancement of new 2022 advance pricing agreements. Despite these complexities, no APAs were revoked or cancelled in 2022 and only an average of 6 were withdrawn during the year.

Note: Under an APA, the government signs off on a company's transfer pricing arrangements over a set period, providing tax certainty between both sides on how the transactions are valued by the countries involved.