Comprehensive Toolkit Provides Insights to IRS Strategies
The IRS Transfer Pricing Practice (TPP) released a Transfer Pricing Audit Roadmap on February 14, 2014. The roadmap provides comprehensive guidance for IRS auditors and recommends following a 24-month transfer pricing audit plan. Multinational companies can expect the IRS will rely on this blueprint when planning, assessing, and executing transfer pricing cases.
The roadmap can be found at the following link: http://www.irs.gov/pub/irs-utl/FinalTrfPrcRoadMap.pdf
Why is This Transfer Pricing Roadmap Important?
The long-awaited roadmap memorializes IRS best practices for evaluating transfer pricing issues and clarifies expectations for audits. Most notably, the 26-page roadmap recommends:
- Thorough assessments of transfer pricing documentation prior to meeting with the taxpayer, and
- Fact-finding – including interviews – would normally continue over 15 months of the recommended 24 month audit cycle.
If the IRS decides to proceed with an audit, companies can expect extensive information requests and interviews with management from most, if not all, areas of the business.
Fact Development and Interpretation of Transfer Pricing Results
The roadmap consists of several key themes to guide transfer pricing exam teams:
- The goal of a transfer pricing audit is to establish “a reasonable result under the facts and circumstances of a given case.” A taxpayer’s position that does not appear to follow economic reality will be subject to more intense scrutiny
- Assessments of company transfer pricing documentation, prior to meeting with taxpayers, is stressed as a critical first step
- Persuasive explanations of IRS theories are critical to the success of an audit. The IRS expects the Notice of Proposed Adjustment should appear to be “inevitable” when issued
Implications
Since the roadmap emphasizes interpretation of facts early in the process, companies should anticipate IRS arguments when defending intercompany transactions.
The IRS will look for obvious ‘Red-Flags’ when first assessing transfer pricing risks. Typical risk areas include operating losses for US subsidiaries of foreign-owned companies, or relatively large profits for subsidiaries of US companies.
Documentation is the first, and best, opportunity to prevent a transfer pricing audit. While IRS auditors will know something about your company from tax return information and your website, transfer pricing documentation reports allow companies to explain the business, including why results are reasonable. IRS economists will be assessing the quality of transfer pricing documentation prior to meeting with the taxpayer.
The IRS is required to request documentation as part of every tax audit with a 30-day deadline. The IRS may also request documentation prepared for other tax authorities. Companies without transfer pricing support may be surprised by initial IRS positions when meeting for the first time.
Once the IRS develops a theory on transfer pricing, companies will have difficulty convincing auditors to change positions. The IRS normally expects to spend substantial resources when conducting transfer pricing audits. While the roadmap does emphasize the importance of “keeping an open mind,” realistically auditors that spend substantial time and effort on audits will be less convinced of new facts and arguments late in the process.
Other Highlights
The roadmap includes an enormous list of documents that can be requested at each stage of the transfer pricing audit cycle. Given the factual nature of transfer pricing audits, the IRS will expect taxpayers to designate a main contact to assist the IRS in gathering this information and organizing interviews.
The roadmap also envisions a transfer pricing orientation meeting where the taxpayer can provide additional details on intercompany transactions, including an in-person review of the documentation. In our experience, this orientation meeting represents one of the better chances to defend the company’s transfer pricing arrangements.
The IRS will prepare several risk analyses for discussion with clients over the course of the 24-month audit cycle, updated as new information is gathered and assessed.
Recommendations
The roadmap represents a step toward a more structured approach to transfer pricing enforcement for the IRS. The 24-month audit timeline may surprise some taxpayers who have not faced a transfer pricing review, including middle-market companies.
Companies need to have an articulate message when explaining intercompany pricing to tax authorities. Standalone arguments such as “foreign exchange risks,” “poor business conditions,” and “we have a policy” may not be sufficient to convince the IRS transfer pricing audit team. Bottom line: companies should conduct a risk assessment of transfer pricing issues to anticipate IRS positions and prepare accordingly.
