Transfer Pricing Audits: Flipping The Tested Party

In some recent transfer pricing audits, the Internal Revenue Service (IRS) "flipped the tested party" after examining transactions between related U.S. and foreign companies. Typically, this practice results in the attribution of a larger portion of profit from the relevant business activity to the United States. On its face, the expression "flipping (or switching) the tested party" suggests that the IRS and the taxpayer have essentially similar views of the transactions (and the entities involved), but have approached the pricing from different angles: The taxpayer priced the transaction by comparing the profits of one party (usually the U.S. entity) to those of comparable unrelated parties, whereas the IRS priced the transaction by comparing the profits of the other party (usually the foreign entity) to those of comparable unrelated parties. In some cases, however, it appears that in purporting to flip the tested party, the IRS may in fact have misconstrued the