4.61.3 Development of IRC 482 Cases

Manual Transmittal

December 13, 2018

Purpose

(1) This transmits revised IRM 4.61.3, International Program Audit Guidelines, Development of IRC 482 Cases.

Material Changes

(1) Completely revised and reorganized content to reflect current examination processes and procedures relating to transfer pricing examinations.

(2) Added IRM 4.61.3.1, Program Scope and Objectives, in accordance with the requirements described in IRM 1.11.2, Internal Management Documents System, Internal Revenue Manual (IRM) Process, and renumbered subsequent subsections accordingly.

(3) Revised and renamed former IRM 4.61.3.1, Development of IRC section 482 Cases to IRM 4.61.3.2, Introduction to IRC 482.

(4) The following former subsections were removed, with various content updated and incorporated into new subsections as described in (5) below:

IRM Section Title
4.61.3.4.1 Preaudit Techniques
4.61.3.4.2 Understanding the Taxpayer’s Operations
4.61.3.4.3 Reviewing Balance Sheets and Income
4.61.3.4.4 Taxpayer Documentation
4.61.3.5.2 Scope and Depth of Functional Analysis
4.61.3.5.3 Risk Analysis
4.61.3.7 Selecting the Method

(5) The following new subsections were added. Where content from removed IRM subsections was incorporated, updated or otherwise revised, such changes are noted.

IRM Subsection Title
4.61.3.3 Overview of the Planning Phase for IRC 482 Examinations
4.61.3.3.1 Issue Team Member Collaboration and Coordination
4.61.3.3.2 Case Manager Roles and Responsibilities
4.61.3.3.3 Issue Manager Roles and Responsibilities
4.61.3.3.4 Managers of Team Members Who Are Not Designated as the Case Manager or Issue Manager
4.61.3.3.5 Other Specialists
4.61.3.3.6 Other Resources for the Issue Team
4.61.3.3.8 Initial Transfer Pricing Risk Assessment — this new subsection incorporates and updates content from previous IRM 4.61.3.4.1, Preaudit Techniques.
4.61.3.3.9 Internal Planning Discussions
4.61.3.3.10 Issue Team Timelines and Key Milestones
4.61.3.3.11 Opening Conference, Issue Discussion Meetings and Examination Plan — This new subsection incorporates and supersedes Interim Guidance Memorandum LB&I-04-0618-012, Release of Transfer Pricing Examination Process and Interim Instructions for Sharing with Taxpayers, dated June 29, 2018.
4.61.3.4 Overview of the Execution Phase for IRC 482 Examinations
4.61.3.4.1 Examination Techniques to Gather Evidence
4.61.3.4.2 Researching Federal Tax Law
4.61.3.4.3 Information Document Request (IDR) Process
4.61.3.4.3.1 Issuing the Initial Transfer Pricing Documentation IDR for the Taxpayer’s IRC 6662(e) Documentation. The new subsection incorporates and updates content from previous IRM 4.61.3.4.4, Taxpayer Documentation, and incorporates and supersedes Directive LB&I-04-0118-001, Interim Instructions on Issuance of Mandatory Transfer Pricing Information Document Request (IDR) in LB&I Examinations, dated January 12, 2018.
4.61.3.4.4 Issue Management and Development – this new subsection incorporates and updates content from previous IRM 4.61.3.4.2, Understanding the Taxpayer’s Operations.
4.61.3.4.5 Continuous Risk Analysis
4.61.3.4.6 Taxpayer Meetings
4.61.3.4.7 Taxpayer’s Intercompany Transfer of Tangible Property. This new subsection incorporates and updates content from previous IRM 4.61.3.4.5, Transfers of Tangible Property.
4.61.3.4.8 Taxpayer’s Intercompany Transfer of Intangible Property. This new subsection incorporates and updates content from previous IRM 4.61.3.4.6, Transfers of Intangible Property.
4.61.3.4.9 Cost Sharing Arrangements (CSAs) Under IRC 482 Regulations.
4.61.3.4.10 Taxpayer’s Intercompany Services Transactions — This new subsection incorporates and updates content from previous IRM 4.61.3.4.7, Services.
4.61.3.4.11 Searching for Comparable Uncontrolled Transactions — This new subsection incorporates and updates content from previous IRM 4.61.3.6, Searching for Comparables.
4.61.3.4.11.1 Comparability Analysis — This new subsection incorporates and updates content from previous IRM 4.61.3.5, Comparability.
4.61.3.4.11.2 Functional Analysis — This new subsection incorporates and updates content from previous IRM 4.61.3.5.1, Functional Analysis, and previous IRM 4.61.3.5.2, Scope and Depth of Functional Analysis.
4.61.3.4.11.3 Comparable Transaction Risk Analysis — This new subsection incorporates and updates content from previous IRM 4.61.3.5.3, Risk Analysis.
4.61.3.4.12 Selecting the Best Method — This new subsection incorporates content from previous IRM 4.61.3.7, Selecting the Method. This new subsection also incorporates and supersedes, in relevant part, guidance from Directive LB&I 04-0118-006, Revised Instructions for LB&I on Transfer Pricing Issue Selection and Scope of Analysis - Best Method Selection, dated January 29, 2018
4.61.3.4.12.1 Transfer Pricing Review Panel (TPRP)
4.61.3.4.14 Written Acknowledgment of the Facts (AOF)
4.61.3.4.15 Economist Report
4.61.3.4.16 Notice of Proposed Adjustment (NOPA)
4.61.3.4.17 Penalty Considerations
4.61.3.5 Overview of the Resolution of Phase for IRC 482 Examinations
4.61.3.5.1 Issue Resolution
4.61.3.5.2 Management Involvement in the Issue Resolution Process
4.61.3.5.3 Completing the Transfer Pricing Examination
4.61.3.5.4 Application of Rev. Proc. 99-32
4.61.3.5.5 Appeals
4.61.3.6 Coordination with U.S. Competent Authority
4.61.3.7 Country-by-Country (CbC) Report — this new subsection incorporates and supersedes guidance from Directive LB&I-04-1017-006, Country-by-Country Report Guidance and Procedures for Large Business and International (LB&I) Division, dated October 12, 2017.
4.61.3.7.1 Appropriate Use Guidelines
4.61.3.7.2 The CbC Report and the Examination Process
4.61.3.7.3 Effective Use Guidelines
4.61.3.7.4 CbC Report Related Resources

(6) The following subsections were retained, updated and renumbered accordingly.

Former IRM Subsection Renumbered IRM Subsection Title
4.61.3.9 4.61.3.3.7 Assistance from Counsel
4.61.3.5.4 4.61.3.4.11.4 Contractual Terms
4.61.3.5.5 4.61.3.4.11.5 Economic Conditions
4.61.3.5.6 4.61.3.4.11.6 Property or Services
4.61.3.8 4.61.3.4.13 Computing the Adjustment

(7) Added new Exhibit 4.61.3-1, Acronyms.

(8) Revised and retitled Exhibit 4.61.3-2, Development of IRC 482 Cases — General Transfer Pricing Audit Tools, References and Resources.

(9) The following exhibits were removed:

IRM Exhibit Title
Exhibit 4.61.3-1 On-Site Visitations
Exhibit 4.61.3-3 Presentation of Findings
Exhibit 4.61.3-4 Transfer Pricing Functional Analysis Questionnaire

(10) Various editorial changes were made throughout, including updates to references and cross-references.

Effect on Other Documents

This IRM supersedes IRM 4.61.3, Development of IRC section 482 Cases, dated May 1, 2006.
This IRM incorporates and supersedes Interim Guidance Memorandum LB&I 04-0618-012, Release of Transfer Pricing Examination Process and Interim Instructions for Sharing with Taxpayers, dated June 29, 2018.

This IRM incorporates and supersedes, in relevant part, Directive LB&I 04-0118-006, Revised Instructions for LB&I on Transfer Pricing Issue Selection and Scope of Analysis - Best Method Selection, dated January 29, 2018.

This IRM incorporates and supersedes Directive LB&I 04-0118-001, Interim Instructions on Issuance of Mandatory Transfer Pricing Information Document Request (IDR) in LB&I Examinations, dated January 12, 2018.

This IRM incorporates and supersedes Directive LB&I-04-1017-006, Country-by-Country Report Guidance and Procedures for Large Business and International (LB&I) Division, dated October 12, 2017.

Audience

All LB&I personnel

Effective Date

(12-13-2018)

Jennifer L. Best
Director, Treaty and Transfer Pricing Operations
Large Business and International Division

Program Scope and Objectives

  1. This IRM provides general guidelines in the development of IRC 482 cases. The guidelines are intended to apply both to inbound and outbound transactions.

  2. Purpose: The purpose of this IRM is to provide transfer pricing examination techniques.

  3. Audience: The intended audience is all Large Business & International (LB&I) personnel.

  4. Policy Owner: Treaty and Transfer Pricing Operations (TTPO), LB&I.

  5. Program Owner: TTPO.

  6. Primary Stakeholders: LB&I personnel.

  7. Program Goals: The goal of this program is to provide processes to assist with the planning, execution and resolution of transfer pricing examinations.

Background

  1. IRC 482 transfer pricing examinations are factually intensive and require a thorough analysis of functions performed, resources employed and risks assumed along with an accurate understanding of relevant financial information. They are resource intensive for both the IRS and taxpayers. LB&I’s Transfer Pricing Examination Process (TPEP) was introduced to provide a framework and guidelines for transfer pricing examinations. The TPEP provides best practices and processes to assist with the planning, execution and resolution of transfer pricing examinations consistent with Publication 5125, LB&I Examination Process (LEP). This IRM incorporates TPEP best practices and processes to assist agents with transfer pricing issue development and examinations.

  2. This IRM also incorporates additional guidance issued by the Commissioner, LB&I, applicable to transfer pricing examinations.

  3. Check for the most recent TPEP and directives or other guidance that may be applicable to transfer pricing examinations.

Authority

  1. See IRM 4.46.1.1.2, Authority.

Roles and Responsibilities

  1. Personnel performing transfer pricing examinations, their managers and executives share an equal responsibility in the conduct of a quality transfer pricing examination. Also see IRM 4.46.1.1.3, Roles and Responsibilities.

  2. For case manager responsibilities, see IRM 4.46.1.1.3.1, Case Manager Roles and Responsibilities.

  3. For issue manager responsibilities, see IRM 4.46.1.1.3.2, Issue Manager Roles and Responsibilities.

  4. For responsibilities of managers other than the case manager or issue manager, see IRM 4.46.1.1.3.3, Managers of Team Members Who Are Not Designated as the Case Manager or Issue Manager.

Program Objectives and Review

  1. The goal is to provide the process for conducting transfer pricing examinations focusing on best practices and examination techniques consistent with the LEP.

