IRS Website Issues FAQs on IRC 482 and How to Prepare 482 Documentation to Avoid Penalties
May 13, 2020
On the IRS website "Transfer Pricing Documentation Frequently Asked Questions (FAQs)" (updated 4/14/2020), the IRS has issued a series of frequently asked questions (FAQs) concerning the best practices and common mistakes in preparing transfer pricing documentation.
IRC Sec. 6662(e)(1)(B)(ii) provides that there is a substantial valuation misstatement if the net section 482 transfer price adjustment for the tax year exceeds the lesser of $5 million or 10% of the taxpayer's gross receipts ("net adjustment penalty").
The 20% (or 40%) Code Sec. 6662 penalty for underpayment of tax attributable to a substantial valuation misstatement (or a gross valuation misstatement) applies to Code Sec. 482
company pricing adjustments.
Understanding How To Determine and Document Intercompany Prices To Avoid A Potential Penalty,
or Salvage A Situation Where This Hasn't Been Done,
Can Produce Worthwhile Tax Savings!
Generally, if the dollar thresholds of the net adjustment penalty are met, a taxpayer potentially can avoid the penalty if the taxpayer's APA has satisfied the transfer pricing documentation requirements of Code Sec. 6662(e)(3)(B) and Reg. §1.6662-6 (sometimes referred to as the 6662(e) documentation). Reg. § 1.6662-6(d)(2)(iii)(B) sets forth the principal documents that must be maintained by a taxpayer to satisfy the 6662(e) documentation requirements.
Having 6662(E) Documentation Does Not
Automatically Protect Against Penalties.
The documentation must also be assessed for adequacy and reasonableness. To satisfy the documentation requirement of the penalty regulations, taxpayers must select and apply a method in a reasonable manner and document the fact they reasonably selected and applied the best method for their analysis. (Section A of Transfer Pricing Documentation Frequently Asked Questions (FAQs))
In a 2018 Public Report, the Internal Revenue Service Advisory Council (IRSAC) IRS Large Business & International Division (LB&I) Subgroup observed that some stakeholders in the US transfer pricing community believed the quality of transfer pricing documentation had declined.
The IRSAC LB&I Subgroup recommended the IRS provide information to taxpayers to promote higher quality transfer pricing documentation. (Section B of Transfer Pricing Documentation Frequently Asked Questions (FAQs))
In response to the IRSAC recommendation, and based on the IRS's observations of best practices and common mistakes in preparing transfer pricing documentation, the IRS has issued the following FAQs which are based on the IRS' observations of best practices and common mistakes in preparing transfer pricing documentation.
The suggestions and recommendations are consistent with the requirements in the regulations to provide adequate and reasonable support for the arm's length nature of intercompany pricing.
Many taxpayers would benefit from insights on the information that could be provided to the IRS to increase the chance of audit deselection or more efficient audits.
The IRS believes the potential for deselection of issues earlier in the examination process could be a powerful incentive for many taxpayers to improve their transfer pricing documentation.
These FAQs and responses are illustrative and are being shared in the spirit of transparency to encourage cooperative compliance by taxpayers. The responses, and examples therein, are high-level only and should not be relied on to analyze actual transactions.
A 1 Transfer pricing reports that comprehensively document the reasonable selection and application of a transfer pricing method, consistent with the requirements of § 6662(e), help demonstrate low levels of compliance risk and in turn help support early deselection of the transfer pricing issue from further examination. High-quality transfer pricing documentation allows the examining agent to rely on the taxpayer's analysis of functions, risks, intangibles, value drivers, etc., saving both the taxpayer and the IRS time examining low-risk transfer pricing issues. Thus, robust transfer pricing documentation facilitates more efficient transfer pricing risk assessments and examinations for both taxpayers and examiners...
Q 2 How can a "self-assessment" help to anticipate questions and prepare better 6662(e) documentation?
A 2 Taxpayers may want to consider conducting a "self-assessment" of the potential indicators of transfer pricing non-compliance. If taxpayers undertake a basic sensitivity analysis around the parameters of their application of the best method, they can potentially anticipate and proactively address concerns the IRS might raise. A starting point is a sensitivity analysis of the parameters used. For example, if the tested party's results would fall outside the benchmark range with the removal of just one company from the comparable company set, the taxpayer should consider re-evaluating the strength of the comparability analysis of the benchmark companies...
A 3 The IRS's guiding principle is to ensure taxpayers are complying with § 482 and the regulations thereunder. Under the arm's length standard, related taxpayers must report income based upon intercompany prices unrelated parties would have charged under the same circumstances.
In this paradigm, taxpayers determine the best method and use that method to check the controlled prices applied during the year achieved results consistent with those that would have been achieved if uncontrolled parties had engaged in the same transactions...
A 4 Below are some, but by no means all, of the areas the IRS has identified that could benefit from improvement. Strengthening the sections identified below will not provide a safe harbor against either a continued examination or imposition of penalties but may result in the deselection of certain audit issues and/or a more efficient audit. The more complex the transaction, the greater the need for detailed analysis and documentation...
Q 5 What are some features of the most useful transfer pricing documentation reports?
A 5 Notwithstanding that IRC § 6662(e) penalty protection is limited to the information and analysis provided in the 6662(e) documentation, the IRS can and should consider whether there are other sources of relevant data. For example, the examination team should be probing what data and information the taxpayer had access to or should reasonably have identified and considered at the time of the transaction. Knowing what information was or should have been available to the taxpayer assists the examination team in determining if the taxpayer adequately searched for, considered and applied the relevant body of information and whether the taxpayer adequately incorporated and addressed that data in its 6662(e) documentation analysis... Q 6 Can you provide an example of a presentation of a company's intercompany transactions that would be a helpful summary for examiners to use in risk assessment? A 6 In general, making transfer pricing documentation more "user friendly" will make the IRS's review and assessment of the return positions as efficient as possible. Providing something as simple as a summary of information about the intercompany transactions at the beginning of the transfer pricing documentation helps IRS examiners understand the taxpayer's transactions. An intercompany transaction summary can help focus review and examination on the most significant transactions...
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