Contributed by Marini & Associates, P.A., USA
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.
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