Acronyms

  1. See Exhibit 4.61.3-1, Acronyms.

Related Resources

  1. Related resources include the following:

    • Publication 5300, Transfer Pricing Examination Process

    • Publication 5125, LB&I Examination Process

    • IRM 4.10.3, Examination Techniques

    • IRM 4.11.5, Allocation of Income and Deductions – IRC 482

    • IRM 4.11.57, Third Party Contacts

    • IRM 4.46.3, Planning the Examination

    • IRM 4.46.4, Executing the Examination

    • IRM 4.46.5, Resolving the Examination

    • IRM 4.46.6, Workpapers and Reports Resources

    • IRM 4.46.10, Outside Expert Program

    • IRM 4.60.2, Mutual Agreement Procedures and Report Guidelines

    • IRM 4.60.3, Tax Treaty Related Matters

    • IRM 4.60.8, International Examination and Processing Procedures

    • IRM 20.1.1, Penalty Handbook, Introduction and Penalty Relief

    • IRM 20.1.5, Return Related Penalties

    • IRM 25.5, Summons

Introduction to IRC 482

  1. The purpose of IRC 482 is to ensure taxpayers clearly reflect income attributable to controlled transactions and to prevent the avoidance of taxes with respect to such transactions. IRC 482 authorizes the Service to distribute, allocate or apportion items of income, deductions, credits, or allowances to clearly reflect income or prevent evasion of taxes.

  2. IRC 482 cases involve determining whether controlled transactions meet the arm’s length standard. This IRM provision provides general guidelines to issue teams in the development of IRC 482 cases. IRC 482 issues occur in the context of a wide variety of factual patterns. Consequently, establishing specific guidelines for every type of factual pattern is impractical.

  3. In the case of any transfer (or license) of intangible property, the income with respect to such transfer or license shall be commensurate with the income attributable to the intangible.

  4. Valuation of transfers of intangible property (including intangible property transferred with other property or services) is required on an aggregate basis or on the basis of realistic alternatives to such transfer, if it is the most reliable means of valuation of such transfer.

  5. Issue teams should exercise care and good judgment when recommending IRC 482 adjustments. De minimis adjustments should not be made. In this context, de minimis is not meant to be a specific dollar figure. Rather, issue teams should look to those situations where there have been substantial deviations from the arm’s length standard, resulting in a significant shifting of income.

IRC 482 Regulations

  1. The Treasury Regulations further define and expand upon IRC 482. Key components of the regulations include:

    1. Arm’s Length Standard: The standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. A controlled transaction meets the arm's length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm's length result). Treas. Reg. 1.482-1(b)(1).

    2. Controlled Taxpayer: Common ownership (greater than 50% ownership) or control as defined in Treas. Reg. 1.482-1(i)(4) and (5).

    3. Best Method Rule: The best method is the one that, based upon facts and circumstances, provides the most reliable measure of an arm’s length result.

    4. Comparability: The relative reliability of a method, based on comparing the results of a controlled transaction to transactions between uncontrolled parties, depends on the degree of comparability. All facts and circumstances must be considered. Consideration must be given to completeness and accuracy of data, reliability of assumptions, and sensitivity of results. The regulations name five factors that must be considered in evaluating comparability: functions, contractual terms, risks, economic conditions, and property or services transferred. Adjustments must be made for differences between the transactions if they improve the reliability of the results. The extent and reliability of any adjustments will affect the reliability of the analysis. Treas. Reg. 1.482-1(d).

    5. Arm’s Length Range and Interquartile Range: The application of a method may produce a number of results from which a reliable range of results may be derived. A taxpayer will not be subject to adjustment if its results fall within such range. This arm’s length range can consist of comparables all of whose material differences have likely been ascertained, quantified and compensated. Because such close comparables are often not available, a valid statistical refinement, such as an interquartile range, of the sufficiently reliable comparables is often used. Treas. Reg. 1.482-1(e).

    6. Cost Sharing Arrangements (CSAs): Special rules apply to IRC 482 CSAs at Treas. Reg. 1.482-7.

Overview of the Planning Phase for IRC 482 Examinations

  1. For information on the planning phase of an LB&I examination, see IRM 4.46.3, Planning the Examination.

  2. The planning phase for a transfer pricing examination determines the scope of the examination. Issues selected for transfer pricing examinations should have the broadest impact on achieving compliance.

Issue Team Member Collaboration and Coordination

  1. The Issue Selection and Collaboration Process should be used to determine if a specialist should be assigned to an Industry Case (IC). Refer to IRM 4.46.3, Planning the Examination, for more information. The team assigned to examine a specific issue, such as an intercompany transaction, is referred to as the issue team. For transfer pricing cases, the issue team will include members of the Transfer Pricing Practice (TPP) and/or Cross-Border Activities (CBA). For examinations arising under LB&I campaigns, examination team members should follow the specific guidance provided for within the campaign. The transfer pricing issue team generally includes:

    1. Senior revenue agent (SRA) and revenue agent (RA)

    2. Economist

    3. Tax Law Specialist

  2. In accordance with IRM 4.46.1.1.3, Roles and Responsibilities, there should be coordination and collaboration among team members and other specialists and advisors, including the:

    1. Case manager

    2. Issue manager

    3. Team coordinator

    4. SRA and/or RA

    5. Computer Audit Specialist (CAS)

    6. Counsel

    7. Other specialists and advisors, as necessary

  3. Transfer pricing issue teams should consult with the Advance Pricing and Mutual Agreement (APMA) program regarding transfer pricing transactions between the U.S. taxpayer and related parties in the U.S. treaty-partner countries that may generate adjustments for which a taxpayer may request competent authority assistance. For information on the APMA program, see IRM 4.61.3.6, Coordination with U.S. Competent Authority.

Case Manager Roles and Responsibilities

  1. See IRM 4.46.1.1.3.1, Case Manager Roles and Responsibilities.

Issue Manager Roles and Responsibilities

  1. For transfer pricing issues, TPP or CBA resources must be assigned to the examination and the TPP or CBA manager will be the issue manager. For examinations arising under LB&I campaigns, examination team members should follow the specific guidance provided for within the campaign.

  2. See IRM 4.46.1.1.3.2, Issue Manager Roles and Responsibilities.

Managers of Team Members Who Are Not Designated as the Case Manager or Issue Manager

  1. See IRM 4.46.1.1.3.3, Managers of Team Members Who Are Not Designated as the Case Manager or Issue Manager.

Other Specialists

  1. Other specialists such as engineers, financial product specialists and a CAS may also be requested, as needed, following appropriate referral processes.

  2. If a specialist is assigned to the transfer pricing issue, it is important that the specialist be consulted regarding internal meetings, Information Document Request (IDR) issuances and responses, questionnaires, interviews, tours, and other audit steps. For example, an engineer may be helpful touring a manufacturing plant or during interviews in a case in which software development processes are important.

Other Resources for the Issue Team

  1. The following TTPO Practice Networks are available to assist issue teams with case development and transfer pricing issues and can connect issue teams to other employees with relevant industry knowledge and expertise:

    1. The Income Shifting Practice Network (ISPN)

    2. The Economics Practice Network (EPN)

  2. See Exhibit 4.61.3-2, Development of IRC 482 Cases - General Transfer Pricing Audit Tools, References and Resources, for additional resources to assist in developing transfer pricing and income shifting issues.

Assistance from Counsel

  1. LB&I Field Counsel should be consulted early and throughout the entire examination process. National Office Counsel, in coordination with LB&I Field Counsel, should be consulted on transfer pricing matters that are very large, complex or involve controversial legal issues.

  2. Counsel may provide the following assistance to the issue team:

    1. Review IDRs, questionnaires and interview questions to help obtain information which may be summonsed if necessary.

    2. Review the taxpayer’s position and analysis.

    3. Assist with formulation of legal positions.

    4. Review Notices of Proposed Adjustments (NOPAs), economist reports, other specialist reports, the taxpayer’s protest, and examination’s rebuttal to the taxpayer’s protest.

    5. Attend meetings, especially when opposing counsel is expected to be present, to assist in the orderly development of facts and presentation of positions.

    6. Provide legal analysis interpreting regulations and case law.

    7. Coordinate legal positions with Associate Chief Counsel International (ACCI) and other affected Chief Counsel offices.

    8. Interpret taxpayer’s contracts and transactions.

    9. Review summonses.

    10. Review IRC 982 requests for documents maintained in foreign countries.

    11. Recommend certain information be obtained (e.g., through information exchange under the applicable income tax treaty).

    12. Research intellectual property law, foreign law or any other area of non-tax law related to the case.

    13. Engage with economists and other experts to ensure preparation of pertinent, accurate and comprehensive positions.

    14. Assist the issue team in Appeals, including the pre-conference meeting phase, Appeals conferences and post-closing conference.

    15. Consult regarding designation of a case for litigation.

Initial Transfer Pricing Risk Assessment

  1. The issue team will complete an initial transfer pricing risk assessment to identify issues that may warrant examination. Each examination is unique and may require different techniques. Priorities should be established through an issue-driven risk process, which compares the potential benefits to be derived from examining an issue to the resources required to perform the examination. See IRM 4.46.3.3, Risk Analysis Process, for information on general risk analysis of the return.

  2. The purpose of the initial transfer pricing risk assessment is to identify specific transactions between the U.S. taxpayer and its affiliates warranting examination and its impact to other aspects of the tax return. See IRM 4.46.3.3.5.1, Overall Tax Impact. The issue team should also establish if material intercompany transactions are with a treaty partner and consult with APMA to consider the competent authority experience in order to properly risk assess transactions and determine whether the issue should be examined. The issue team should consider, but is not limited to, the following items:

    1. Worldwide effective tax rate and profitability

    2. Whether the taxpayer’s overall tax position might benefit from income shifting

    3. Industry averages, benchmarks or reference sets, if available

    4. Subpart F and other issues and need to collaborate with CBA

    5. Net operating losses

    6. Collateral adjustments and other impacting factors

    7. Tax treaties and the need to collaborate with relevant APMA personnel

    8. Any Advance Pricing Agreements (APAs) or prior Mutual Agreement Procedure (MAP) agreements on transfer pricing issues

  3. The issue team should gain an understanding of the tax return and of the taxpayer’s history, background, overall core business operations and profit drivers. Review the taxpayer’s websites, investor relations materials including SEC registration statements, annual reports (Form 10-K and Form 20-F) and Regulation Fair Disclosure presentations of public companies, as well as foreign and private company research services, in order to obtain information such as, but not limited to, the following:

    1. Overview of the taxpayer’s business, including operations in other countries

    2. Geographical, legal and tax organizational structure

    3. Financial statements

    4. Segmented operational and profitability levels

    5. Functional activities and associated locations

    6. Significant transactions, including acquisitions of unrelated parties

    7. Descriptions of patents, trademarks and other intangibles

    8. Industry and competitor information

    9. Key products and technologies

    10. Merger, acquisition and other reorganization activity

    Also see IRM 4.46.3.3.5, Risk Analysis Factors to Consider.

  4. Risk assessment includes the review of historical examination information and prior years’ Issue Management System (IMS) information, if applicable, to identify potential controlled transactions. See IRM 4.46.3.3.1, Examiner’s Preliminary Risk Analysis – Information Resources, on examiner’s preliminary risk analysis relating to the documents from prior examinations, with an emphasis of the following items, but not limited to:

    1. Taxpayer’s transfer pricing documentation

    2. NOPAs of prior transfer pricing issues

    3. Prior economist's report

    4. Other specialists' reports

    5. Any legal advice

    6. Taxpayer protests, examination’s rebuttals to the taxpayer’s protest and Appeals Case Memorandums (ACMs)

    7. Any case historical notes

  5. The current issue team should contact and meet with the issue team from the prior examination cycle, if possible.

  6. The issue team should refer to the IRC 482 Audit Toolkit for general transfer pricing guidance and resources to assist with the initial risk assessment and throughout the transfer pricing examination.

