2014 IRSAC Large Business and International Report


Notice: Historical Content

This is an archival or historical document and may not reflect current law, policies or procedures.


The IRSAC LB&I Subgroup (hereinafter “Subgroup”) consists of five tax professionals with a variety of experience in large corporate tax departments, large public accounting firms, government, and academia.  We have been honored to serve on the Council and appreciate the opportunity to submit this report.

The Subgroup has had the opportunity to discuss several topics throughout the year with LB&I management.  This report is a summary of those discussions and the Subgroup’s recommendations with respect to each topic.  We would like to thank LB&I Commissioner Heather Maloy and the professionals on her staff for their time spent discussing these topics with the Subgroup and for their valuable input and feedback.

The Subgroup is reporting on the following three issues:

1.   Risk Assessing Large Taxpayers

At the request of LB&I management, this report builds upon the recommendations contained in last year’s report concerning efforts to better risk assess taxpayers. The subgroup reviewed a comprehensive report prepared by the Organization for Economic Co-operation and Development (OECD) and analyzed in particular the tax risk assessment programs in Australia, Canada, and New Zealand. The subgroup then developed a series of recommendations, including the revision of Schedule UTP “Uncertain Tax Positions” (as well as the expansion of the class of taxpayers required to complete it) and the expansion of LB&I’s Compliance Management Operations (CMO) program.

2.  Rules of Engagement and Escalation of Issues

LB&I asked for the Subgroup’s assistance in identifying ways to increase efficiency in the resolution of issues at the examination level. The exam team will often seek the assistance of expertise within the IRS, including functional experts, technical experts, and issue experts. It is important that there be an understanding as to who “owns” an exam issue when these varied parties all have input. In this report, the Subgroup focuses on opportunities for better educating taxpayers and IRS employees on resolution of issues when these various experts are involved in the analysis of an issue.

 3.  CAP Taxpayers with Pending APAs

Taxpayers participating in the real-time review program known as the Compliance Assurance Process seek to achieve financial certainty sooner than business taxpayers that undergo typical post-filing examinations. Although the same goal of early certainty may prompt taxpayers with significant international transactions to enter the Advance Pricing Agreement program to resolve transfer pricing matters, these agreements can take several years to negotiate. As a result, the taxpayer’s goal of achieving financial certainty sooner is thwarted. This report explores several options to facilitate financial certainty under the Compliance Assurance Process while the Advance Pricing Agreement process is still underway.



Executive Summary 

At the request of LB&I management, this report builds upon the recommendations contained in last year’s report concerning efforts to better risk assess taxpayers. The subgroup reviewed a comprehensive report prepared by the Organisation for Economic Co-operation and Development (OECD) and analyzed in particular the tax risk assessment programs in Australia, Canada, and New Zealand. The subgroup then developed a series of recommendations, including the revision of Schedule UTP “Uncertain Tax Positions” (as well as the expansion of the class of taxpayers required to complete it) and the expansion of LB&I’s Compliance Management Operations (CMO) program.


  1. 2013 Recommendations

For half a century, the returns of the largest business enterprises have been scrutinized as part of the so-called Coordinated Industry Case (CIC) Program. In 2012, to both conserve resources and improve IRS case development and resolution, the IRS set out to modernize its risk assessment capabilities. As described by the then acting Commissioner, the IRS wanted “to spend less time with compliant taxpayers” and “to reduce the time spent looking for issues and increase the time spent understanding and resolving them.”

As part of its efforts, in 2013 the IRS asked IRSAC’s Large Business & International subgroup “to recommend risk assessment techniques that may be employed as part of the audit selection process.” In its report last year, IRSAC reviewed risk assessment efforts of tax authorities in the United Kingdom and Australia and then turned to the challenges of implementing a risk assessment protocol in the United States, starting with the need to train IRS agents in risk assessment methodologies. It recommended that any proposed risk assessment methodology be developed using a select group of taxpayers in the Compliance Assurance Process (CAP) program.

Second the IRSAC recommended that the initial request for risk assessment information should be in the form of a “yes or no” list of indicators that is part of the filed tax return, suggesting that the checklist could be a section of Schedule UTP that would be required for all taxpayers. Based on the responses to the initial questions, the IRS could make further inquiries. The subgroup suggested 17 risk assessment factors — many of which speak to the oversight of companies’ tax function by their board of directors — including (a) the amount of guidance and oversight provided by the board of directors; (b) the board’s providing guidance to management on the level of tax risk to be taken by the company; (c) whether appropriate review and sign-off procedures are in place for material transactions; (d) whether the company has reported a material weakness or financial restatement relating to the tax function; and (e) whether the taxpayer has been involved with major tax planning initiatives during the year.

