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IRS Exam Teams Are Reminded to Consider Imposing Transfer Pricing Penalties

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On January 12, 2018, the Commissioner of the IRS’ Large Business and International Division issued a Directive to IRS examiners to encourage them to evaluate whether the imposition of penalties is appropriate when contemporaneous transfer pricing documentation is not adequately prepared.

A transfer price is the price charged for goods, services or intangibles that are sold or transferred between related legal entities within a multinational enterprise. Transfer pricing regulations require that a transfer price be arm’s length, meaning that the transfer price must be consistent with the price that would have been charged to an unrelated party.

The IRS may impose a penalty on a multinational enterprise operating in the U.S. if a transfer pricing adjustment eclipses $10,000. The penalties range from 20% to 40% of the underpayment of tax. A taxpayer can avoid such penalties by having adequate contemporaneous transfer pricing documentation and providing it to the IRS within 30 days.

The Directive reminds examiners that simply having a study is not sufficient. Rather, the study must meet the parameters of section 6662(e) and its regulations. The transfer pricing documentation is to be assessed for “adequacy and reasonableness.” This includes a review as to whether the taxpayer “reasonably selected the best method for their analysis and that they reasonably applied that best method.” A taxpayer may have acted unreasonably if they used “inaccurate inputs” and failed to “adequately search for or consider material information,” or “follow the best method rule in selecting and applying the method,” or the appearance of “results that differ significantly from the arm’s length result and that are sizable in relation to the controlled transaction.”

In addition, the Directive also urges examiners to explore what data and information the taxpayer had access to in order to verify whether the “taxpayer adequately searched for, considered and applied the relevant body of information and whether the taxpayer adequately incorporated and addressed that data” in their transfer pricing documentation.

This IRS Directive is not just a reminder to IRS examiners, but also serves as a reminder to multinational companies of the importance of having transfer pricing documentation prepared on an annual basis. For more information, please contact Andrew Bostian at abostian@blumshapiro.com or 617-658-5232.

Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.

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