  7. To assist in gaining an understanding of the tax return, the issue team can access the CAS Examination Resources webpage for a variety of applications and tools to conduct analysis of various returns. The Auditors Workbench is also a tool that can be used to analyze data from Forms 1120, 1065, 1120S, and others that provide specific analysis of transfer pricing issues. Other return tax forms to analyze may include, but are not limited to:

    1. Form 926 - Return by a U.S Transferor of Property to a Foreign Corporation

    2. Form 4797 - Sales of Business Property

    3. Form 5471 - Information Return of U.S. Persons With Respect To Certain Foreign Corporations

    4. Form 5472 - Information Return of a 25% Foreign Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business

    5. Form 8858 - Information Return of U.S. Persons With Respect To Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs)

    6. Form 8865 - Return of U.S. Persons With Respect To Certain Foreign Partnerships (including Schedule O, Transfer of Property to a Foreign Partnership)

    7. Form 8833 - Treaty-Based Return Position Disclosure

    8. Form 8975 - Country-by-Country Report

    9. Form 1120, Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More

    10. Schedule UTP - Uncertain Tax Positions

  8. See IRM 4.61.3.7, Country-by-Country (CbC) Report, for more information about reviewing Form 8975 and the accompanying Schedules A (Tax Jurisdiction and Constituent Entity Information) in planning the examination. If the taxpayer is part of a foreign multinational enterprise but is not the ultimate parent, then review a copy of the CbC Report that the U.S. receives from the foreign tax authority. Also see IRM 11.3.25.2, Information Received from Foreign Tax Authorities, for information on automatically exchanged foreign reports.

  9. The issue team should perform an analysis to compute key financial ratios for multiple years, make industry comparisons, and consider whether cross border income shifting is occurring. Ratios should be based on both tax and financial data. The ratios are useful as a diagnostic tool to help focus the examination. However, they do not provide a definitive indication as to whether the price for a controlled transaction achieves an arm’s length result. To determine whether ratios indicate potential transfer pricing issues, the issue team should appropriately develop the relevant facts. Development of these facts may indicate other issues and adjustments, such as subpart F, that may interact with the transfer pricing issues. Below are some of the tools that can be used to compute ratio analyses of the U.S. party and foreign related parties to the transaction:

    1. Auditors Workbench - ratio analysis reports

    2. Taxpayer Information Gateway (TIG) Report - company financial data, worldwide profitability analysis and historical information

    3. Campaign and Case Built File - provides issue-focused financial ratios and analysis

    4. The IRS has subscriptions to other helpful tools. Subscription services may change over time, so consult the ISPN with any questions.

  10. Each examination will have different considerations and key financial ratios. The issue team should consider some of the following ratios that may be applicable in the initial transfer pricing risk assessment:

    1. Gross profit to net sales

    2. Operating profit to net sales

    3. Operating expenses to net sales

    4. Gross profit to operating expenses (Berry ratio)

    5. Effective tax rate (worldwide and individual entity)

    6. Changes in assets, especially intangible assets

    7. Net return on equity

    8. Profit per employee

    9. Revenue per employee

    10. Related party revenues to total revenues

    11. Return on assets

  11. The issue team should utilize research tools that can be helpful in understanding a company’s overall business and profit drivers. Compare the taxpayer’s financial ratios to applicable standard industry ratios. Consider expected arm’s length profit ranges for particular functions (e.g., distribution, manufacturing, services, etc.) and geographic regions (e.g., North America, Latin America, Asia, etc.). Substantial deviations from the standard industry ratios may indicate a need for further probe or inquiry.

  12. Treas. Reg. 1.482-1(d)(2) states that "unadjusted industry average returns themselves cannot establish arm's length results." Therefore, industry average returns should only be used to establish transfer pricing risk and should not be used to make a transfer pricing adjustment.

  13. The issue team will document their initial risk analysis. For information on conducting and documenting risk analysis performed as part of the examination, refer to IRM 4.46.3.3.6, Documenting the Risk Analysis.

Internal Planning Discussions

  1. The issue team will conduct internal planning discussions. General agenda items will include intercompany transactions to potentially be covered under examination, timeframes, key milestones, and other topics specific to the transfer pricing examination:

    1. Discuss the initial risk analysis, preliminary audit steps, estimated examination timeline, and key milestone dates.

    2. Discuss staff resources needed.

    3. Discuss the accounting data and records that will be requested from the taxpayer, such as segmented profit and loss statements for specific product(s) or product line(s).

    4. Discuss the IDR process (formulation of questions, taxpayer input, response times, and dealing with delays).

    5. The issue team will participate in the examination internal planning discussions and come to the internal planning meeting with a list of the potential material transfer pricing issue(s) and related preliminary audit procedures for consideration and collaboration.

  2. For more information on general internal planning and discussions, see IRM 4.46.3.4, Internal Planning and Internal Planning Discussions.

Issue Team Timelines and Key Milestones

  1. See IRM 4.46.3.4.8.4, Setting Tentative Timelines for the Case and Issues. The issue team should:

    1. Collaborate with the team coordinator and case manager regarding the potential transfer pricing issue(s).

    2. Establish a tentative timeline with key milestone dates for completion of the transfer pricing examination.

Opening Conference, Issue Discussion Meetings and Examination Plan

  1. The issue team will participate in the formal opening conference with the taxpayer. For information on opening conference agenda topics see IRM 4.46.3.6.1, Opening Conference/Meeting Agenda, and Exhibit 4.46.3-3, Sample Agenda for Opening Conference/Meeting.

  2. In addition to the agenda topics outlined in IRM 4.46.3.6.1 and Exhibit 4.46.3-3, the issue team will provide the taxpayer with information to locate the TPEP on IRS.gov. The issue team will discuss the TPEP with the taxpayer in order to facilitate an understanding of the process and provide insight into what is expected during a transfer pricing examination.

  3. The issue team will participate in issue discussions with the taxpayer after the preliminary transfer pricing risk analysis has been prepared. Transfer pricing issues are complex and require collaboration from both sides to have successful issue discussions. See IRM 4.46.3.8, Issue Discussion Meetings.

  4. The issue team will prepare required examination plan forms for the transfer pricing issues(s) that will be incorporated into the overall case examination plan. The issue team will work with the taxpayer to establish a plan to complete the transfer pricing examination in a timely manner. The transfer pricing examination plan should be developed in a transparent manner working with the taxpayer, be issue-driven, and specify the following: material intercompany transactions, audit steps, timeline(s), and communication agreements. The examination plan may be adjusted throughout the examination process. See IRM 4.46.3.9, Examination Plan.

    1. For information on the IC Examination Plan, see IRM 4.46.3.9.6, IC Examination Plan.

    2. For information on the Coordinated Industry Case (CIC) Examination Plan, see IRM 4.46.3.10.1, CIC Examination Plan.

Overview of the Execution Phase for IRC 482 Examinations

  1. Stages of issue development include determining the facts, applying the law to those facts and understanding the various tax implications of the issue. The issue team should conduct interactive discussions using the IDR process to develop the facts. Every effort should be made to resolve any factual differences with the taxpayer. Open communication and continuous reassessment of the examination plan and compliance risk should occur throughout the execution phase.

  2. For more information on the execution phase, see IRM 4.46.4, Executing the Examination.

Examination Techniques to Gather Evidence

  1. In addition to the audit steps outlined in the examination plan, the issue team should also consider the other examination techniques used to gather evidence in IRM 4.46.4.3, Examination Techniques Used to Gather Evidence.

Researching Federal Tax Law

  1. Issue teams must consider the various legal authorities and guidance available to them when developing and resolving issues. See IRM 4.46.4.4, Researching Federal Tax Law, for a listing of various legal authorities and guidance. Obtain LB&I Field Counsel assistance when appropriate.

  2. For transfer pricing issues, relevant guidance is provided primarily in IRC 482 and the regulations thereunder. Treas. Reg. 1.482-0 will help issue teams locate detailed guidance in the transfer pricing regulations relevant to specific issues and concepts.

Information Document Request (IDR) Process

  1. Issue IDRs for factual development, including requests for interviews, plant tours and site visits.

  2. The issue team should coordinate IDRs with the entire case team to avoid duplicate IDR requests.

  3. Follow the requirements in IRM 4.46.4.6, Information Document Request Process, and IRM 4.46.4.6.3, IDR Enforcement Process.

Issuing the Initial Transfer Pricing Documentation IDR for the Taxpayer’s IRC 6662(e) Documentation
  1. The Initial Transfer Pricing Documentation IDR for the taxpayer’s IRC 6662(e) documentation will be issued in accordance with the following procedures:

    1. For examinations arising under approved LB&I campaigns, issue team members will follow the specific guidance for the Initial Transfer Pricing Documentation IDR provided for within the campaign. If no such guidance is provided, the procedures under item b), below, will apply.

    2. For examinations with initial indications of transfer pricing compliance risk (considering the volume and type of transactions), a TPP and/or CBA Practice Area employee assigned as a consultant or team member to the case will issue the Initial Transfer Pricing Documentation IDR. If TPP or CBA resources are not assigned, the Initial Transfer Pricing Documentation IDR will not be issued.

    3. In all circumstances, time expended for the issuance of the Initial Transfer Pricing Documentation IDR will be charged to SAIN 003 Preliminary Examination Time; Uniform Issue List (UIL) 00000.00-00 – Administrative Procedures until the issue team decides the issue will be developed and the appropriate international UIL code (i.e., 9411, 9422, or 9423) will be determined and utilized going forward.

  2. The team coordinator and issue team members should collaborate on the issuance of the Initial Transfer Pricing Documentation IDR. It is important to issue the Initial Transfer Pricing Documentation IDR early in the examination process to start working the issue as soon as possible in order to close the examination in a timely manner.

  3. The Initial Transfer Pricing Documentation IDR should include a request for principal documents.

  4. IRC 6662(e)(3)(B)(i)(III) and (ii)(III) and Treas. Reg. 1.6662-6(d)(2)(iii) require that the taxpayer respond within 30 calendar days. The 30-day response period starts with the date the Initial Transfer Pricing Documentation IDR is issued.

    1. The 30-day response period is specified by statute.

    2. The issue team should use this 30-day period to perform analysis of currently available information which should include prior tax returns and financial statements.

  5. Taxpayers are not required to have IRC 6662(e) documentation. However, penalties apply when the taxpayer fails to create or to timely provide IRC 6662(e) documentation or when the IRC 6662(e) documentation provided is unreasonable or inadequate, assuming the net adjustment penalty thresholds are met. See IRM 4.61.3.4.17, Penalty Considerations, below.

Issue Management and Development

  1. See IRM 4.46.4.7, Issue Management and Development.

  2. The issue team should review the taxpayer’s IRC 6662(e) documentation prior to the taxpayer orientation meetings and note areas that require further development, confirmation or inquiry:

    1. Coordinate and update the initial risk analysis, timeline, examination plan, and hypothesis with issue team members.

    2. Evaluate the taxpayer’s best method selection and the potential applicability of other methods.

    3. Evaluate the taxpayer’s application of its best method selection (e.g., inputs and assumptions).

    4. Consider whether documentation meets the requirements of Treas. Reg. 1.6662-6(d)(2) or (d)(3).

    5. Determine whether the documentation covers all material controlled transactions.

    6. Consider whether additional information may be necessary in order to evaluate subpart F or other tax implications.

    7. When the transaction involves a treaty partner, the issue team will consult with APMA.

    Reminder:

    In evaluating the taxpayer’s IRC 6662(e) documentation, the issue team should consider not only whether the documentation timing requirements of Treas. Reg. 1.6662-6(d)(2)(iii) are met, but also whether the taxpayer’s IRC 6662(e) documentation reasonably and adequately addresses the related party transactions and whether the conclusions reached can be considered reasonable.

