IRS Transfer Pricing Audit Roadmap


Transfer Pricing NEWS

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The Transfer Pricing Operations (TPO) of the Large Business and International (LB&I) division of IRS released the 26-page Transfer Pricing Audit Roadmap to the public on February 14, 2014.

The Transfer Pricing Audit Roadmap (“Roadmap”) provides audit procedures around an approximate 24-month audit timeline. The stated goals of the roadmap are to assist both the IRS and taxpayer in the discussion and resolution of transfer pricing issues in a timely and orderly fashion, and to resolve issues in the Exam level rather than at Appeals. Also, the Roadmap is intended to provide insight into what to expect during a transfer pricing examination, as well as put a concrete work plan into place for the TPO to execute its transfer pricing audits. The Roadmap is not official guidance; it is a working document for revenue agents in planning their examinations without having to regularly consult the Internal Revenue Manual.

The Roadmap states, “Proper development of a transfer pricing position may take as much as 2-3 years or more.” Given this extended timeline, the Roadmap acknowledges that up-front planning will be essential to the examination process before the IRS commits significant resources to a transfer pricing examination.

There are three phases to the audit process as described in the Roadmap: Planning, Execution, and Resolution.

1. Planning

The Planning phase can last up to 6 months, and starts before the audit cycle begins. The Planning phase consists of a pre-examination analysis, an opening conference (which starts the 24-month examination clock), a transfer pricing orientation meeting (i.e., explanations by the taxpayer of its transfer pricing arrangements and financial information), and the preparation of the initial risk analysis and examination plan.

Company employees involved in the structuring of intercompany transactions will be requested to participate at the transfer pricing orientation meeting. Personnel “responsible for the transfer pricing study” will also be asked to participate. The IRS does not want the transfer pricing orientation meeting to be a high level review of the documentation, but rather a “comprehensive presentation,” according to the Roadmap. Domestic and foreign site visits may also be requested. The transfer pricing orientation meeting is perhaps the most important meeting during the audit, as it gives the taxpayer the opportunity to make its most compelling case for why its transfer pricing methods, analysis, and results are appropriate.

In the Planning phase the IRS will evaluate whether it thinks the taxpayer is shifting income to lower tax jurisdictions using transfer pricing. The Roadmap encourages IRS examiners to assess the functions, assets, and risks of the related parties involved in the intercompany transaction. These functions, assets, and risks should be described in the taxpayer’s transfer pricing documentation, which is reviewed by the IRS examination team. The Roadmap suggests that transfer pricing issues deserve further scrutiny if the taxpayer’s results are “at odds with common sense and economic reality” and if the taxpayer does not provide a convincing transfer pricing documentation report.

2. Execution

In the Execution phase, which can take up to 14 months, the Examiner will request information on the relevant transfer pricing issues from the taxpayer so that the IRS transfer pricing specialist can prepare a report on agreed facts. The IRS team will choose what it thinks is the best method for the intercompany transaction(s) at issue. The IRS team will apply its chosen transfer pricing method to determine an appropriate intercompany price. If this intercompany price is different than the taxpayer’s actual transfer price, and the IRS-determined price is beneficial to the IRS, then the IRS will have arrived at its basis for a proposed Section 482 adjustment.

3. Resolution

In the Resolution phase, which can take up to 6 months, the audit team conducts a pre-Notice of Proposed Adjustment (NOPA) issue presentation, resolution discussions with the taxpayer, and it issues a final NOPA. The taxpayer may disagree with the IRS position and is encouraged to state its reasons for disagreement.


Transfer Pricing INSIGHTS

  • The Roadmap states that “Transfer pricing cases are usually won and lost on the facts,” emphasizing fact gathering as a means of building a case not only for exam, but for successful litigation. There is consistent emphasis in the Roadmap reminding the exam team of the importance of first building a solid understanding of the facts before forming hypotheses and ultimately reaching conclusions. Accordingly, taxpayers are well-advised to ensure that their transfer pricing documentation is robust and presents a factual picture consistent with its tax returns and financial statements.
  • Expect increased involvement of IRS transfer pricing specialists within most audits, particularly during the Planning phase. The IRS developed the Roadmap to ensure that field audit teams use the transfer pricing resources within the Service. A key theme in the Roadmap is that “transfer pricing specialists must be involved in assessing potential transfer pricing issues at the earliest possible stage – ideally before the official audit commencement date.” These specialists will “help weed out issues that are not worth pursuing” and also help identify additional expertise that might be required to evaluate a taxpayer’s transfer pricing.
  • Transfer pricing documentation is the first and best opportunity to prevent a transfer pricing audit. While IRS auditors will know something about a taxpayer from tax return information and the company’s website, transfer pricing documentation reports allow companies to explain the business, including reasonable intercompany pricing results. IRS economists will assess the quality of transfer pricing documentation prior to meeting with the taxpayer. Companies without transfer pricing documentation may be surprised by initial IRS positions when meeting for the first time.
  • The IRS will issue the mandatory transfer pricing documentation information document request (IDR) with the IRS’ initial contact letter, rather than at the opening conference with the taxpayer, which has usually been the case.  Taxpayers therefore should be sure their transfer pricing documentation is complete and on hand (transfer pricing documentation must be prepared contemporaneously and be in existence when the Federal tax return is filed, and must be provided to the IRS within 30 days of receiving the documentation IDR).
  • Taxpayers can expect examiners to review the following documents during the Planning phase: IRC Section 6662(e) documentation (i.e., “transfer pricing documentation” – for penalty protection), forms 5471, 5472, 8833, 8858, 8865, 926, and schedules M-3 and UTP. The IRS team may also issue an IDR requesting worldwide, geographic, and segmented accounting data and financial statements from the taxpayer. If foreign data are important to the IRS team, it may request it from treaty partners – during the Planning phase.
  • To the extent the field team follows the roadmap guidance, taxpayers should expect a more rigorous transfer pricing examination. Taxpayers should be prepared for this process, which in most cases means much more will be required than merely updating comparables data in boilerplate or outdated transfer pricing studies.
  • Multinationals are faced with the prospect of double taxation unless the foreign tax authority agrees with the IRS position. While the Roadmap does not mention the Competent Authority process, any proper resolution should consider getting the IRS and the foreign tax authority to agree to a resolution. When there is not a resolution such disputes are typically handed off by the IRS examination team to either IRS Appeals or the Competent Authority process.






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