  1. 2014 Request

LB&I Commissioner Maloy has asked the LB&I Subgroup to review best practices of other countries such as Australia, New Zealand, and Canada and consider whether they hold promise for LB&I. In particular, the subgroup was asked to develop recommendations to enhance LB&I’s risk assessment protocols, such as refining the recommendations contained in last year’s IRSAC report.  


  1. 2013 OECD Report

In 2013, the Organisation for Economic Co-operation and Development (OECD) published Co-operative Compliance: A Framework, which is based on a survey of 21 members of the OECD’s Forum on Tax Administration (FTA) as well as consultations with the Business and Industry Advisory Committee. The framework provides a status report — five years after the issuance of FTA’s Study into the Role of Tax Intermediaries on efforts of revenue bodies to establish a so-called enhanced relationship with large business taxpayers based on trust and cooperation and details the practical experiences of countries that developed cooperative compliance programs.

Advancing the term “co-operative compliance” to replace “enhanced relationship,”[1] the OECD report confirms that collaborative and trust-based relationships have been widely established between large corporate taxpayers and revenue bodies, listing 24 countries that have such programs. It also concludes that concepts of cooperative compliance have been fully integrated into the coherent compliance risk management strategies that revenue bodies have adopted, which reflects an increasing focus on understanding and influencing taxpayer compliance behavior.

The 2013 OECD report also reflects the business community’s experiences of the cooperative compliance approach, highlighting the importance of transparency and disclosure on the part of both parties in a framework of cooperative compliance to reduce uncertainties over companies’ tax positions more effectively and efficiently. The importance of good corporate governance systems that support transparency and disclosure has emerged much more clearly over the past five years as an integral part of cooperative compliance. The report thus confirms that tax is increasingly (and appropriately) more important in the boardroom, devoting an entire chapter to the importance of a solid tax control framework. The report highlights the central importance of a tax control framework in bringing rigor to the cooperative compliance concept, demonstrating that the relationship between taxpayers and revenue bodies is based on objective criteria and justified trust. The report concludes with some thoughts about the future direction of the cooperative compliance concept. It suggests that the concept of the tax control framework could be developed further and that further work on measures of effectiveness may be needed.

  1. Canada

Under the Canada Revenue Agency’s (CRA) Approach to Large Business Compliance program which is to be phased in over five years beginning in 2010, large corporations are assigned one of three overall levels of risk (high, medium, and low) with a taxpayer’s rating depending on numerous factors. In general, the level of audit coverage is adjusted based on the rating, with quick reviews for low-risk taxpayers and full audits for high-risk ones.

Risk assessments are based on the taxpayer’s tax filing history, relationship with CRA, and industry considerations. The quality of the taxpayer’s tax governance is given priority in CRA’s approach to assessing risk. An integral part of the Canadian initiative is a meeting between Canada Revenue Agency representatives and senior representatives of the taxpayer, who may include chief financial officers (CFOs) and other executives with oversight responsibilities. In advance of the meeting, taxpayers are provided with interview questions that are relevant to the taxpayer’s risk rating. Although the process can vary from case to case, some or all of the questions may be directly addressed during the meeting. There will also be a discussion of CRA’s redefined risk-based approach to large business compliance and CRA’s findings and observations noted during the taxpayer’s risk assessment. CRA will also seek to understand how the taxpayer manages tax risk at its highest governance levels. And there will be a discussion of the risk of non-compliance associated with the company’s business activities, governance regime, internal controls, and inherent and behavioral risk factors affecting the risk segmentation. For example, the CFO may be asked detailed questions about the quality of the company’s tax oversight, controls, and involvement in aggressive tax planning or unusual or complex transactions. While taxpayers are informed that they should not view the meeting as an opportunity to “negotiate” its ranking, for medium and high risk taxpayers there will be a discussion of what can be done to reduce the rating in the future.

The taxpayer’s risk rating, however, is not the end of the story: Each audit program is individually tailored to the particular taxpayer — that is to say, not every high-risk taxpayer will be treated in the same manner. Thus, one might be subjected to an intense international tax audit, whereas another could be subject to an aggressive tax planning audit.

The objective of Canada’s new approach is to reduce the number of large corporations audited by changing CRA’s assumption that all are high risk to a more focused risk-based approach. CRA has released information indicating that after the initial risk reviews, 37 percent of large corporations were high risk, 38 percent are medium risk, and 25 percent are low risk. Anecdotal reports suggest the split may currently be one-third, one-third, and one-third. Although some taxpayers have seen their audit coverage reduced or eliminated, concerns have been raised that the process remains subjective, taxpayers are provided with only limited input into the process, and the “carrot” of a low or medium risk taxpayer being able to obtain real-time audit assistance has not materialize in many cases, presumably due to resource constraints. Cultural attitudes and distrust on both sides of the relationship remain issues.

