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26 July 2018 US IRS publishes new guide on transfer pricing examinations The United States (US) Internal Revenue Service (IRS) has recently issued Transfer Pricing Examination Process (Publication 5300 (6-2018)), a guide to best practices and processes to assist with the planning, execution and resolution of transfer pricing examinations. The publication, which will be shared with taxpayers at the start of an examination, is intended to be consistent with the Large Business & International (LB&I) Examination Process (LEP) (Publication 5125). The Transfer Pricing Examination Process (TPEP) supplants the Transfer Pricing Audit Roadmap (Roadmap), a 2014 toolkit designed to provide IRS examiners with audit techniques, advice, links and reference materials that may be helpful in planning, executing and resolving transfer pricing examinations. In many respects, the TPEP is similar to the Roadmap. For example, it is divided into three parts: Planning, Execution, and Resolution. It also continues to emphasize the early collection of facts, the notion of a working hypothesis, collaboration among team members of different disciplines and reporting chains, and meaningful discussion of the facts and working hypothesis with the taxpayer during the audit. However, the TPEP includes new material related to country-by-country (CbC) reporting (CbCR), the new instructions around the Initial Transfer Pricing Documentation Information Document Request (IDR), and exhibits related to the recently developed Practice Units. Under the TPEP, the planning phase occurs before the Opening Conference and is the phase during which issues are identified and the scope of the audit is determined. However, the examination plan may be adjusted throughout the examination process. In keeping with the IRS's increasing focus on "issue-based examinations," IRS issue teams are formed during this phase. The TPEP continues to exhort issue teams to collaborate and coordinate among themselves. The TPEP encourages teams to use all information available to them to perform their risk assessment, including information from the various Practice Units, prior-year work papers and transfer pricing documentation, as well as functional and economic analyses. When the IRS formed its Transfer Pricing Practice (TPP) several years ago, the TPP sought to understand how foreign jurisdictions might view IRS-initiated adjustments in an effort to improve the sustainability of those adjustments. In an apparent effort to continue this collaboration, the TPEP encourages teams to seek input from the Advance Pricing and Mutual Agreement (APMA) program. Issue teams are encouraged to use the information provided on Form 8975, Country-by-Country Report, to analyze high level transfer pricing risk, including Base Erosion and Profit Shifting (BEPS) related risk. There has been much concern about tax authorities using the information in CbC reports inappropriately. In an apparent effort to mitigate the inappropriate use of CbCR information, the IRS plans to require its employees to complete CbCR-related training. Like the Roadmap, the TPEP instructs issue teams to compute key financial ratios for multiple years, make industry comparisons and consider whether there is potential cross-border income shifting. The TPEP points out that, "[w]hether financial ratios indicate potential non-arm's length transfer pricing issues, the team needs to complete rigorous development of the relevant facts and circumstances to support a transfer pricing adjustment, a Subpart F adjustment, or both." Issue teams are encouraged to research the taxpayer to understand its core business operations, profit drivers, history of the company, and background of the company. The Initial Transfer Pricing Documentation IDR (formerly known as the Mandatory Transfer Pricing IDR) is no longer required for all cases, and the TPEP explains that the Senior Revenue Agent/Team Coordinator and issue team members will collaborate on the issuance of the IDR. Armed with the facts and the financial ratios, teams are instructed to develop a preliminary working hypothesis, which will include an issue statement that will be proved or disproved as additional information is obtained. Here again, the TPEP cautions against using general risk assessment tools, such as benchmarking effective tax rates or industry averages, by noting that "unadjusted industry average returns themselves cannot establish arm's length results." The issue team concludes the fact gathering and risk assessment part of the planning phase by preparing and submitting an initial risk assessment to the Issue Manager and Territory Manager. The issue team will conduct internal planning meetings to discuss an estimated audit timeline, key milestones, accounting data and records needed for the examination, and the IDR process, among other things. The planning phase concludes with the issue team participating in the formal opening conference with the taxpayer. The TPEP notes that transfer pricing examinations are factually intensive and require a thorough analysis of functions, assets and risks, along with an accurate understanding of relevant financial information. Accordingly, issue teams are encouraged to conduct interactive discussions for purposes of developing the facts and resolving problems that arise from any inaccurate or incomplete facts. Here again, the emphasis is on open communication and continuous reassessment of the facts and working hypothesis. Although the Initial Transfer Pricing Documentation IDR is no longer mandatory, issue teams are instructed to issue the IDR early in the examination and review and analyze the taxpayer's documentation before the taxpayer orientation meetings. The orientation meetings are supposed to be conducted within 30 days of the opening conference. Orientation meetings are generally focused on a walk-through of a