Additionally, in a notable shift in policy, Domestic Examiners at IRS will now have greater authority in deciding whether Transfer Pricing issues should be included in an audit, and will not be required to defer to International Examiners on such matters.   

All of these actions will certainly lead to greater scrutiny by the IRS of Transfer Pricing issues for organizations of all sizes.

Our Global Business Services Group has substantial experience in delivering solutions to global businesses with cross-border pricing compliance and planning concerns.  Often, such solutions yield significant opportunities to reduce worldwide effective tax rates, in addition to minimizing the risk of penalties, both in the US and other countries.  

TRANSFER PRICING COMPLIANCE  

A general overview of the required documentation follows.  Please keep in mind that the IRS intended the rules to be very specific and they can be difficult to comply with the first time.  In practice, it is possible that a company can comply with the rules and be pragmatic at the same time.

Documentation

Documenting transfer prices means avoiding the penalty provisions.  A 20-percent or 40-percent penalty will automatically be added to any tax assessed as a result of a transfer pricing adjustment when the adjustment is above a certain size or percentage of the originally reported price.  The penalty will apply unless the taxpayer does three things:

§         First, establish that at the time the corporation tax return was filed, specified documentation had been prepared and existed, and supported The taxpayer’s pricing;

§         Second, provide these documents to the IRS within 30 days of an auditor’s request for them; and

§         Third, demonstrate the details of the pricing method that was used and its ability to determine a “correct” price for goods or services.

The three requirements come directly from the statute.  If the taxpayer does not comply with these requirements, the only hope of avoiding a penalty is to defeat the underlying pricing adjustment made by the IRS.  In other words, without proper documentation, the taxpayer’s transfer pricing must be right.  The substantive pricing regulations will hamper the efforts to prove that the taxpayer is right under some pricing methods if the corporation does not have contemporaneous documentation.

Required Documents

The required documentation is divided into two categories, “principal” and “background” documents.  There are nine types of “principal” documents; these are the ones that must exist when the taxpayer files a U.S. tax return.  Most of these required items neither the taxpayer nor the rest of the corporate group will have on file as part of the taxpayer’s natural business, so fact gathering and analysis will be necessary.

The nine types of “principal” documents are elements that might be found in a transfer pricing report.   The overall objective of the “principal” documents is to describe the taxpayer’s analysis for an examining agent.   The nine “principal” document categories are not mutually exclusive.  

Listed below are the categories of information the IRS expects to see:  

à        A description of the group’s organizational and transactional structure (including an organization chart).

 à        An overall description of the taxpayer’s business and its industry. 

 à        A description of the intercompany (“controlled”) transactions, including functional and risk analyses, and any internal documents or data supporting that analysis. 

 à        A description of any comparables that were used to determine prices, margins, etc.; and a further description of how comparability was evaluated, and what (if any) adjustments were made.  

 à        An explanation of any economic analysis and projections relied upon in developing the method. 

à        A description of the pricing method that was selected as the basis for setting the intercompany price.  

à        An explanation of why the chosen method was selected, and a description of why other methods were rejected.  

à        Any other documentation explicitly required by the regulations under Section 482. 

à        A general index of the principal and “background” documents, and a description of the record keeping system used to catalog and access them. 

Practical Considerations

Some of the items listed above will be more difficult for the taxpayer to produce than others.  If the taxpayer has not followed U.S. transfer pricing developments, they may not be aware of some of the regulatory restrictions on various pricing analyses.  Although there will be some variation in the economics from year to year, that variation probably will be evolutionary rather than revolutionary.  Once the taxpayer has developed an analysis; it can be updated with less expenditure of time and anxiety than the original product. 

As you can see, the term documentation is somewhat misleading.  More is required than simply collecting documents.  The required “documentation” that fends off a penalty is, in fact, a pricing analysis under U.S. rules.  No “paint by numbers” approach works for everyone.  With a couple hundred pages of tax regulations defining substantive pricing, we could only hit the high spots in this summary.

Our Global Business Services Group would be more than happy to assist you in establishing a supportable Transfer Pricing methodology, work with you in compiling the documentation necessary to support the pricing methodologies currently utilized by your organization, or review and update your Transfer Pricing models, whichever is the most beneficial in your situation.

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