  3. The issue team members should work collaboratively. The issue team economist will:

    1. Evaluate the taxpayer’s best method selection analysis based upon its transfer pricing documentation in accordance with Treas. Reg. 1.482-1 and IRM 4.61.3.4.12, Selecting the Best Method.

    2. Coordinate the issuance of IDRs with other issue team members as necessary to obtain appropriate documents and information necessary for the economic analysis.

    3. Analyze the facts, including accounting data, to determine the applicable economic analysis under the law.

    4. Start drafting portions of the economist report to document the facts and conclusions throughout the development of the issue. See IRM 4.61.3.4.15, Economist Report.

  4. The issue team should prepare and issue an IDR to request a financial statement orientation to be conducted within 30 days from the opening conference. The orientation meeting should be scheduled to coordinate with the availability of the issue team. Generally, the financial statement orientation IDR should request, but not be limited to:

    1. A walk-through of the geographic, legal entity, tax, and functional organizational charts, and all reporting platforms that exist (for example, different management reporting systems).

    2. Reconciliation from the geographic trial balance to the Form 10-K consolidated financial statements.

    3. Reconciliation between relevant foreign accounting standards and Generally Accepted Accounting Principles (GAAP) (for example International Financial Reporting Standards versus GAAP).

    4. Segmented financial statements and roll-ups to the consolidated financial statements, including roll-ups of disregarded entities into controlled foreign corporations (CFCs).

    5. Map from the tax return, to the trial balance, to the general ledger.

    6. Working papers for book/tax differences.

    7. Year-end and month-end adjusting entries.

    8. True-up entries.

    9. Chart of accounts.

    10. List of cost centers and profit centers.

    11. Taxpayer’s relevant accounting practices and policies.

  5. The issue team should prepare and issue an IDR early in the execution phase requesting a transfer pricing/supply chain orientation meeting. The meeting should include, but is not limited to, discussion of:

    1. The taxpayer’s background and the history of intercompany transactions.

    2. Selected intercompany transactions in the year(s) under examination, including: (1) the taxpayer’s rationale for entering into the transactions; (2) the taxpayer’s value driver(s) associated with intangibles, services, loans, leases, and sales of tangible property and other transactions; and (3) the taxpayer’s explanation as to how each intercompany transaction may be associated with the transfer of functions, risks, assets and/or potential income.

    3. The characterization and business reason for the transaction.

    4. Identification of persons responsible for structuring the transactions from the tax planning perspective, including step plans for structuring/restructuring including, but not limited to, special purpose or new entities.

    5. The functions performed, resources employed and risks assumed by each controlled party to the controlled transaction.

    6. The total profits or losses associated with each material controlled transaction and each controlled party’s share of the total profits or losses.

    7. How the preparer of the IRC 6662(e) documentation gained knowledge of each controlled party’s functions performed, resources employed and risks assumed (e.g., interviews or meeting minutes).

    8. The need to request background documentation or identify taxpayer and/or preparer personnel to interview.

    9. The need to request additional documentation, including contracts and agreements.

    10. The transfer pricing methods selected by the taxpayer for significant transactions.

  6. The issue team should consider other transactions and broader financial results of the controlled taxpayers with uncontrolled parties for potential comparables.

  7. The issue team should gain an understanding of the taxpayer’s industry, operations and activities. As a starting point, the issue team can review publicly available information (e.g., the taxpayer’s website, industry websites, industry publications, public announcements, and the like). The issue team should prepare and issue IDRs to follow-up on and establish facts learned from outside sources of information. Establishing facts regarding the taxpayer’s industry, operations and activities may entail preparing and issuing IDRs for documents including, but not limited to:

    1. Annual reports and other significant securities filings

    2. Investor solicitations and investor relations materials

    3. Articles about the taxpayer from trade publications and other sources

    4. Reports published by securities firms

    5. Internal publications

    6. Minutes of meetings of the following: board of directors, shareholders, various departments, and committees reporting to the board of directors

    7. Policy and procedure manuals

    8. Customs entry documents

    9. Sales catalogs, brochures and pamphlets

    10. E-mails, faxes and other written correspondence between the U.S. taxpayer and foreign affiliates

  8. Gaining an understanding of the taxpayer’s business may involve many inquiries. The following list provides examples and is not all-inclusive:

    1. Are affiliates manufacturing the same or similar products as the taxpayer?

    2. Are affiliates using the same or similar intangibles? If so, were the intangibles sold or licensed?

    3. How is intellectual property transferred between affiliates and the taxpayer?

    4. Is there an IRC 482 CSA? If so, which participants made platform contributions?

    5. Which members of the controlled group do research and development (R&D)?

    6. How are the results of R&D disseminated among members of the controlled group?

    7. What R&D is conducted?

    8. Are marketing intangibles being used?

    9. Which members of the controlled group developed the marketing intangibles?

    10. Which members of the controlled group advertise?

    11. Which members of the group make key planning, financial and operational decisions?

  9. Issue team members may want to consider consulting with an outside industry expert when appropriate. See IRM 4.46.10, Outside Expert Program, for guidelines and procedures.

  10. The issue team should request and perform a review and analysis of relevant intercompany agreements. Collaborate with LB&I Field Counsel to understand legal terms and content of intercompany agreements:

    1. Determine the relationships of agreements to each other and to the transaction at issue.

    2. Determine the relevant parties to the agreements and their relationship to each other.

    3. Identify important terms of the agreements, including each party’s rights to terminate the agreement or otherwise avoid or recapture associated benefits and burdens.

    4. Identify pricing and forms of payment and circumstances that may affect whether the amounts specified will be paid.

    5. Assess the risks assigned to the controlled parties.

    6. Determine if the conduct of the parties is consistent with the form of the agreements.

    7. Identify any pertinent legal issues, as well as relevant non-tax legal issues.

Continuous Risk Analysis

  1. The issue team must use their professional judgment to determine which issues will continue to be examined or modified in scope as an examination proceeds. New information discovered by LB&I during an examination may necessitate modifying the examination plan to include new issues or remove issues. The issue team should refer to IRM 4.46.4.9, Continuous Risk Analysis, for general guidance. In addition, the issue team should:

    1. Perform a mid-cycle risk analysis in accordance with IRM 4.46.3.3.6, Documenting the Risk Analysis.

    2. Conduct internal meetings to discuss the progress of transfer pricing issues and re-evaluate audit steps and timing for next steps.

    3. Discuss materiality and compliance considerations of the transfer pricing issue(s).

    4. Elevate any concerns that may impact the case timeline.

    5. Collaborate with case manager and team coordinator to update the examination plan, timeline and milestone dates, as needed.

    6. Contemporaneously document workpapers and monitor progress of the transfer pricing examination.

Taxpayer Meetings

  1. The issue team should meet periodically with the taxpayer to confirm all relevant facts for transfer pricing issue(s) developed during the examination. Early and frequent discussions beginning with the development of the transfer pricing issue and continuing through resolution are crucial for a complete understanding of the respective merits of each parties’ positions on the transfer pricing issue.

  2. The issue team should:

    1. Consider a full and open discussion with the taxpayer, including the relevant personnel from the taxpayer’s business operations, as the tax department may not be knowledgeable of all the facts and circumstances relevant to the transfer pricing issue. Discussions may be facilitated through presentations made to the issue team by the taxpayer’s knowledgeable personnel.

    2. Ensure that facts to be relied upon are gathered and collaborate with the taxpayer to obtain all information necessary for the examination. Discuss and issue additional IDRs, as necessary.

    3. As the transfer pricing examination is concluding, discuss the preliminary findings with the taxpayer and engage in a meaningful discussion to ensure all facts are known and each party understands each other’s positions and the interpretation of material facts relied upon.

    4. Explain the APA program and its benefits to the taxpayer and encourage its use as a tool to achieve certainty in transfer pricing transactions when appropriate.

  3. A written agenda should be prepared for every taxpayer meeting and shared with the taxpayer in advance. Designate a dedicated note taker for meetings and make sure to document attendees present at each meeting. Also consider whether meetings should be documented by a court reporter or other recording, depending on the size and scope of the potential transfer pricing issue, the nature of the discussion and any recommendations of Counsel. See IRM 4.46.4.10.1, Hold Issue Discussions.

Taxpayer’s Intercompany Transfer of Tangible Property

  1. A taxpayer may have controlled transactions involving many different products or many separate transactions. Analyzing every individual transaction to determine its arm’s length price is impractical. Applying methods to overall results for product lines or other groupings is often more appropriate.

  2. Treas. Reg. 1.482-3 establishes the following methods for determining an arm’s length charge for a controlled transfer of tangible property:

    1. The Comparable Uncontrolled Price (CUP) Method

    2. The Resale Price Method

    3. The Cost-Plus Method

    4. The Comparable Profits Method (CPM)

    5. The Profit Split Method (PSM)

    6. Unspecified Methods

Taxpayer’s Intercompany Transfer of Intangible Property

  1. The issue team should gain an understanding of the taxpayer’s intangible property and any relevant intercompany transactions. Identifying and analyzing intangible transactions within the taxpayer’s affiliated group is a key step to any IRC 482 examination.

  2. For purposes of IRC 482 and IRC 367(d), IRC 367(d)(4) (formerly IRC 936(h)(3)(B), as modified by the Tax Cuts and Jobs Act of 2017) defines intangible property as any of the following:

    1. Patent, invention, formula, process, design, pattern, or know-how

    2. Copyright, literary, musical, or artistic composition

    3. Trademark, trade name or brand name

    4. Franchise, license or contract

    5. Method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical data

    6. Any goodwill, going concern value or workforce in place (including its composition and terms and conditions (contractual or otherwise) of its employment)

    7. Any other item the value or potential value of which is not attributable to tangible property or the services of any individual

  3. An intangible may be of great significance because of its mobility and potential for substantial economic return. When intercompany transactions involve significant income-producing intangibles, determining their arm’s length price is important.

  4. Treas. Reg. 1.482-4 specifies the following methods for determining an arm’s length charge for a controlled transfer of intangible property:

    1. The Comparable Uncontrolled Transaction (CUT) Method

    2. The CPM

    3. The PSM

    4. Unspecified Methods

  5. The parent entity may transfer a bundle of intangibles in a single transaction or multiple transactions to a subsidiary. In these cases, the issue team should identify the different individual intangibles being transferred. The consideration and use of aggregation or consideration of available realistic alternatives may be required in order to determine the most reliable means of valuation of such transfer.

