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Monday, April 20, 2020

IRS Publishes Transfer Pricing Documentation Best Practices FAQs


In general, a taxpayer may avoid penalties described in Internal Revenue Code (IRC) § 6662(e) by maintaining contemporaneous transfer pricing documentation meeting the requirements of § 482 regulations. In January 2018, the IRS Large Business & International Division issued a directive to agents not to waive the penalties for mere existence of transfer pricing documentation but to examine the adequacy and reasonableness of the documentation.

To promote higher quality transfer pricing documentation, the IRS recently published a list of six frequently asked questions (FAQs) on transfer pricing documentation best practices. Below are some notable points:

  • FAQ 1 explains the benefits to taxpayers who invest in robust transfer pricing documentation, notably that a limited risk distributor may incur losses due to unusual business circumstances such as reduction in sales and not due to incorrect intercompany pricing. Having inadequate information reduces the reliability of the transfer pricing documentation and increases the time and length of the audit involving multiple rounds of Information Document Requests (IDRs).
  • FAQ 2 recommends that taxpayers consider conducting a self-assessment of the potential indicators of transfer pricing non-compliance, such as sensitivity analysis of search parameters used, strength of the benchmarking set, comparing tested party results with a variety of profit level indicators, and evaluating how system profits are shared between related parties.
  • FAQ 3 explains the IRS’ guiding principle in establishing arm’s length price by emphasizing the compliance with the § 482 regulations. Additionally, the IRS stresses the importance of providing complete information on the economic analysis and need and application of comparability adjustments to take into account current business environment.
  • FAQ 4 identifies the areas in transfer pricing documentation that could benefit from improvement:
    • Industry and Company Analysis sections are a place for a taxpayer to “tell its story” and provide context for related party transactions.
    • Functional Analysis should be well-supported factually, linking the business’s operational structure to the subject transactions and intercompany pricing, and explain how and where the value is created that supports the allocation of profits among the parties.
    • Risk Analysis should be consistent with intercompany agreements since they generally establish how risks are allocated.
  • FAQ 5 illustrates the features of most useful transfer pricing documentation, which touches upon similar areas of transfer pricing documentation as that of FAQ 4.
  • FAQ 6 provides an example presentation of a company’s intercompany transactions that would be a helpful summary for examiners to use in risk assessment. Providing a summary of the intercompany transactions at the beginning of the documentation helps the IRS deselect certain transactions from the scope of the audit, saving time. (See example grid below).
Sample Intercompany Transaction Summary
Thousands USD
Country Transaction TP Doc Location Reference APA Amt Reported Local Tax Form Transfer Pricing Policy Transfer Pricing Method Tested Party Benchmark Range Actual Results
CA XYZ America License of Trademarks, know how A1 Y $12,345 Royalty Rate-2% of Net Sales CUT N/A Royalty Rate LQ 2% 2.10%
M 3.4%
UQ 4.3%
IT XYZ America purchase of product form from F Sub for distribution to US Market B2 N $23,456 Cost Plus 10% Markup CPM(3yr) XYZ America OM LQ 1.6% OM=2.9%
M 3.4%
UQ 3.8%

We’re here to help

We’re closely monitoring any changes to the international and transfer pricing landscape, and we will send out updates as they become available. Reach out to Tax Partner Nghi Huynh if you need further information on this topic.

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