Congress and the Internal Revenue Service are concerned about the ability of multinational corporate taxpayers to organize their operations so that significant profits are shifted from corporations doing business in the United States to their foreign subsidiaries or affiliates in low-tax jurisdictions. This shifting of income away from the United States, resulting in lower current U.S. income taxes—the object of the exercise—can be achieved through intercompany pricing arrangements.

Congress has, in §482 of the Internal Revenue Code, authorized the IRS to allocate income and deductions between related parties to the extent necessary to prevent avoidance of U.S. tax or to reflect more clearly the income of the related parties.

About 50 percent of large corporate tax examinations involve intercompany pricing (also referred to as transfer pricing) or other reallocation issues. Since 95 percent of all litigated tax cases are heard by the U.S. Tax Court, most intercompany-pricing disputes have been and will be heard by the Tax Court. A powerful motivating factor channeling cases to the Tax Court is that the disputed taxes in these cases can amount to many tens, and not infrequently hundreds, of millions of dollars. A corporation disputing the IRS reallocation and resultant increased tax is not required to pay the disputed tax before having its case heard in the Tax Court. To have its case heard in a U.S. district court or the U.S. Claims Court, the taxpayer corporation must first pay the disputed tax.

Intercompany Pricing Dispute

Until recently, the IRS had opposed arbitration in tax cases. On March 12, 1992, however, Apple Computer and the IRS entered into a stipulation by which they agreed to have an intercompany pricing dispute resolved by arbitration rather than decided in a trial before the Tax Court. The agreement aroused considerable interest because trials in intercompany pricing cases tend to be long and can involve hundreds of thousands of documents, complex economic analyses and technical testimony from expert witnesses.

Transfer-pricing disputes are fact-intensive since they involve issues of whether a taxpayer’s intercompany-pricing structure comports with a standard of an "uncontrolled taxpayer dealing at arm’s length with another uncontrolled taxpayer." Once the IRS challenges a taxpayer’s arrangements for the transfer pricing of tangibles or intangibles, the burden of proof is on the taxpayer to show not only that the resulting reallocation of income as reached by the IRS is arbitrary, unreasonable or capricious, but that the taxpayer’s existing pricing arrangements satisfy the arm’s length standard.