  6. As a starting point, the issue team can review publicly available information (e.g., the taxpayer’s website, industry websites, public announcements, and the like) to broadly identify the taxpayer’s intangibles. The issue team should prepare and issue IDRs to follow-up on and establish facts learned from outside sources. Consider interviews of key personnel. Establishing facts regarding the taxpayer’s intangibles may require the review of, but not limited to:

    1. U.S. and foreign patents and patent prosecution files

    2. The taxpayer’s licenses and assignments available to the public at the U.S. Patent and Trademark Office

    3. Patent litigation involving the taxpayer and affiliates

    4. U.S. and foreign trademark and trade name registrations and trademark litigation involving the taxpayer

    5. Copyright registrations at the U.S. Copyright Office

    6. State franchise registrations

    7. License agreements (and amendments) with U.S. and foreign affiliates and with uncontrolled parties, including sublicense agreements

    8. The taxpayer’s internal and investor relations materials

Cost Sharing Arrangements (CSAs) Under IRC 482 Regulations

  1. A CSA is a contract by which the participants agree to share the cost of developing one or more intangibles (referred to as "cost shared intangibles" ) within the intangible development activity (IDA) of the CSA that will be separately exploited by each of the participants. By participating in a CSA, each participant obtains a separate interest in the cost shared intangibles (usually within a geographic area, but the regulations allow division upon other bases as well). Consequently, each participant may separately exploit the cost shared intangibles in a manner consistent with that interest, without owing additional compensation.

  2. At the inception of the CSA, a participant may contribute existing resources, capabilities and/or rights (including intangibles) it has to the CSA. In this situation, a Platform Contribution Transaction (PCT) payment is owed to the contributing participant from the other participants. In addition, a participant may subsequently acquire or develop resources, capabilities and/or rights outside the CSA and contribute these to the CSA. This will require a subsequent PCT payment.

  3. The cost sharing regulations include guidance on evaluating the method for valuing a PCT consistent with measuring the value by reference to the future income anticipated to be generated by the resulting cost shared intangibles.

  4. Treas. Reg. 1.482-7(g) provides supplemental guidance on methods applicable to PCTs:

    1. The CUT Method

    2. The Income Method

    3. The Acquisition Price Method

    4. The Market Capitalization Method

    5. The Residual Profit Split Method

    6. Unspecified Methods

  5. During the CSA, participants share the intangible development costs in proportion to their shares of the benefits they reasonably anticipate from their individual exploitation of the cost-shared intangibles (referred to as “reasonably anticipated benefits” (RAB) shares) in cost sharing transactions (CSTs).

  6. A CSA produces arm’s length results if, and only if, the requirements of the relevant regulations are satisfied, which include various documentation and reporting requirements. The IRC 6662(e) penalty regulations apply to CSAs.

  7. The issue team should issue IDRs to review CSAs, related agreements and amendments to gather an understanding of the participants, intangibles and rights involved in the CSA. The issue team should understand the scope and costs of the IDAs covered by the CSA. Considerations to address include, but are not limited to:

    1. What are the participants’ rights and benefits within the CSA?

    2. What are the participants’ territories and respective RAB shares within the CSA?

    3. How are the RAB shares calculated and applied to the PCT and IDA cost pool?

    4. Was there a change in participation under the CSA where either (1) a controlled participant transferred all or part of its interests and obligations under the CSA to another controlled taxpayer or (2) the participants’ division of interests or relative capabilities to benefit from the cost shared intangibles were materially altered?

    5. If so, was any consideration reported by the taxpayer for the transfer of the interests in the cost shared intangibles?

    6. Compare the controlled participants listed on the required CSA statement to the tax return.

    7. Have all platform contributions been accounted for in PCTs and compensated with arm’s length PCT payments?

    8. What are the functions performed, risks assumed and resources employed by participants in the CSA?

    9. What significant non-routine contributions, other than platform contributions, are the controlled participants providing to the CSA?

      Reminder:

      In evaluating the taxpayer’s CSA, the issue team should refer to the effective dates and applicable regulation for the CSA transaction being analyzed.

Taxpayer’s Intercompany Services Transactions

  1. Treas. Reg. 1.482-9 provides the transfer pricing methods for determining arm’s length prices for controlled services transactions. The amount that a controlled party charges for services performed for another party of a controlled group must meet the arm’s length standard.

  2. The potential tax issue is whether the price being charged to the related party for these services meets the arm’s length standard for what an uncontrolled party would pay for similar services.

  3. The arm’s length amount charged in a controlled services transaction must be determined using one of the following transfer pricing methods:

    1. The Services Cost Method (subject to certain requirements)

    2. The Comparable Uncontrolled Services Price Method

    3. The Gross Services Margin Method

    4. The Cost of Services Plus Method

    5. The CPM

    6. The PSM

    7. Unspecified Methods

  4. As a starting point, the issue team should issue IDRs to obtain an understanding of the services transactions to include, but not limited to:

    1. Is there a controlled services transaction?

    2. What are the types of activities performed?

    3. Has the activity resulted in a benefit to another party?

    4. Are the services “specified covered services”?

    5. Do the services relate to a key competitive advantage?

    6. Do the services relate to core capabilities?

    7. Do the services contribute to the fundamental risks of success or failure of the business?

    8. Are the services performed by highly skilled or non-skilled employees?

    9. If highly skilled employees provide the services, does this suggest these are high value services?

    10. Do the services make use of property, including intangible property?

Searching for Comparable Uncontrolled Transactions

  1. An uncontrolled transaction need not be identical to the controlled transaction to be considered comparable. However, it should be sufficiently similar. In other words, with adjustment for some differences, it should facilitate a reliable measure of an arm’s length result. Material differences will reduce the comparability of the controlled transaction and the uncontrolled transaction.

  2. The availability of comparables will vary from examination to examination. The search for a comparable uncontrolled transaction should begin with a review of the taxpayer’s operations and the taxpayer’s search process for comparables as documented in the taxpayer’s transfer pricing documentation.

  3. The taxpayer itself may have engaged in uncontrolled transactions potentially comparable to the controlled transaction. This type of comparable is known as an internal comparable. The issue team should obtain documents and information to perform a comparability analysis to see if these internal comparables may be used to determine whether the taxpayer’s pricing is arm’s length. See IRM 4.61.3.4.11.1, Comparability Analysis, below.

  4. Reviewing the taxpayer’s operations may also reveal unrelated parties that engage in comparable uncontrolled transactions. These types of comparables are known as external comparables. The issue team should obtain documents and information to perform a comparability analysis to see if these external comparables may be used to determine whether the taxpayer’s pricing is arm’s length.

  5. The Service has subscriptions to many helpful tools that can assist in researching information on external comparables and the identification of comparables for purposes of the comparability analysis. Subscription services may change over time, so consult the ISPN with any questions.

Comparability Analysis
  1. The issue team should perform a detailed analysis of the similarities and differences between the controlled transaction and the potentially comparable uncontrolled transactions.

  2. Treas. Reg. 1.482-1(d) provides general rules for determining comparability. Treas. Reg. 1.482-1(d)(3) provides five factors for determining whether controlled and uncontrolled transactions are comparable. The relative importance of the five comparability factors depends on the method applied. For example, some methods focus on product comparability and other methods focus on functional comparability. The comparability factors are:

    1. Functions performed

    2. Contractual terms

    3. Risks assumed

    4. Economic conditions

    5. Property or services

  3. A comparability analysis is the basis for determining comparable transactions and profitability benchmarks. A comparability analysis is not a pricing method and by itself does not determine the arm’s length result of the controlled transaction.

Functional Analysis
  1. Determining whether controlled and uncontrolled transactions are comparable requires a comparison of functions performed. The issue team must analyze the functions performed in both the controlled and uncontrolled transactions. See Treas. Reg. 1.482-1(d)(3)(i).

  2. The purpose and goal of the functional analysis is to clearly identify the economically significant activities undertaken by each party in the controlled transaction and then compare them with the functions undertaken by the parties in the potentially comparable uncontrolled transaction. An economically significant activity is one that, at arm’s length, materially affects the following:

    1. The price charged in a transaction

    2. The profits and/or losses from a transaction

  3. Understanding the flow of intangibles, products and services within the organization provides critical information about the performance of functions among entities. Therefore, it is an important starting point for the functional analysis. Key functions may include, but are not limited to:

    1. Conceptualization

    2. R&D

    3. Procurement or sourcing

    4. Manufacturing or assembly

    5. Testing and quality control

    6. Packaging and labeling

    7. Inventory management

    8. Transportation and warehousing

    9. Strategic and tactical marketing

    10. Customer support

    11. Maintenance and technical support

    12. Sales and distribution

    13. Warranty administration

    14. Financing the production or inventory

    15. Financing and collections related to third party transactions

  4. A functional analysis involves determining the following:

    1. What functions were performed by the transacting parties concerning the transaction?

    2. Who performed the functions?

    3. When were the functions performed?

    4. Where were the functions performed?

    5. How were the functions performed?

    6. Why were the functions performed?

    7. What resources were employed to perform the function?

    8. What tangible and intangible assets were employed?

    9. How were intangibles employed in the performance of functions?

    10. Why was the transaction structured the way it was?

    11. Who bears the risk of payment for the functions being performed?

  5. In performing a functional analysis, the following additional considerations should be addressed:

    1. Did the taxpayer or another affiliate sell or license the item in the controlled entity's market? Before the controlled entity's formation? After the controlled entity's formation? If sales were to unrelated distributors, what resale margins did the unrelated distributors earn?

    2. Who determines the price of the products?

    3. Does the controlled entity rely on a distribution network or customer list that was previously established by the parent?

    4. Did the controlled entity develop new customers?

    5. Have sales or licenses of the parent’s product in the subsidiary’s market increased following any reorganization?

    6. Have sales or licenses of the parent’s product in the subsidiary’s market increased following the subsidiary’s formation?

  6. In performing a functional analysis involving intangible property transactions, it is necessary to determine whether the form of the transaction (e.g. sale or license) is consistent with the substance of the transaction. The functions performed by each party to the transaction typically correlate with the risks assumed. Additional considerations in performing a functional analysis of intangible transactions include:

    1. Who owned the intangible before and after the transaction?

    2. If an intangible was owned before the transaction by a U.S. entity, was the intangible transferred to either: (1) a foreign corporation under IRC 351 or IRC 361 to which IRC 367(d) applies; or (2) an IRC 721(c) partnership with related foreign partners (with respect to the U.S. transferor) to which IRC 721(c) applies?

    3. What were the terms of the transaction between the controlled parties?

    4. How did the controlled transferee utilize the intangible?

    5. What amounts were paid pursuant to the transaction?

    6. Did the controlled transferee use the intangible in its own research, manufacturing, or marketing operations? If so, was the controlled transferee compensated by another affiliate for the research costs?

    7. Did the controlled transferee re-transfer or sub-license the intangible? If so, to whom?

    8. What were the terms of the second transfer or sub-license? What were the amounts of the payments under the second transfer or sub-license?

    9. If royalties were based on sales, what were the amounts of those sales and upon what sales base were payments made? If royalties were based on production, how was the production measured?

  7. Inquiries should be made about the assets (tangible and intangible) used and the resources employed in the functions in order to fully understand the specific functions performed by the parties involved in the controlled transaction.

  8. With respect to resources employed, the issue team should obtain a functional organization chart for each entity involved in the controlled transaction. This chart should identify entities, departments and personnel associated with the functions performed.

