The IRS released a Transfer Pricing Audit Roadmap on February 18, 2014. The Roadmap, which was issued through the IRS Transfer Pricing Operations of the Large Business and International (LB&I) division, was developed to provide audit techniques and tools for transfer pricing examinations. The Roadmap is designed as a comprehensive toolkit based on an audit timeline.
Transfer pricing involves an area of U.S. federal taxation which requires payments in certain intercompany transactions to be based on an arm’s length standard. The arm’s length standard is applied to determine whether intercompany pricing is consistent with pricing that would be prevalent in a transaction between unrelated parties. Section 482 of the U.S. Internal Revenue Code is the provision of U.S. federal taxation law that governs transfer pricing. Under I.R.C. Section 482, the IRS has the authority to reallocate income, expense, deductions, credits and allowances to clearly reflect income or to prevent the evasion of taxes. Section 482 applies to inter-company payments between commonly controlled entities. The regulations under Section 482 provide that the best method must be applied in determining the transfer price that is the most reliable measure of the arm’s length standard.
The IRS typically targets U.S. taxpayers for transfer pricing audits based on information disclosed on foreign reporting forms filed with the U.S. federal tax return. U.S. taxpayers who file the Form 5471, 8865 or 8858 to report ownership of a foreign company are subject to a high level of scrutiny concerning intercompany payments reported on such forms. The Transfer Pricing Audit Roadmap identifies these forms and other forms such as the Forms 5472 and 926 as the starting point when the IRS reviews a U.S. federal tax return for controlled transactions.
There are specific phases of a transfer pricing audit that are outlined in the Roadmap. The Planning Phase includes the pre-examination analysis, the opening conference, taxpayer orientations, and the preparation of the initial risk analysis and the examination plan. The Pre-Examination Analysis includes the review of the taxpayer’s contemporaneous transfer pricing documentation. The Planning Phase is a process that may continue for up to six months. The Execution Phase, which may continue for up to 14 months, includes fact-finding and information gathering followed by issue development with economic analysis and a preliminary report with findings. The Resolution Phase includes issue presentation, issue resolution, and case closing. The Resolution Phase is a process that may continue for up to six months.
Overall, the Audit Roadmap is a definitive indication that transfer pricing audits with the IRS are typically a lengthy process. Therefore, it is important to substantiate intercompany transfer pricing with the appropriate policy, methodology, and documentation.
For more information, please contact our international tax advisor at 301.231.6200.