January 29, 2018
Control No: LB&I-04-0118-006
Impacted IRM 220.127.116.11
MEMORANDUM FOR LARGE BUSINESS AND INTERNATIONAL DIVISION EMPLOYEES
|From:||Douglas W. O’Donnell
/s/ Douglas W. O’Donnell
Commissioner, Large Business and International Division
|Subject:||Revised Instructions for LB&I on Transfer Pricing Issue Selection and Scope of Analysis - Best Method Selection|
This directive replaces the previously issued directive LB&I-04-0118-002 dated January 12, 2018.
This directive provides instructions to Large Business & International (LB&I) with respect to certain scope limitations on transfer pricing analysis.
Transfer pricing issues make up a substantial portion of the LB&I inventory. As a result, significant LB&I resources are devoted to transfer pricing issues. LB&I recognizes that it needs to manage transfer pricing issues under examination and related resources in the most efficient and effective manner possible. This Directive provides instructions with respect to managing certain transfer pricing issues in inventory.
This Directive applies to:
• Examinations of LB&I taxpayers (i.e., assets equal to or greater than $10,000,000) who are required to file (including extensions) forms 5471 or 5472 with their original annual US tax return
• Taxpayers in the Advance Pricing Agreement (APA) program.
TRANSFER PRICING ISSUE SELECTION GUIDANCE
Obtain Treaties and Transfer Pricing Operations (TTPO) Transfer Pricing Review Panel approval before changing the taxpayer’s selection of a Treas. Reg. §1.482 method as the best method as supported in contemporaneous transfer pricing documentation or APA submission
Proper selection and application of a transfer pricing method, under Treas. Reg. §1.482, is critical to enforcement of the arm’s length principle. In transfer pricing documentation reports, taxpayers represent that their analysis considered the specified method options based on their specific facts and circumstances using the best method under the principles of Treas. Reg. §1.482-1(c). To ignore that analysis and conclusion and start the best method selection analysis from scratch protracts the examination timeline and diverts resources. Starting with the taxpayer’s selection of the best method, the examination team should thoroughly analyze the taxpayer’s application of their selected method. When the examination team analyzes the taxpayer’s application of the selected method and concludes that changes to the application of that method are appropriate, these changes should be thoroughly developed and documented as early as possible in the examination. Differences in the method application, whether they are related to comparable company selection, tested party data, or other factors can result in corrections and adjustments to the determination of the arm’s length result of related party transactions.
During the course of an examination’s factual development of related party transactions, if information supports a conclusion that a method other than the taxpayer’s chosen method would result in a more reliable measure of the arm’s length result, the approval process under this Directive for the alternative method must be used. The examples in Treas. Reg. §1.482-8 are instructive in considering how to evaluate the reasonableness of the taxpayer’s best method analysis. This approval process applies not only to examinations with Transfer Pricing Practice (TPP) involvement but also those conducted by Cross Border Activities (CBA) or Geographic Practice Area revenue agents without TPP involvement (including Campaigns).
When the examiner changes the application of the taxpayer’s best method - but not the selection of the best method - the required approval process set forth in this Directive does not apply.
This Directive applies only in cases where the taxpayer has timely provided as part of their IRC §6662(e) documentation a report that both clearly states the method the taxpayer has selected as the best method and the analysis to support that conclusion. When the taxpayer does not definitively identify the selection of a best method in its documentation, the examiner’s best method analysis is not subject to the approval process defined in this guidance. When the documentation does not explicitly include an analysis and conclusion that the method used is the best method, penalties would apply if adjustments to tax exceed the penalty threshold under regulations under IRC §6662.
Taxpayers may use an unspecified method as the best method. However, use of an unspecified method may warrant a higher level of additional scrutiny by the examination team. To conclude that an unspecified method is the “best method,” the taxpayer has the burden to affirmatively establish that none of the specified methods in the regulations was likely to result in a price that would clearly reflect income. Taxpayers must make a reasonable effort to evaluate the potential applicability of the specified methods. Examiners should fully review the best method analysis that rejects each of the specified methods. In such case, if the examiner wants to use an alternative method (specified or unspecified) as the best method, the approval process in this guidance also applies.
In Advance Pricing Agreements
This guidance is also applicable to the APA process, subject to the exception described below for certain bilateral APA issues. When taxpayers prepare and submit an APA application for consideration by the Advance Pricing and Mutual Agreement program (APMA), the assigned APA team must start with a thorough review of the taxpayer’s analysis and conclusion regarding its selection of the best method under Treas. Reg. §1.482 in the case of a unilateral APA request or its selection of the “most appropriate method” under the OECD Transfer Pricing Guidelines in the case of bilateral APA requests. Where the APA team concludes a method other than the method proposed by the taxpayer produces a more reliable measure of the arm’s length result, given the particular facts and circumstances, the approval process under this Directive must be followed. Practical tax administration and efficient use of limited APMA resources mean we should not ignore the analysis provided by the taxpayer and start from scratch to develop the best method analysis. If the taxpayer has provided a robust analysis and conclusion to support their selection of the best method, the APA team should apply the analytic principles and concepts described above in the context of the APA submission to critically evaluate the taxpayer’s method determination. Again, changes in the application or assumptions used in the taxpayer’s selected method are not subject to this approval process.
Once the APA team has begun formal negotiations with a competent authority on a bilateral APA, the approval process in this Directive is not required.
Approval of TTPO Transfer Pricing Review Panel
When an alternative method is warranted by the specific facts and circumstances, the recommendation for a method change must be elevated through the issue manager’s or APA team leader’s management chain to the applicable Director of Field Operations (DFO) level for referral to the national TTPO Transfer Pricing Review Panel. The Review Panel will consist of the TPP Director or APMA Director (depending on whether the case is an APA or an examination), a Senior Advisor to the TTPO Director, and the Income Shifting Practice Network Manager. Key questions the Review Panel will focus on include: (1) Why the taxpayer’s method is unreliable, (2) Whether the taxpayer’s method can be adjusted to make it more reliable, and (3) If not, what method is more reliable, and why. The method-change recommendation must include the analysis supporting the alternative method selection and provide the Review Panel with support for answers to these questions. Further information on implementation of the approval process will be communicated directly to the Territory Managers and APMA Assistant Directors for discussion with their respective teams. The approval process is not intended to impede the proper analysis of compliance with the transfer pricing regulations; it is designed to support the best and highest use of limited transfer pricing resources.
These instructions apply to transfer pricing examinations opened in the IRS Information Management System (IMS) or APAs submitted from October 1, 2017 forward.
These instructions will be incorporated into Internal Revenue Manual (IRM) 4.61.3 and the APMA Revenue Procedure by a date not to exceed two years from its release.
For further information regarding this Directive and any of the specific issues addressed herein, please contact the Director of Treaties and Transfer Pricing Operations.
This Directive is not an official pronouncement of law and cannot be used, cited or relied upon as such. In addition, nothing in this Directive should be construed as affecting the operation of any other provision of the Code, regulations or guidance thereunder. These instructions are intended for internal decision making only.
cc: Division Counsel, LB&I