  9. Examining the functions performed by personnel involves examining their roles and credentials. Job titles often do not adequately describe the functions that personnel perform. The issue team should consider the following inquiries:

    1. Number of employees in each jurisdiction (e.g., as reported on Form 8975, Schedule A, or in an exchanged CbC Report, if a taxpayer was required to file a CbC Report)

    2. The compensation paid to the personnel

    3. The way compensation is structured

    4. The level of skills, training and education possessed by the personnel

    5. Job/position descriptions, reporting structure and hierarchy of positions

    6. Performance evaluations and bonus activity

    7. Outsourced positions

    8. Contracted and loaned personnel

  10. The issue team should identify the significant intangibles used by each of the controlled parties in performing various functions relevant to the controlled transactions. The issue team should also identify and obtain documentation that establishes ownership of the intangibles used. See Treas. Reg. 1.482-4(f)(3). The following questions, among others, should be addressed:

    1. What are the taxpayer’s intangibles?

    2. Who developed the intangibles?

    3. How are intangibles used among the controlled group?

    4. Was further development of the intangible conducted after the controlled party transaction? If so, by which entity?

    5. Which party to the controlled transaction bears the risk associated with intangible development?

    6. To what extent do the taxpayer’s products include intangibles, and how does the taxpayer charge for these intangibles in the price of its products?

    7. Did any of the controlled parties purchase or license intangibles from unrelated parties? Which party? What were the terms of the agreement?

  11. The issue team should identify the significant tangible assets (i.e., property, plant and equipment) used by each of the controlled parties in performing various functions relevant to the controlled transaction(s). Some of this information can be obtained publicly. The following questions, among others, should be addressed:

    1. How was the asset acquired? Who procured the asset? Were head office approvals required?

    2. When was the asset acquired?

    3. From whom was the asset acquired?

    4. How much did the asset cost?

    5. Is the asset generic or custom-designed?

    6. If custom-designed, who designed it?

    7. Are there any embedded intangibles within the asset?

    8. Are there any embedded services within the asset?

    9. Is there a related party loan on the asset?

  12. A functional analysis is a critical aspect of any transfer pricing examination and is best conducted as a team with robust internal communication and ongoing discussions with the taxpayer to further understand the key functions within its business operations. Performing a functional analysis involves more than a review of books and records. Interaction with the taxpayer should go beyond the tax department. The tax department may not have the knowledge to perform a thorough functional analysis. The issue team should interview the taxpayer’s operational personnel most familiar with the taxpayer’s operations. Work with the taxpayer (and use your own judgment) to identify key personnel for interviews. As appropriate, the issue team should try to conduct on-site visits. Consider changes that may have occurred at the site/plant with the passage of time. If the facility is outside your area, consider contacting another field office to conduct the visit on the team’s behalf. On-site visits enable an issue team to do the following:

    1. View the taxpayer’s operations and observe the functions performed.

    2. Gain an understanding of the dependence or independence of the operation.

    3. Gain an understanding of the extent to which various functions drive the profitability of the overall business.

    4. Discover additional relevant facts.

    Reminder:

    The U.S. Competent Authority must be consulted before any visit is conducted outside of the United States.

  13. Consider the need for a court reporter at interviews following procedures for the Court Reporter Services Request form. Allow 45 days to process the request.

  14. The issue team must consider the potential for other tax issues to maximize the efficiency and effectiveness of the examination. In planning and performing a functional analysis, consider information needed for any subpart F, effectively connected income or permanent establishment implications, and consult relevant specialists.

Comparable Transaction Risk Analysis
  1. Another factor for determining whether controlled and uncontrolled transactions are comparable is risk. A risk analysis of the controlled transactions should be performed with the functional analysis. A proper risk analysis will normally require consideration of multiple years of data.

  2. Risk involves uncertainty and potential exposure to loss. A company taking on more risk may suffer greater losses or earn greater profits compared to a company taking on less risk.

  3. The parties to a transaction may take on different risks and share certain risks. If a party is the true bearer of a risk, it is important to understand the impact, character and allocation of each material risk. Identifying the party to the transaction that is the true bearer of risk is important to determine the arm’s length price. If a party is a true bearer of risk, it should realize the profits or suffer the losses associated with taking on the risk. If one party purports to take on a risk, another party should not realize the profit or suffer the loss associated with taking on the risk.

  4. Generally, the contractual terms of a controlled transaction determine the controlled party that bears a particular risk. This allocation of risk specified or implied by the contractual terms should generally be respected if it conforms with the economic substance of the controlled transaction. Relevant facts in determining economic substance relevant to risk include, but are not limited to:

    1. Whether the actual conduct of the controlled parties is consistent with the contractual terms. If not, contact LB&I Field Counsel about whether the allocation of risks provided by the contractual terms should be respected. See Treas. Reg. 1.482-1(d)(3)(iii)(B)(1).

    2. Whether the taxpayer has the capacity to fund losses that might be expected to result from assumption of the risk or whether another party might ultimately be responsible for the losses. The controlled party that bears the risk is the party that would suffer the consequences of resulting losses. See Treas. Reg. 1.482-1(d)(3)(iii)(B)(2).

    3. Whether the extent of the taxpayer’s managerial or operational control over business activities and decisions directly influence the amount of income or loss recognized. At arm’s length, transacting parties generally bear risks of business activities that they control. Consider whether the entity exercising control over the business activities that incur risk, arranged for adequate expertise and operational infrastructure to address known risks. See Treas. Reg. 1.482-1(d)(3)(iii)(B)(3).

    4. Whether the risks assumed are commensurate with the potential economic benefit of the controlled transaction. If not, the purported risks may be unrealistic or actual risks may be artificially allocated in a way requiring special economic analysis.

    5. Whether applicable laws, such as agency, joint and several liability, and responsibilities to other stakeholders affect contracted risks. Consult Counsel if appropriate.

    6. Whether collateral arrangements such as insurance, indemnification and express and/or implied responsibilities affect contracted risks.

  5. Treas. Reg. 1.482-1(d)(3)(iii)(A) provides examples of risks that the issue team should consider in evaluating comparability between controlled and uncontrolled transactions. They include, but are not limited to:

    1. Market risks, including fluctuations in costs, supply, demand, prices, and inventory levels

    2. Intangible development risks associated with the success or failure of R&D activities

    3. Financial risks, including fluctuations in foreign currency rates of exchange and interest rates

    4. Credit and collection risks

    5. Product liability and warranty risks

    6. General business risks relating to the ownership of property, plant and equipment

    7. Advertising and marketing risks

Contractual Terms
  1. Another factor for determining whether controlled and uncontrolled transactions are comparable is contractual terms. The issue team must analyze the contractual terms of both the controlled and uncontrolled transactions and evaluate differences.

  2. Controlled taxpayers often enter into written sales, distribution, licensing, cost sharing, and other agreements. The issue team should obtain copies of all written agreements between the taxpayer and controlled parties relevant to the intercompany transactions under examination. Written agreements include the original agreement and any amendments, addendums, exhibits, and other related agreements as well as other related documents and correspondence. When reviewing, consider the dates the agreements are signed and effective and the personnel involved. The issue team should also consider obtaining documents (including correspondence, meeting notes and minutes, and presentations) relating to the negotiation of the agreements. If no formal contract exists, consider whether there are other documents that outline the terms, such as emails. See IRM 4.61.3.4.4, Issue Management and Development.

  3. The issue team should respect contractual terms between controlled parties if they are consistent with the economic substance of the underlying transactions. "Economic substance" for this purpose essentially means the reality of the arrangement and situation. It is distinct from the "economic substance doctrine." The economic substance of the transaction will be an important consideration in any evaluation of comparability. In evaluating the economic substance of a contract, the issue team should give the greatest weight to the following (see Treas. Reg. 1.482-1(d)(3)(ii)(B)):

    1. The actual conduct of the contracting parties.

    2. The respective legal rights of the contracting parties (which may relate to future benefits and obligations, not just current conduct).

      Note:

      If the taxpayer’s written contractual terms are inconsistent with the economic substance of the underlying transaction, the Service may disregard them and impute contractual terms that are consistent with economic substance. In this event, consult Counsel.

  4. Treas. Reg. 1.482-1(d)(3)(ii)(A) provides examples of contractual terms that should be considered in evaluating comparability between controlled and uncontrolled transactions. They include, but are not limited to:

    1. The form of consideration charged or paid

    2. Sales or purchase volume

    3. The scope and terms of any intangibles licensed

    4. The scope and terms of warranties provided

    5. Rights to updates, revisions or modifications

    6. The duration of the agreement, including termination or renegotiation rights

    7. Collateral transactions or relations, including services

    8. Extension of credit and payment terms

Economic Conditions
  1. Another factor for determining whether controlled and uncontrolled transactions are comparable is consideration of economic conditions. Economic conditions may affect the prices charged and the profit earned.

  2. Treas. Reg. 1.482-1(d)(3)(iv) provides examples of economic conditions that should be considered in evaluating comparability between controlled and uncontrolled transactions. They include, but are not limited to:

    1. Similarity of geographic markets

    2. Relative size of each geographic market and its level of economic development, including market position (e.g., monopoly, limited competition, etc.)

    3. Maturity of the geographic market (e.g., start-up, saturated)

    4. Applicable market shares for the relevant products, properties or services in the marketplace

    5. The location specific costs of production and distribution

    6. Extent of competition in each market

    7. Economic conditions of the particular industry within the market

    8. Alternatives realistically available within the marketplace

Property or Services
  1. Another factor for determining whether controlled and uncontrolled transactions are comparable is consideration of property or services utilized, transferred or provided. See Treas. Reg. 1.482-1(d)(3)(v).

  2. If there are any embedded property or services, they must be accounted for in evaluating the comparability of the controlled transaction and uncontrolled transaction. There may be circumstances where the embedded property or service must be separately evaluated. On the other hand, there may be other situations where the property or services may need to be aggregated for the most reliable evaluation. Treas. Reg. 1.482-3(f) provides coordination rules for tangible goods transactions with embedded intangible property. Treas. Reg. 1.482-9(m) provides coordination rules for services transactions, including intangible property transactions.

  3. The taxpayer’s transfer pricing documentation may provide an aggregate price for intercompany transactions, rather than individually pricing each separate component of the intercompany transaction. Alternatively, the taxpayer’s transfer pricing documentation may provide for separate pricing. Economists and LB&I Field Counsel can assist in determining whether separate or aggregate pricing is most reliable based on the economics and law applied to a specific transaction.

  4. The issue team should consider the documents obtained in IRM 4.61.3.3.8, Initial Transfer Pricing Risk Assessment, and consider obtaining the following information to analyze property or services:

    1. Tours of the facilities

    2. Sales catalogs, brochures, pamphlets, and other literature

    3. Technical literature describing the property or services

    4. Descriptions of competitors’ similar products or services

  5. In addition to technical and managerial personnel, the issue team should consider interviewing sales and marketing personnel employed by the taxpayer. Sales and marketing personnel can often describe the taxpayer’s products and services in detail and emphasize certain distinctions from potential comparables.

Selecting the Best Method

  1. The regulations specify methods to be used to determine the arm’s length amount charged in controlled transactions and Treas. Reg. 1.482-1(c) provides general rules for determining the best method to evaluate the pricing of the taxpayer’s controlled transaction. In general, the arm’s length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm’s length result. The two primary factors to consider are the degree of comparability and the quality of the data and assumptions.

  2. Taxpayers may use an unspecified method as the best method. An unspecified method is any pricing method that is not specified in the regulations for the particular type of transaction. For purposes of IRC 6662(e) penalty protection, if a taxpayer selects an unspecified method as the best method, it has the burden to affirmatively establish that none of the specified methods in the regulations were likely to achieve an arm’s length result and that it selected and applied its unspecified method in a way most reliable to achieve an arm’s length result.

