IRS representatives have recently addressed the IRS's current approach to asserting penalties in transfer pricing cases, saying that both the documentation and method of transfer pricing must pass muster.

On September 18, 2024, Michelle Ng, IRS Office of Associate Chief Counsel (International) attorney, said that taxpayers should consult IRS FAQs on transfer pricing documentation so they can understand what the IRS is requesting.¹ In addition to documentation backing up a taxpayer's position, however, the chosen method of transfer pricing must also be reasonable, she said.²

This comes after Brad Anwyll, IRS Transfer Pricing Practice director of field operations, said at a TEI conference on September 10, 2024, that the IRS is looking at the transfer pricing standards more closely and is "more willing to assert penalties even if there is transfer pricing documentation."³ Anwyll also said that the IRS wants to hire around 70 new economists, tax specialists and revenue agents for the transfer pricing practice.⁴

These discussions align with the IRS's previous guidance on penalizing inadequate documentation. For example, an official working in the IRS's transfer pricing practice stated in a September 2022 TEI seminar that the IRS will assert more penalties in the hopes of receiving better documentation reports (see Tax Alert 2022-1426). Although the IRS will not apply a "'wholesale across-the-board' assertion of penalties," the official noted that it previously failed to apply penalties where appropriate and would aim to refocus its efforts on applying penalties to avoid such errors.

In addition, there have been recent transfer pricing court cases where the IRS has asserted penalties. For example, the IRS asserted penalties against Walgreens Boots Alliance (see Tax Alert 2024-0725) and Eaton Corp. in transfer pricing disputes (see Tax Alert 2023-0719).

IRC Section 6662 imposes a penalty on any underpayment attributable to a substantial valuation misstatement for either a transaction between persons described in IRC Section 482 (the transactional penalty) or a new IRC Section 482 transfer price adjustment (the net adjustment penalty). The penalty equals 20% of the underpayment of tax attributable to the substantial valuation misstatement. Under IRC Section 6662(h), the penalty increases to 40% of the underpayment for a gross valuation misstatement for either penalty. IRC Section 6662(e)(3)(B) may protect against penalties if the taxpayer (1) used a regulatory-specified method to determine the transfer price, (2) has documentation to support the selection of the price and (3) provides the documentation within 30 days of a request from the IRS.

Implications

Over the past four to five years, the IRS has communicated its intent to look more closely at transfer pricing standards and the quality of transfer pricing documentation when considering whether to assert penalties. Taxpayers should take this as a clear signal that transfer pricing documentation must be both comprehensive and robust, aligning with the methods considered reasonable by the IRS. Taxpayers should proactively review their transfer pricing policies and documentation to comply with the latest IRS standards and expectations. Given the IRS's stated focus on transfer pricing, taxpayers need to be fully prepared for the possibility of tax examinations focusing on transfer pricing and the IRS asserting IRC Section 6662 penalties even in cases with standard IRC Section 6662 documentation.