The IRS has issued new legal advice regarding transfer pricing adjustments for high-profit-potential intangible property. This guidance, outlined in Legal Advice Issued by Associate Chief Counsel 2025-001, emphasizes the IRS's authority to adjust transfer pricing based on actual profits to align reported income with economic reality.
Authority Under Code Sec. 482: The IRS can reallocate income between commonly controlled entities to ensure reported income reflects economic reality. This is done by applying the arm's length standard (ALS) and the "commensurate with income principle" for high-profit-potential intangible assets.
Arm's Length Standard (ALS): This standard ensures that transactions between related parties resemble those between independent entities. However, taxpayers may not use ALS alone to overcome adjustments if actual profits significantly exceed projections.
Commensurate with Income Principle: This principle ensures that compensation for intangible assets remains aligned with actual income over time. If actual profits exceed projections, the IRS may adjust transfer pricing to reflect this increased value. For example:
- Licensing of Intangible Property: If a U.S. company licenses intellectual property to a foreign affiliate and actual profits exceed initial estimates, the IRS may adjust the royalty rate to ensure it aligns with the income generated by the asset.
- Cost-Sharing Arrangements (CSA): If actual profits from shared development efforts far exceed projections, the IRS may adjust platform contribution transaction (PCT) payments to reflect the increased value of the intangible assets.
To avoid adjustments, taxpayers must satisfy specific exceptions by demonstrating that their transfer pricing methods align with IRS requirements.
Simply Invoking ALS Or Claiming Compliance
With The Best Method Rule Is Insufficient.
This guidance underscores the IRS's focus on ensuring that intercompany transactions involving intangible property accurately reflect economic reality, preventing undervaluation and income distortions.
Read more at: Tax Times blog
