Maybe I lack relevant local knowledge (I am not a US citizen) but seems like this describes a situation where a government agency had discretion to perhaps do something legal but immoral back in 2016. Did they, in fact? That is, did the IRS tell Vanguard it owes a large new tax bill on a "transfer pricing" rationale?
The UK's GAAR has this trick called a "double reasonableness test" which it uses to get rid of some types of tax _avoidance_ and that seems like an appropriate legal rule here if, in fact, the IRS does abuse this discretion.
The double reasonableness test asks this:
Could any reasonable person (not you, the jury member, judge or whatever, but some other reasonable person you're capable of imagining) think that this way of doing things was reasonable ?
Only if the answer is "No", which it will be only for the most extraordinarily tortured ways of avoiding tax, then this method of avoiding tax is prohibited. You don't go to jail or anything, your avoidance trick just doesn't work and you owe the taxes as usual.
What this is really exposing is a facet of the sham of "transfer pricing" in general.
The problem with transfer pricing is that "market price" is a context-dependent volatile fiction. If you buy a jar of peanut butter, it might cost $2 at one store and $2.50 at another on the other side of town. Which one is the market price? The difference is 25%, which at scale is enough to consume most companies' entire profit margin. And the answer is both, because the less expensive one is on the outskirts of town and the other is in the center of town where rents are higher and you pay a premium for the convenience.
Which is one of the ways international companies avoid tax. You have a 10% profit margin internationally, so you overpay/underpay by 10% for everything from your sister company and make zero profit in the high tax jurisdiction, but the entire difference is within the "market price" margin of error. It's even possible to justify the difference by making note of some value add feature/service you did or didn't have that justifies a higher or lower price.
The entire concept is a farce because the error margins are larger than typical profit margins.
Which is how you get bizarre nonsense situations like this. If Vanguard is charging less than others had historically, are they charging less than the market price, or that just the new market price?
It's much more bizarre than that. Vanguard is organized upside-down from most funds companies. Instead of a company that owns mutual funds, Vanguard funds own the management services company (and investors in turn own the funds). This aligns the incentives of Vanguard with its investors --- which is exactly what you want from a fund manager.
Vanguard is in trouble for "charging" the funds below-market rate on the services provided by the management company. But the only reason there are charges to pay attention to at all is that Vanguard deliberately organized itself to return as much money as possible to investors.
Suppose you open a car dealership that gives every person who buys a car a share of the dealership. The next thing you know that dealership has the best service and the lowest prices and makes no profits, because all the owners are also customers and they care less about getting a $10 dividend than about service quality and price.
So then the argument is they're under-charging themselves and they owe tax on the difference between what they charged themselves and the fair market value. But it turns out all the customers love this ownership structure and having to compete with it has caused all the other dealerships to lose business and cut prices, and two new independent dealerships with the same structure sprang up and are now charging similar prices, meanwhile several of the incumbents with the old structure have gone out of business.
So the question is, what's the market price? It's clearly lower than it was, even the old incumbents that are still around are charging less, and losing market share while doing it. If there are now multiple companies offering the razor thin margins, isn't that the new market price? It's a price available to any member of the public and it's what anybody has to compete with if they want to enter the market.
The argument that there is a difference between what they're charging and the market price is ignoring the fact that their aggressive competition has lowered the market price down to what they're charging. But if you try to compare with what rates were like in 1975 then you get a squirrely result.
It's the same problem as with any of it. The grey area covers the entire map. The price they're charging is reasonable -- someone could charge it and operate a sustainable business, and several people do. But somebody else argues that it used to be higher. They're both right, and that's why the entire concept is a farce.
I don't see it that way, since they could have simply organized the company the ordinary way, with a services company that owned multiple funds, and avoided these tax implications: the "transfers" we'd be talking about would still be happening, but they would be untaxable.
But that's irrelevant if you're not giving this defunct historical market value to the transfers. The only thing taxable is the difference between what they charge and the market value. The rate they charge is available to the general public -- it should be the new market value.
I'm not sure we're clear on what's happening. The transactions we're talking about are only transactions due to a consumer-protective structure Vanguard adopted. Fidelity also provides IT services to its funds (for instance), and won't provide IT services to anyone else in the market, but because it owns the funds, there's no taxable transaction occurring.
If Vanguard's tax filings are actually non-compliant, we should change the laws immediately.
There's a Matt Levine piece on this somewhere, it's worth finding and reading.
The UK's GAAR has this trick called a "double reasonableness test" which it uses to get rid of some types of tax _avoidance_ and that seems like an appropriate legal rule here if, in fact, the IRS does abuse this discretion.
The double reasonableness test asks this:
Could any reasonable person (not you, the jury member, judge or whatever, but some other reasonable person you're capable of imagining) think that this way of doing things was reasonable ?
Only if the answer is "No", which it will be only for the most extraordinarily tortured ways of avoiding tax, then this method of avoiding tax is prohibited. You don't go to jail or anything, your avoidance trick just doesn't work and you owe the taxes as usual.