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The IRS’s new Transfer Pricing Examination Process manual: how it can be used by multinational taxpayers

The IRS on June 29 released a new manual for IRS personnel, the Transfer Pricing Examination Process, replacing the 2014 Transfer Pricing Audit Roadmap. The new guidance, prepared by the IRS's Large Business & International Division's (LB&I) Treaty and Transfer Pricing Operations, is designed to provide IRS agents with "best practices and processes" for conducting transfer pricing examinations.

Though designed as a tool for IRS agents, taxpayers can use the Transfer Pricing Examination Process to prepare for transfer pricing examinations, as they used the 2014 roadmap.

The new guidance states that, to use resources most efficiently, LB&I is using data analytics to identify issues for examination that have the most significant risk for non-compliance.

The transfer pricing examination process

Mirroring the former roadmap, the Transfer Pricing Examination Process divides transfer pricing examinations into three phases: the planning phase, the execution phase, and the resolution phase. For each phase, the manual describes the types of materials that agents should review, the personnel that should be staffed and/or consulted, and the types of analysis that should be completed.

The Transfer Pricing Examination Process is focused on the proper flow and review of documents provided by the taxpayer and the IRS's review of prior year work papers if the taxpayer's transfer pricing was previously examined. It provides for meetings with both the taxpayer and the issue team; however, those meetings may not take place until after the issue team has already completed most of the steps set forth in the "Planning Phase."

Planning phase

In the Planning Phase, the issue team analyzes materials, including the prior audit data; the income tax return; the Form 8975, country-by-country report; the taxpayer's websites; and any SEC-filed annual report, Form 10-K, or Form 20-F. Using this data, the IRS team prepares a financial ratio analysis of the US taxpayer and the foreign related parties to the intercompany transactions. The issue team will also develop a "preliminary working hypothesis" and complete its initial risk analysis.

Unfortunately, all these steps are taken before the opening conference with the taxpayer. This could lead the team to form erroneous perceptions of the taxpayer's transfer pricing and to reach improper conclusions before the taxpayer has an opportunity to describe its business, its operations, and its significant transactions. These initial impressions and conclusions about a taxpayer's transfer pricing are part of what makes transfer pricing audits challenging. It can be very difficult to change an exam team's preconceived ideas, and teams often develop skepticism about a taxpayer where there are simply differences of opinion.

The issue team begins its review by analyzing a taxpayer's Annual Reports and SEC filings. These documents have a very specific focus and that focus is typically not on developing and describing the facts that ultimately impact transfer pricing issues. Accordingly, in an audit process that follows a checklist approach, where many of the items on the list are checked off before the taxpayer enters the room, it is extremely difficult to prevent the opening conference from starting in a contentious place.

Execution Phase

The "Execution Phase" of the Transfer Pricing Examination Process anticipates a number of meetings with both the issue team and the taxpayer present. In these meetings, the issue team is expected to confirm the material facts it developed in the Planning Phase of the examination and discuss its preliminary findings with the taxpayer.

The Execution Phase includes orientation meetings on the taxpayer's financial statements; geographic, legal entity, tax, and functional organizational charts; transfer pricing, including the history and background of its intercompany transactions, functional profile, supply chain analysis; and the profits and losses associated with each material, controlled transaction.

The new IRS guidance also instructs the issue team to hold periodic meetings throughout the Execution Phase with LB&I Division Counsel, IRS Practice Network members, and their respective managers to update or reassess the IRS's working theory of the case and, if necessary, further develop specific transactions or issues.

If the meetings are held with both the IRS and the taxpayer present, this process could be a productive opportunity for the IRS and the taxpayer to discuss the particular nuances of relevant transactions and to close issues that do not warrant additional analysis.

Resolution Phase

During the final phase of a transfer pricing audit, namely, the "Resolution Phase," the Transfer Pricing Examination Process anticipates additional meetings between the taxpayer and the issue team with the goal of reaching an agreement on the tax treatment of the issues examined.

The meetings during the Resolution Phase are expected to include discussions and an evaluation of the taxpayer's position, with a focus on identifying the remaining disputed facts and/ or legal arguments.

The issue team is directed to include LB&I Division Counsel if any closing agreement will be entered. If no agreement is reached, the issue team will finalize the notice of proposed adjustment, the economist report, the revenue agent report, and the 30-day letter.

Protests

Taxpayers have an opportunity to file a protest after they receive the 30-day letter. If a protest is submitted, the issue team will review the protest, prepare a rebuttal, and finally begin preparing for the Appeals opening conference.

Taxpayers with US Competent Authority issues do not need to wait until the conclusion of their transfer pricing audit to file a request for Competent Authority assistance. A request can be made as soon as the taxpayer receives the amount of the proposed adjustment in writing on, e.g., a Form 5701, a notice of proposed adjustment, or a Form 4549.

Advancing the taxpayer's position

The opening conference and the financial statement, transfer pricing, and supply chain orientation meetings can be used as opportunities to distinguish facts the issue team may view in a negative light and to affirmatively present facts that may not have been adequately described in materials the issue team reviewed during the Planning Phase.

The taxpayer has additional opportunities to present its affirmative arguments during the meetings held during the Resolution Phase.

The Transfer Pricing Examination Process encourages the issue team to "conduct weekly or bi-weekly discussions with the taxpayer to support communication and ensure common expectations" on the audit progress and timelines. Taxpayers should stay in regular contact with the issue team to ensure that their voice is heard early and often during all phases of transfer pricing audits.

While I applaud the IRS for setting out a new Transfer Pricing Examination Process, the success or failure of this procedures will be highly dependent on a balanced implementation.