  3. The issue team should start with the taxpayer’s best method selection and thoroughly analyze the taxpayer’s application of its selected method. The examples in Treas. Reg. 1.482-8 are instructive in considering how to evaluate the reasonableness of the taxpayer’s best method analysis. The issue team should also fully review the taxpayer’s analysis of each method that was rejected. If the issue team concludes that changes to the application of the taxpayer’s best method are appropriate to achieve an arm’s length result, these changes should be thoroughly developed and documented as early as possible in the examination. Where, based upon the facts and circumstances, changes to the application of the taxpayer’s method cannot reliably achieve an arm’s length result, use of an alternative method may be warranted as the best method, subject to the Transfer Pricing Review Panel (TPRP) process. See IRM 4.61.3.4.12.1, Transfer Pricing Review Panel (TPRP), below.

Transfer Pricing Review Panel (TPRP)
  1. For examinations opened in IMS from October 1, 2017 forward, when the taxpayer has timely provided transfer pricing documentation that both clearly states and analyzes the best method selection, but the issue team determines, based on the specific facts and circumstances, that an alternative method is the best method to achieve a more reliable measure of the arm’s length result, the issue team must obtain TPRP approval for use of the alternative method.

  2. When the taxpayer does not definitively identify the selection of a best method or provide sufficient supporting analysis in its transfer pricing documentation, the issue team’s use of an alternative best method is not subject to the TPRP approval process. Likewise, when the issue team changes the application of the taxpayer’s best method, but not the selection of the best method, TPRP approval is not required.

  3. The TPRP approval process applies not only to examinations with TPP or CBA involvement, but also to those conducted by Geographic Practice Areas without TPP involvement (including campaigns). An issue team’s recommendation for a method change should be elevated through the issue manager’s management chain to the applicable Director of Field Operations for referral to the TPRP.

  4. TPRP approval is an additional level of managerial review and is considered an intermediate step in the examination to help ensure transfer pricing cases are fully developed.

  5. The TPRP will generally consist of the TPP Director or APMA Director (depending on whether the case is an examination case or an APA program case), a Senior Advisor to the TTPO Director and the ISPN Manager or other PN manager, but substitutions can be made by the TTPO Director from time to time depending on personnel changes, case complexity or individual availability. See IRM 4.60.8.3.3, Advance Pricing Agreement (APA) Cases.

  6. Key factors the TPRP will focus on, based upon the facts and circumstances of the case, include:

    1. Reasons the issue team concludes that the taxpayer’s method is unreliable in achieving an arm’s length result.

    2. Whether the taxpayer’s method can be adjusted to make it more reliable.

    3. If not, what method is the best method to more reliably achieve an arm’s length result and why.

Computing the Adjustment

  1. In some cases, application of the best method will produce a single result that is the most reliable measure of an arm’s length result. Arm’s length results are rarely a precise answer. In many cases, applying the best method may produce a range of potential arm’s length results (arm’s length range or interquartile range). An IRC 482 adjustment is not appropriate if the taxpayer’s results fall within an arm’s length range or interquartile range. See IRM 4.46.5.7, Completing the Examination, for concluding an examination without an IRC 482 adjustment. If the taxpayer’s results fall outside an arm’s length range, an IRC 482 adjustment may be appropriate.

  2. The issue team will clearly document and explain IRC 482 adjustment computations, specifically detailing the uncontrolled comparables used and any reasons for adjustments to the comparable data (or lack thereof). The computation should be documented in:

    1. The case file workpapers.

    2. A detailed explanation of the IRC 482 adjustment will be within the economist report in the "IRS Economist’s Determination of Arm’s Length Price based Upon Economic Analysis" section. See IRM 4.61.3.4.15, Economist Report.

    3. The NOPA will discuss the adjustment. The level of detail repeated within the NOPA from the economist report will vary depending on the needs of the case, including the importance of particular economic issues to the ultimate result. See IRM 4.61.3.4.16, Notice of Proposed Adjustment (NOPA).

  3. The issue team will consider appropriate collateral adjustments with respect to allocations which may include correlative allocations, conforming adjustments and setoffs. See Treas. Reg. 1.482-1(g).

  4. Where an adjustment is made to the primary-adjustment taxpayer under IRC 482, the concurrent examination of the income tax return(s) of the correlative-adjustment taxpayers should ordinarily be made. See IRM 4.11.5.5, Examination Reports, for further guidance on correlative adjustments.

  5. When an allocation is made under IRC 482, a conforming adjustment must be made to conform a taxpayer’s account to reflect the allocated amount. Generally, the conforming adjustment treats the allocated amount, depending on the allocation, as either a dividend or a capital contribution. In appropriate cases, the allocated amount may, instead, be repaid in accordance with the applicable revenue procedures without the otherwise required conforming adjustment (or the tax consequences of the conforming adjustment). See IRM 4.61.3.5.4, Application of Rev. Proc. 99-32, for more information.

Written Acknowledgment of the Facts (AOF)

  1. The issue team must use an AOF IDR to solicit a written acknowledgment of the facts for all LB&I examinations on potentially unagreed issues before issuing a NOPA. See IRM 4.46.4.10, Written Acknowledgement of the Facts (AOF), for additional information.

  2. The facts in the AOF must be consistent with the facts in both the draft economist report and draft NOPA. See IRM 4.46.4.10.3, Issue the Draft Form 886-A with a Pro-Forma AOF IDR.

  3. Consult Counsel for options to address missing and/or withheld material facts.

Economist Report

  1. The issue team economist has ultimate responsibility for drafting the economist report whether an IRC 482 adjustment is pursued or not. The issue team should work collaboratively to draft the factual background section and to ensure that information necessary to support the Service’s position is clearly reflected in the economist report. The economist report should be objective, principled and should stand on its own. The economist report should include the following:

    1. Executive Summary

    2. Factual Background and Functional Analysis of the Taxpayer and the Transactions at Issue

    3. Summary of Taxpayer’s Proposed Economic Analysis for the Transaction at Issue

    4. Critique of Taxpayer’s Methodology and Analysis for the Transaction at Issue

    5. IRS Economist’s Determination of Arm’s Length Price based Upon Economic Analysis

    6. Summary and Conclusion

    Reminder:

    The economist report should be written in a manner that is easy for non-economists to follow. It should be consistent with the functional analysis and facts developed by the issue team and contained either in the NOPA or in the examination workpapers in the event that an examination has been concluded without an IRC 482 adjustment. To avoid redundancies, the economist report should only contain facts and law relevant to the economic analysis.

Notice of Proposed Adjustment (NOPA)

  1. For LB&I cases, all adjustments are proposed on Form 5701, Notice of Proposed Adjustment, which is accompanied by Form 886-A, Explanation of Items. The Form 5701 provides a summary of the proposed adjustment and the Form 886-A provides a detailed explanation of the adjustment.

  2. The issue team and issue manager should adhere to IRM 4.46.4.12, Notice of Proposed Adjustment (NOPA).

  3. The NOPA (and Explanation of Items) should include:

    1. Adjustment Table

    2. Issue Statement

    3. Executive Summary of Issue

    4. Facts

    5. Law

    6. Taxpayer’s Position

    7. Analysis – Government’s Position

    8. Conclusion

  4. For guidance on including the taxpayer’s response to the AOF in the NOPA, see IRM 4.46.4.10.4, Incorporate the Taxpayer’s Response in the Final Form 886-A Issued with the NOPA.

  5. Coordinate with Counsel regarding the legal analysis presented in the NOPA and economist report.

    Reminder:

    The NOPA should be well-organized and easy to follow. All relevant facts, law and analysis to support the adjustment should be contained in the body of the NOPA, with associated footnotes to the sources of information.

Penalty Considerations

  1. Penalties should be considered when adjustments are made as part of the examination. Identifying, calculating and asserting the appropriate penalties are primarily the issue team’s responsibility. These determinations should take place throughout the examination process and be discussed with the taxpayer at the same time as the primary adjustment. Workpapers must support the analysis and conclusion.

  2. IRC 6662(e) documentation does not automatically protect against penalties. The IRC 6662(e) documentation must be assessed for adequacy and reasonableness.

  3. Factors to consider in evaluating the adequacy of a taxpayer’s transfer pricing documentation are outlined in the regulations. To meet the reasonable cause exception of the penalty regulations, taxpayers must document that they reasonably selected the best method for their analysis and they reasonably applied that best method.

  4. One of the factors relevant to the determination of whether a taxpayer selected and applied a specified method in a reasonable manner is "[t]he extent to which the taxpayer relied on a transfer pricing methodology developed and applied pursuant to an Advance Pricing Agreement for a prior taxable year, or specifically approved by the Internal Revenue Service pursuant to a transfer pricing audit of the transactions at issue for a prior taxable year..." See Treas. Reg. 1.6662-6(d)(2)(ii)(A)(6).

  5. The issue team should consult with Counsel, as appropriate. See IRM 4.46.4.11, Penalty Consideration.

  6. For more information on penalties, see IRM 20.1.1.2.3, Managerial Approval for Penalty Assessments, IRM 20.1.5.9, IRC 6662(e) Substantial Valuation Misstatement, and IRM Exhibit 20.1.5-3, IRC Section 6662(e) Transfer Pricing Penalty.

Overview of the Resolution Phase for IRC 482 Examinations

  1. See IRM 4.46.5, Resolving the Examination.

  2. The goal of the resolution phase is to reach agreement, if possible, on the tax treatment of each issue examined and if necessary, issue a NOPA. See IRM 4.61.3.4.16, Notice of Proposed Adjustment (NOPA).

  3. The issue manager, in collaboration with the case manager, will lead the issue team in the resolution phase of transfer pricing issues.

Issue Resolution

  1. The issue team should give the taxpayer an opportunity to agree or disagree with the findings for each transfer pricing issue developed during the examination. For a transfer pricing issue to be resolved there must be an open discussion by the issue team and the taxpayer in these three areas: factual development, the law that applies to the facts and each party's interpretation of the law. The issue team should follow IRM 4.46.5.2.1, Factual Development, IRM 4.46.5.2.2, Application of the Law, and IRM 4.46.5.2.3, Interpretation of the Law.

Management Involvement in the Issue Resolution Process

  1. See IRM 4.46.5.5, Management Involvement in the Issue Resolution Process.

Completing the Transfer Pricing Examination

  1. Upon completion of the transfer pricing examination, the issue team should comply with IRM 4.46.5.7, Completing the Examination, to secure concurrence from the issue manager and case manager and complete their portion of the overall case examination report.

  2. The issue team will finalize the NOPA, international examiner report, economist report, and secure final approvals. Refer to IRM 4.46.5.7.1, Types of Examination Reports Based on Agreement and IRM 4.60.9, International Examiner Report.

  3. Issue final Pattern Letter 1853(P) with the final amounts and countries of origin. This provides notification to the taxpayer of potential double taxation and treaty-based rights.

  4. Prepare the MAP report, if applicable. Coordinate and discuss with APMA.

  5. The issue team and issue manager should collaborate with the team coordinator and the case manager to ensure the transfer pricing NOPA is timely prepared for inclusion into the Revenue Agent’s Report (RAR).

