By Elisa Kaminsky, BaseFirma, Miami
The IRS issued written guidance on April 15 regarding transfer pricing documentation frequently asked questions. This publication includes recommendations and the IRS position on best practices for transfer pricing documentation in the United States.
Background on this initiative
In 2018, the IRS issued a directive to its employees regarding the application of penalties in transfer pricing audits. While some of the guidance may seem obvious for some taxpayers and tax practitioners, the IRS examiners have noticed a decline in the quality of taxpayer’s transfer pricing documentation. The IRS intends to encourage companies to increase the quality of their available documentation. The frequently asked questions recently published are based on the IRS’s experiences of best practices and common mistakes. The IRS intends to provide additional guidance about the relevant US transfer pricing rules and offers insights to promote higher-quality documentation.
Key comments
The IRS recommends taxpayers should thoroughly explain if unforeseen business circumstances impacted the company’s results. This could help better explain that negative results were not due to manipulated intercompany prices.
The IRS also recommends taxpayers to conduct a self-assessment of the potential indicators of transfer pricing non-compliance, including a sensitivity analysis of the major profit level indicators and comparables that may be rejected and have an impact on the arm’s length range. The latter provides some insight into the strength of the comparability analysis of the benchmark companies.
At the comparability level, when there are good, yet imperfect, comparable companies, comparability adjustments should be applied. Inclusion of a thorough analysis of how and why comparability adjustments were selected and applied is also required.
The IRS further identified what sections from a transfer pricing study should be improved whenever applicable. Such sections include an Industry and company analysis providing a clear context for related party transactions. This is particularly relevant due to the current COVID-19 crisis the world is experiencing. For instance, if a specific industry is experiencing a downturn, then adjustments may be needed to separate the effects of bad risk realization from the effects of intercompany pricing.
Other sections that may require additional details and a better description include functional analysis linked to the company’s analyses, risk analysis aligned with intercompany agreements and risk allocation within all relevant participants in a transaction. Also, provide reasonable analysis to support for the best method selection, and the reason for rejecting specified methods, including the availability of internal comparables since this is something that companies usually ignore and take for granted. Moreover, taxpayers are required to provide analysis to support the selection of the profit level indicator used, just selecting an indicator is not enough. Detailed comparability analysis should be conducted, as well as the impact of differences in risks or functions between the tested party and the comparable companies, and well-reasoned support for proposed adjustments to the application of a specified method.
On top of the above sections in the report, the IRS incentivizes taxpayers to maintain detailed explanations of the data used in the analysis, especially if segmented financials are employed. It is recommended this information to be submitted in Excel files to expedite the examination process.
Finally, while there is no rigid template or format to use for US transfer pricing documentation, the IRS prefers to review “user-friendly” documentation during an examination process. Providing something as simple as an executive summary at the beginning of the transfer pricing documentation can help better understand the entire document.
The takeaway
The above-mentioned items are some, but not all, of the areas the IRS has identified that could benefit from improvement. However, it is important to mention that strengthening said sections does not guarantee a safe harbor against an examination or imposition of penalties but may help in the deselection of certain audit issues and/or a more efficient audit.
Many times it is difficult, yet recommended that taxpayers maintain clear and available information on their transfer pricing documentation, further evaluate the availability of internal comparables, and asses its results periodically compared to those of the industry or other companies within the same group. The more complex the transaction, the greater the need for detailed analysis and documentation. Finally, it is highly recommended taxpayers plan their transfer prices amid the COVID-19 pandemic and the serious impact on some multinational group’s transfer prices.
Elisa Kaminsky
Elisa has international transfer pricing consulting and analysis experience in a variety of industrial sectors. She has consulted for multinationals in planning and documenting their intragroup tangible and intangible transactions.
Elisa has been involved in numerous transfer pricing projects for companies operating in various industries, including private banking, transportation and logistics, insurance, personal goods and telecommunications. She specializes in managing multi-country transfer pricing projects for multinationals throughout the globe.
Elisa holds an MBA degree from Florida International University, Miami and graduated from Universidad Austral in Argentina with a degree in Public Accounting.
In addition, she is a certified project management professional and a US Enrolled Tax Agent candidate.
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Elisa Kaminsky
Transfer Pricing Manager
BaseFirma, Inc.
Email: [email protected] or [email protected]
Web: basefirma.com
Tel: +1 (305) 461 3212 ext. 105
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