In most transfer pricing disputes, the taxpayer squares off with the IRS or some other taxing authority, and the issue is the amount of tax due. But, in some cases, a company’s transfer pricing policies can lead to disputes between private parties. It is important for tax-department personnel to be aware of the risks from these private disputes so that they can take them into account when setting up intercompany documentation and transfer pricing policies. Examples include:
- Securities litigation. Securities litigation represents perhaps the largest private-party risk arising from a company’s transfer pricing policies. Companies should consider the possibility that shareholders could allege that they were misled by the company’s securities filings in the event the IRS or another taxing authority assets a transfer pricing adjustment. If the company’s transfer pricing is viewed as particularly aggressive, shareholders might argue that the company knowingly failed to disclose actual or contingent tax liabilities, resulting in an artificially inflated share price. In that case, a taxpayer could find itself litigating—in different courts simultaneously—an IRS adjustment in tax litigation and a shareholder lawsuit related to the very same adjustment.
- M&A Activity. Tax matters often impact M&A agreements, and it is common for the merging parties to dispute these agreements in private litigation. Transfer pricing can influence purchase-price adjustments in M&A agreements, potentially leading to a dispute over the proper quantum of that adjustment. Or there could be transfer pricing disputes related specifically to the proper interpretation of a tax matters agreement, which often directly addresses how the merging entities complete their final tax returns.
- JVs and Minority Interests. Over the decades, transactions involving joint ventures, minority shareholders, family-owned businesses, and other less than wholly owned ownership structures have given rise to numerous disputes between taxpayers and the IRS regarding whether and how section 482 applies in such cases (e.g., whether “common control” is present). But such transactions could also give rise to private pricing-related disputes among the parties to the transactions, their owners, or other stakeholders.
- Wrongful Termination. In a prior post, we described the transfer pricing risks that a company faces from its tax-department employees becoming whistleblowers. But whistleblowers also present employment-law risks. If a company dismisses an employee who has raised concerns about the company’s transfer pricing practices, the employee might allege wrongful termination and point to state and federal whistleblower protections. Even if the allegation is meritless, it could tie the company up in litigation for years.
It is an old truism that transfer pricing litigation requires a “whole company” approach. The same is true for private-party transfer pricing disputes. One key risk-mitigation opportunity is for the tax department to coordinate closely with other relevant departments and company personnel who are responsible for these affected areas. For example, risks related to wrongful termination lawsuits could be reduced if the human-resource department was made aware of the tax-specific risks for whistleblowing. Human resources could then, for example, strengthen relevant policies and ensure tax-department managers had appropriate internal training. Overall, breaking down corporate silos so that various departments can work together can reduce the risks related to private-party lawsuits involving transfer pricing.
Of course, in all these kinds of disputes, the taxpayer will be in a strong position if its transfer pricing approach is fully compliant with section 482. But, given that reasonable minds often differ on arm’s-length prices, even the most careful and conservative tax department should be aware of the private-party risks that might arise from their transfer pricing.