A recent Tax Notes article analyzes the “standard of review” that the Tax Court will apply to the IRS’s transfer pricing adjustments. In transfer pricing cases, the Tax Court determines whether the IRS has abused its discretion by proposing an adjustment that is “arbitrary, capricious, or unreasonable.” Although courts often describe this standard as a “heavy” burden for the taxpayer to prove, the Tax Notes article concludes that “recent experience suggest[s] that taxpayers and the IRS are on mostly even ground in transfer pricing litigation.”
We won’t comment on that conclusion in this blog post, although we encourage anyone interested in the intersection between transfer pricing and court procedure to read the article.
We do, however, want to point out that there is at least one area where our experience tells us that the standard of review really might matter: in dealings with IRS personnel. While the IRS has indeed lost many transfer pricing cases, the IRS has always had considerable leverage at administrative levels (e.g., in audit or before Appeals) and in settlement discussions in litigation. No matter whether a court practically puts the IRS and taxpayers “on mostly even ground,” the IRS continues to believe (or at least argue) that the abuse-of-discretion standard of review gives the government the advantage. This could in some cases make IRS agents, Appeals officers, and IRS trial counsel less willing to resolve transfer pricing controversies on terms that are favorable to the taxpayer. It could also mean that IRS personnel will make arguments about the standard of review, which the taxpayer will need to address. Even if IRS personnel are not justified in their thinking, the standard of review does have practical significance in that sense, at least in our experience.