Application of Rev. Proc. 99-32

  1. In some cases, the taxpayer may be eligible to elect Rev. Proc. 99-32 relief.

  2. Rev. Proc. 99-32 sets forth requirements and procedures for treating and repaying the allocated amount as an interest-bearing account receivable or account payable. The transfer pricing issue team will determine whether the taxpayer is eligible to elect Rev. Proc. 99-32 relief. See Rev. Proc. 99-32 and IRM 4.60.3, Tax Treaty Related Matters. Only a U.S. taxpayer which is a domestic corporation or a foreign corporation engaged in U.S. trade or business is eligible. In addition, the following must be met:

    1. Transactions are with related corporate entities only.

    2. Adjustments were made under IRC 482, as well as under IRC 61 or 162 if the adjustment could have been made under IRC 482.

  3. For Service-initiated adjustments, Rev. Proc. 99-32 stipulates the following additional conditions must be met:

    1. No penalty under IRC 6662(e)(1)(B) or (h) on account of the primary adjustment was asserted, and if challenged, finally sustained.

    2. No part of any underpayment of tax in the taxable year of the primary adjustment was due to fraud.

  4. The taxpayer must file a written request under Rev. Proc. 99-32 with the Service that is both:

    1. Filed before "closing action" is taken on the primary adjustment, and

    2. Signed by a person authorized to sign the taxpayer’s federal income tax return.

  5. For purposes of Rev. Proc. 99-32, "closing action" means:

    1. Execution of either a Form 870-AD or a closing agreement. See IRM 4.46.5.6, Closing Agreements, and IRM 4.46.5.9.1, Closing Agreements – Process.

    2. Stipulation to the IRC 482 allocation in the U.S. Tax Court.

    3. Expiration of the statute of limitations on assessment for the taxable year of the primary adjustment.

    4. Final determination of tax liability of the taxable year of the primary adjustment by offer-in-compromise, closing agreement or court action.

  6. Consult LB&I Field Counsel in drafting any closing agreement.

Appeals

  1. If the case is closed unagreed, the taxpayer generally has the right to have their case heard by the Appeals Division. See IRM 4.46.5.11, Conference with Appeals, for general information on the Appeals process for LB&I cases. If the transfer pricing issue is unagreed, upon contact from Appeals that the case has been assigned, the issue manager, in collaboration with the case manager, should work to:

    1. Request a pre-conference meeting.

    2. Prepare the pre-conference presentation with the assistance of Counsel.

    3. Secure Counsel’s participation in the pre-conference meeting, when warranted.

    4. Contact the Appeals Officer and request the issue team’s presence at the taxpayer’s portion of the presentation to Appeals.

    5. Be prepared to address any questions that Appeals may have for the issue team before the conference, during the conference and after the conference.

  2. The issue team should be aware that a case could be returned from Appeals under certain circumstances. See IRM 4.46.5.11.3, Other Communications with Appeals, and IRM 4.46.5.12, Appeals Case Return Procedures.

  3. In the event the case is settled in Appeals, the issue team will request a post-closing conference. See IRM 4.46.5.14, Post-Settlement Conference.

  4. Counsel may assist in evaluating the settlement and ACM.

  5. Determine if a dissent to Appeals’ disposition of the issue is warranted and prepare the dissent, if necessary. See IRM 4.46.5.15, Dissent Procedures for Disagreements with Appeals Determinations.

Coordination with U.S. Competent Authority

  1. The APMA Director is the delegated U.S. Competent Authority for cases arising under the business profits and associated enterprises articles of U.S. tax treaties (transfer pricing issues). APMA endeavors to resolve competent authority cases under the MAP agreement article of a U.S. tax treaty through consultations with the applicable foreign competent authority. See IRM 4.60.8.3.2, Competent Authority Cases.

  2. Taxpayers are not required to wait until the conclusion of an examination to file a competent authority request for assistance with respect to competent authority issues. The taxpayer may request assistance immediately after the amount of the proposed adjustment is communicated to the taxpayer in writing, for example with the NOPA or a Form 4549, Income Tax Examination Changes.

  3. The taxpayer should contact competent authority directly to request assistance. If a request for assistance is accepted, APMA will assume jurisdiction over the transfer pricing issue(s). The issue team and team coordinator, not APMA, will be responsible for protecting the statute of limitations for all tax years affected throughout the competent authority process.

  4. In most cases, APMA and the foreign competent authority will reach a tentative competent authority resolution. If the taxpayer accepts the terms, it becomes final and APMA will close the case. APMA will provide the issue team with the results to be incorporated in the RAR for the taxpayer, and to the extent authorized under the applicable U.S. tax treaty, the competent authority resolution will be implemented notwithstanding any time limits or other procedural limitations under the Code and regulations. See Rev. Proc. 2015-40, sec. 9.04.

  5. If the taxpayer rejects the terms of the tentative competent authority resolution and either APMA or the foreign competent authority is unwilling to consult further, then APMA will formally close the case and return jurisdiction to examination.

  6. Before a tentative competent authority resolution is reached, a taxpayer may request that the terms be extended to cover subsequent taxable periods for which it has filed tax returns. See Rev. Proc. 2015-40, sec. 4.01. In appropriate cases, APMA may request the taxpayer to expand the scope of its competent authority request to include such periods.

  7. An issue under APMA’s jurisdiction is not subject to the concurrent jurisdiction of Appeals. However, a taxpayer may request that Appeals assist APMA in developing its negotiating position on an underlying U.S. adjustment, in a procedure called the Simultaneous Appeals Procedure (SAP) review. If a taxpayer requests SAP review, APMA will decide whether to accept that request after consulting with Appeals. See Rev. Proc. 2015-40, sec. 6.04(1) and sec. 6.04(2).

Country-by-Country (CbC) Report

  1. Treas. Reg. 1.6038-4 sets forth CbC reporting requirements for certain U.S. taxpayers. CbC Reports will generally be filed with the tax authority in the residence jurisdiction of the multinational enterprise’s ultimate parent entity. This tax authority will exchange the CbC Report with the tax authorities in other jurisdictions where the enterprise has constituent entities if the two tax authorities have a competent authority arrangement in place permitting such exchanges, subject to several conditions.

  2. The information from the CbC Report can be used by the issue team to understand the location of revenues and profits in an enterprise and it can be used in conjunction with the transfer pricing documentation to identify potential transfer pricing risk.

  3. The CbC Report is a tool intended to provide useful information to assess high-level transfer pricing risks, Base Erosion and Profit Shifting (BEPS) related risks and, where appropriate, for economic and statistical analysis.

Appropriate Use Guidelines

  1. CbC Report data may be used by issue teams for planning an examination. CbC Report data may also be used as a basis for making further inquiries into a multinational enterprise’s transfer pricing arrangements or into other BEPS related risks in the course of an examination.

  2. The information must not be used as a substitute for a detailed transfer pricing analysis of transactions and prices based on a full functional analysis and a full comparability analysis.

  3. Information in a CbC Report on its own does not constitute conclusive evidence that transfer prices are or are not appropriate and, consequently, examiners must not base transfer pricing adjustments on the CbC Report alone.

  4. Any adjustments made based solely on CbC Report information must be conceded.

The CbC Report and the Examination Process

  1. In the context of the LEP and the TPEP, which cover examination planning, execution and resolution procedures and processes, the CbC Report can be a useful tool.

  2. When examining a return with a CbC Report, issue teams should conduct the risk analysis and planning activities consistent with the LEP, IRM 4.46.3.2, Initial Risk Analysis of the Return, and LB&I campaign guidance.

  3. The information in the CbC Report should not be the sole factor used to determine whether or not to proceed with an examination. As with any issue identified for potential examination, the decision to select an issue for examination is contingent upon the findings from the risk analysis, discussions with the taxpayer, materiality considerations, and other steps outlined in the planning phase as described in the LEP.

  4. The issue team may ask the taxpayer for additional information about relevant facts related to potential transfer pricing issues arising from the CbC Report. However, the taxpayer is not required to create and maintain records that reconcile the amounts on the CbC Report with tax returns or financial data.

Effective Use Guidelines

  1. The CbC Report by itself is not evidence a multinational enterprise is or is not engaged in non-arm’s length transfer pricing or other BEPS related risks.

  2. When reviewed in conjunction with the taxpayer’s IRC 6662(e) documentation and other available information, the CbC Report may provide indicators of where transfer pricing compliance risk may exist.

  3. LB&I employees are required to complete the CbC Report training in the Enterprise Learning Management System (ELMS) prior to analyzing CbC Reports. The ELMS training course provides guidance on the effective use of the CbC Report.

CbC Report Related Resources

  1. Technical resources related to the CbC Report include:

    1. Form 8975 and related instructions

    2. Treas. Reg. 1.6038-4, Information returns required of certain United States persons with respect to such person’s U.S. multinational enterprise group

    3. IRC 6103, Confidentiality and disclosure of returns and return information

    4. IRC 6105, Confidentiality of information arising under treaty obligations

    5. IRM 10.5.1, Privacy and Information Protection, Privacy Policy

    6. IRM 11.3.25, Disclosure to Foreign Countries Pursuant to Tax Treaties

    7. IRS Country-by-Country Reporting Guidance on IRS.gov

Acronyms

This table lists commonly used acronyms and their definitions.

Acronym Definition
ACM Appeals Case Memorandum
AOF Acknowledgment of Facts
APA Advance Pricing Agreement
APMA Advance Pricing and Mutual Agreement
BEPS Base Erosion and Profit Shifting
CAS Computer Audit Specialist
CBA Cross-Border Activities
CbC Country-by-Country
CFC Controlled Foreign Corporation
CIC Coordinated Industry Case
CPM Comparable Profits Method
CSA Cost Sharing Arrangement
CUP Comparable Uncontrolled Price
CUT Comparable Uncontrolled Transaction
EPN Economics Practice Network
GAAP Generally Accepted Accounting Principles
IC Industry Case
IDA Intangible Development Activity
IDR Information Document Request
IMS Issue Management System
ISPN Income Shifting Practice Network
LB&I Large Business and International
LEP LB&I Examination Process
MAP Mutual Agreement Procedures
NOPA Notice of Proposed Adjustment
PCT Platform Contribution Transaction
PSM Profit Split Method
RAB Reasonably Anticipated Benefits
R&D Research and Development
RA Revenue Agent
RAR Revenue Agent’s Report
SAP Simultaneous Appeals Procedures
SRA Senior Revenue Agent
TIG Taxpayer Information Gateway
TPEP Transfer Pricing Examination Process
TPP Transfer Pricing Practice
TPRP Transfer Pricing Review Panel
TTPO Treaty and Transfer Pricing Operations
UIL Uniform Issue List

Development of IRC 482 Cases — General Transfer Pricing Audit Tools, References and Resources

Issue teams should consult the following resources:

  1. Publication 5300, Transfer Pricing Examination Process.

  2. Income Shifting Inbound SharePoint site for inbound controlled transactions. Inbound controlled transactions are structures with a foreign parent.

  3. Income Shifting Outbound SharePoint site for outbound controlled transactions. Outbound controlled transactions are structures with a U.S. parent.

  4. International Knowledge Base SharePoint site, which is a library that provides concept, process and transaction-based Practice Units. These units explain the law, provide audit tools and techniques and contain additional resources. Practice Units are not official pronouncements of law and cannot be used, cited or relied upon as such.

  5. Servicewide Knowledge Management Database.

  6. IRC 482 Audit Toolkit.

  7. Auditors Workbench.

  8. Publication 5125, LB&I Examination Process (LEP).

  9. Computer Audit Specialist (CAS) Examination Resources webpage – Applications and Tools.