Posts Tagged ‘transfer pricing audit’

IRS Transfer Pricing Audit Roadmap

May 3, 2014


Transfer Pricing NEWS

Dollar Hitch Hiking

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.






New Ukraine Transfer Pricing Rules

December 26, 2012

ImagePrior to 2012, Ukraine had not been overly concerned about transfer pricing issues. But recently, in the era of fiscal deficits, the Ukrainian government has been more focused on implementing transfer pricing compliance practices in accordance with OECD member countries.

 Transfer Pricing NEWS

On December 4, 2012 the Parliament of Ukraine registered the draft bill “On amendments to the Tax Code of Ukraine with regard to transfer pricing”.  The draft bill may become effective as early as on July 1, 2013, according to STSU chief Oleksandr Klymenko.

Which transactions are affected (controlled transactions)?

  1. Related party1 transactions with non-Ukraine affiliates (counteragents) who pay corporate income tax at a rate of at least 5% less than in Ukraine, or such counteragents domiciled in a country with a corporate income tax at least 5% less than Ukraine (i.e., 14% as of January 1, 2013); and
  2. The total sum of transactions with a counteragent exceeds 50 million Grynia per year.


The draft bill requires big taxpayers to submit a report on operations and documents related to transfer pricing before May 1st of the year following the year in which transactions occurred.2 Smaller taxpayers must only notify the STSU of their controlled transactions (also, before May 1st of the year following the year in which transactions occurred). The documentation for big taxpayers should contain: detailed information about transactions, counteragents, risk analysis, justification for the selection of a transfer pricing methodology, and determination of the transfer price. Penalties of 5% of the sum of the controlled transactions will be assessed for failure to provide the notification of controlled transactions or the documentation report.3

Prescribed Transfer Pricing Methods

Article 39 of Ukraine’s Tax Code contains a list of five methods for determining the arm’s-length price: comparable uncontrolled price, resale price, cost plus, (transactional) profit split, and transactional net margin. The revised code will also allow for a ‘method of last resort’ (i.e., an unspecified method in cases where there is insufficient data to apply other transfer pricing methods). The method of last resort is typically an independent evaluation by a certified appraiser. This method can be employed only if there is insufficient data to apply the five specified transfer pricing methods. The comparable uncontrolled price method is described in the detail, while the others are not. Finally, it is acceptable to use a combination of two or more of the above transfer pricing methods. Although all the methods are put in a certain order, the Tax Code does not mention a hierarchy of methods.

Safe Harbor

The new transfer pricing rules allow for a 5% safe harbor on certain commodities4.  Tax reassessments are not permitted if the contract price deviates from the “arm’s-length price” by less than 5%. In this case the “arm’s-length price” consists any price from a list of official sources of information, such as data from state authorities, banks, specialized commercial publications, or exchange quotations.

Transfer Pricing Audits

The STSU must provide taxpayers 10 days’ notice of a transfer pricing audit. The maximum duration of the transfer pricing audit is 1 year, consisting of an initial 6-month time-limited audit, and a potential 6-month extension. Taxpayers have 20 days to appeal assessments in tax audits.

Transfer Pricing INSIGHTS 

  • Ukraine realizes it does not have the staffing (nor, more generally speaking, the expertise) to focus on smaller audits at this time. This is a near-term opportunity for multinationals with Ukraine intercompany transactions on certain commodities especially. For example, on Ukraine outbound intercompany commodity transactions to lower tax countries, taxpayers may want to determine transfer prices that are slightly less than (<5%) prices from any of the official sources of information (i.e., data from state authorities, banks, specialized commercial publications, or exchange quotations). Selecting one of the lower prices in the numerous official sources, and then reducing it by almost 5%, can increase tax savings considerably, especially on large transactions (same logic applies with higher tax countries, only higher prices would be advantageous).
  • Likewise, on Ukraine inbound intercompany transactions with lower tax countries, taxpayers may want to determine contract prices that are almost 5% greater than the prices in any of the official sources of information, so long as the price for the imported goods is not less than the customs value. Admittedly, Ukraine is a net exporter of the specified commodities, so this importing strategy is not as applicable as the exporting strategy above.
  • Ukrainian exporters (primarily raw materials) should be most concerned with the new transfer pricing rules. Historically, many Ukrainian exporters sold tangible goods at low prices (e.g., below exchange quotations) to foreign affiliates in lower tax jurisdictions; these foreign affiliates then sold the same goods at higher market prices to third party purchasers, with the profit left in the low tax jurisdiction.
  • MNEs operating in Ukraine may not want to unnecessarily spend money on transfer pricing documentation from expensive professional services firms, since the Ukraine transfer pricing reports, if required, are simplistic, and the STSU does not require a exacting format. All taxpayers must at a minimum notify the STSU of the controlled transactions. Big taxpayers are required to submit more documentation than smaller taxpayers. If the STSU requests additional documentation, the taxpayer has 30 to 60 days to provide it. Compiling Ukraine transfer pricing reports and documentation in-house and/or with a cost-effective independent transfer pricing advisor is a practical solution.
  • Once a taxpayer has determined and implemented a transfer price, the burden of proof that the price is unfair rests with tax authority. The taxpayer is not legally obliged to substantiate the price upon request from the authority.
  • Since the new transfer pricing rules provide that the arm’s-length price for imported goods must be equal to or greater than customs value, it will be interesting to see how this affects how MNEs treat pricing for damaged goods and promotional goods.
  • While Ukraine’s new transfer pricing rules now allow for Advance Pricing Agreements (APAs), the STSU is too unsophisticated on transfer pricing for an APA to be worth the cost of preparation. Since APAs are new to Ukraine, negotiating one is likely to be a time consuming headache for the taxpayer, and even if your company is the first to have a unilateral Ukraine APA, it may not be too helpful since transfer pricing enforcement efforts are lax, and a taxpayer seeing an APA likely has more advanced transfer pricing know how than the STSU. Further, only unilateral APAs are currently allowed, and if these later necessitate competent authority, the STSU is ill equipped for such discussions.


  1. Related parties are defined in Ukrainian tax law as legal entities and/or individuals, whose relationship may affect the terms and economic results of their activities or activities of persons represented by them. An entity qualifies as a related party if ownership of at least 20 percent of shares; based on voting power; share capital; are under common control.
  2. Ukraine has an official register of big taxpayers. Entities are included on this list if either A) Income for the past four consecutive quarters exceeded UAH 500 million or B) Tax payments for the same period were greater than UAH 12 million.
  3. If a transfer pricing adjustment results in additional tax liabilities, the STSU can assess penalties of up to 200 percent of the tax underpayment. However, historically, transfer pricing adjustments have rarely been enforced.
  4. Commodities include: animal oils, grain crops, in-organic and organic chemical products, metals and ferrous metal goods, mineral fuels, ore, and vegetable oils.

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