taxpayer's geographic, legal entity, tax and functional organizational charts, and CbCR and other transfer pricing documentation, among other topics. In particular, issue teams will request a transfer pricing/supply chain orientation meeting. During this meeting, the IRS will want to learn about the taxpayer's intercompany transactions, the rationale for entering into those transactions, value drivers associated with those transactions, and the functions performed, assets used and risks assumed by each of the controlled parties to the transactions, among other things. These meetings provide taxpayers with an excellent opportunity to proactively tell their transfer pricing story. Issue teams are instructed to hold reassessment meetings throughout the Execution Phase, with Practice Network members, LB&I Division Counsel, and appropriate managers. The purpose of these meetings, among other things, is to: (1) discuss new information and reassess or adjust the working hypothesis, (2) determine whether issues should continue to be pursued or closed, (3) determine whether new issues need to be added, and (4) discuss what needs to be done to complete the examination of the issue(s). During the Execution Phase, the issue team will continue to develop information related to the issue(s) that the team is examining. As part of their fact development, issue teams are to review and analyze relevant intercompany agreements. In addition, they will conduct a functional analysis to identify the economically significant activities performed, risks assumed by each entity, and the assets used regarding the transaction(s). They will issue IDRs or summonses for factual development, including requests for interviews, plant tours and site visits. The TPEP instructs teams to coordinate IDR requests with the entire case team to avoid duplicate IDR requests and reminds teams that open communication with the taxpayer throughout the process is critical, primarily to discuss the team's preliminary findings and working hypothesis. The TPEP also emphasizes collaboration among the issue team, taxpayer and the APMA program. Issue teams are to perform a mid-cycle risk assessment to reassess their risk analysis and refine their working hypothesis, determine which transactions require further analysis and whether transactions should be eliminated or added to the work plan, among other things. When the issue team feels it has developed the facts sufficiently, the team should work with an economist to perform a functional analysis consistent with the working hypothesis. The economist drafts an Economist Report discussing the taxpayer's facts and best method analysis as well as the economist's own economic analysis. The TPEP notes that penalties should be considered whenever adjustments are made to a tax return. The IRS recently issued a directive that seems to indicate that it will more aggressively assert the Internal Revenue Code Section 6662(e) penalty. Consistent with that notion, issue teams are instructed to discuss the imposition of penalties at the same time as the primary adjustment. To prepare a coherent Notice of Proposed Adjustment (NOPA), teams are encouraged to collaboratively prepare the NOPA and Economist Report. Again, the TPEP emphasizes the importance of ensuring that the taxpayer agrees with the facts that the team has developed. Accordingly, an IDR requesting that the taxpayer acknowledge the facts (i.e., "acknowledgement-of-facts IDR") should be issued for all transfer pricing issues, whether potentially agreed or unagreed. A taxpayer is not obligated to respond to the acknowledgement-of-facts IDR, but it should consider carefully whether and how to respond. After the issue team has finished the execution phase, it should meet with the taxpayer to discuss all issues before finalizing the NOPA and the Economist Report. This meeting ensures that the team engages in an open dialogue with the taxpayer to determine whether a principled resolution can be reached and, if not, to understand the nature of the disagreement. If the case is agreed, the normal case-closing procedures are to be followed, including discussing the Revenue Procedure 99-32 options (i.e., secondary adjustments) with the taxpayer and issuing the Pattern Letter 1853(P). If a field resolution is not reached, then the issue team is to finalize the NOPA and Economist Report, and secure final approvals. The normal administrative procedures remain in place, including issuing the Revenue Agent Report and ensuring that a minimum of 365 days remain on the statute of limitations for assessment. Teams are instructed to begin preparing the pre-Appeals presentation immediately after closing the case. The TPEP also includes some helpful advice to taxpayers regarding their competent authority rights and procedures. The TPEP also contains a number of helpful exhibits, including a list of Practice Units, which are reference and training tools for evaluating and developing potential issues encountered during the Planning, Execution and Resolution phases of a transfer pricing examination. The TPEP also includes an example of a 36-month examination, which compares unfavorably to the 24-month illustration in the Roadmap, but neither timetable is/was mandatory on the IRS or enforceable by taxpayers. The TPEP supplements the LEP and applies specifically to transfer pricing examinations. Both documents are intended to enhance audit transparency and provide both taxpayers and IRS examination teams with mutual, shared responsibilities and obligations. Like the Roadmap, however, the TPEP is intended to provide only a framework and lay out best practices for transfer pricing examinations. Although the TPEP is not mandatory or enforceable, taxpayers can refer to the TPEP in discussing a particular audit with an IRS exam team or elevating an issue within the IRS when an examination departs from the TPEP (or LEP).
Document ID: 2018-5905 |