Indeed, some tax directors, CRA representatives and outside advisers regard the interviews as little more than “window dressing” that may even be counterproductive. This reaction, justified or not, highlights a challenge tax authorities must address as they strive to transform targeted programs, such as CAP, where taxpayers “self-select” themselves into the program, into more broad-based, universal ones.

  1. Australia

The Australian Tax Office (ATO) has developed a comprehensive risk-differentiation framework (RDF) to assess large corporations’ tax compliance risk and determine the manner in which of it engages with those taxpayers. The RDF is based on the premise that tax risk assessment should take into account the tax authority’s perception of two things:

  • Estimated likelihood of the taxpayer’s having a tax position that ATO disagrees with, or the taxpayer’s having misreported — through error or omission — its tax obligations, as evidenced by its behavior, approach to business activities, governance, and compliance with the tax law; and
  • Consequences (in terms of dollars, relative influence, effect on community confidence) of the potential noncompliance.

The framework is generally applied on an economic group basis, with the economic group being placed into one of four broad risk categories — higher risk, medium risk, key taxpayer, and lower risk — for each relevant tax type. Each year, the large business is notified of its RDF categorization, which determines and “the formality and intensity” of ATO’s approach to the taxpayer. For example, higher risk taxpayers will be subject to continuous review. For key taxpayers, ATO will carefully review the company’s risk management and governance frameworks to evaluate how efficaciously they mitigate tax compliance risks. Significantly, ATO expects key taxpayers “to fully disclose potentially contestable matters to us as they arise,” and it encourages them to enter into annual compliance arrangements (which provide real-time, practical certainty and reduced compliance costs). For medium-risk taxpayers, in contrast, ATO will undertake only targeted activities to deal with tax compliance concerns. And lower-risk taxpayers will face the lightest “touch.”

That said, ATO applies a level of risk analysis to all large businesses, closely examining significant transactions and business results that show inconsistencies between tax and economic income. ATO also assesses the effectiveness and accuracy of a large taxpayer’s business systems, including its tax risk management and governance systems (i.e., its tax control framework), and has released a checklist of matters that may constitute, such as cross-border or tax-haven dealings, tax benefits from financial or other arrangements that are disproportionately high compared with its financial exposure, and lack of capacity or capability in tax governance processes and personnel.

In 2013, the Australian Tax Office (ATO) began exploring an external compliance assurance process (ECAP) for taxpayers in the large market. After several months of consultation and design — which focused on issues relating to auditor independence, materiality, and assurance — in June 2014, ATO announced a pilot ECAP pilot, whose goal is to test the efficacy of using taxpayers’ registered company auditors to conduct assurance on factual matters.

ECAP will only be offered to public groups that have an ATO risk rating of medium or lower (i.e., not high-risk or key taxpayers), and will be limited to factual matters.[2] The ECAP engagement will be initiated by ATO by a letter to the taxpayer identifying the matters to be assured. The taxpayer will then consider their choice and may engage the assurance practitioner.[3] The first phase of the ATO pilot will be limited to 32 taxpayers (16 ATO cases and 16 ECAP cases).  Depending on results, the second phase would involve a much broader pilot or integration into ATO’s ongoing compliance work.

  1. New Zealand

In 2013, New Zealand Inland Revenue (NZIR) launched its Significant Enterprises Initiative, which marked a change in how NZIR approached the risk assessment of multinational corporations. Specifically, most groups of companies with annual turnover in excess of $30 million are now required to provide copies of their financial statements, tax reconciliations, and group structures at the time they file their returns. Moreover, in its October 2013 publication entitled “Multinational Enterprises: Compliance Focus,” NZIR has set forth ten “familiar red flags” that may prompt questions from the tax authorities. None of these, however, formally focuses on tax governance or other common indicia of tax risk.

More generally, NZIR has embraced the increasingly global view that tax management must be a part of good corporate governance, and has released four key questions that taxpayers should consider in respect of their tax risk:

  • Are appropriate resources (including local capability) being applied to tax matters?
  • Are sufficient internal controls, checks and balances in place and actually carried out?
  • Is there good tax awareness in critical business areas beyond the central tax or finance team?
  • Are you aware of legislation changes affecting your business?

Equally important, as part of New Zealand’s involvement in the OECD’s Base-Erosion and Profit Shifting project, NZIR has identified a need for significantly more (and more timely data) about large corporations and their international operations. This has prompted NZIR to propose consideration of the following proposals:

  • Developing a voluntary code of practice for large corporations (potentially modelled on codes in the United Kingdom, South Africa, and Spain).
  • Requiring enhanced information disclosure (in electronic form) from large corporations.
  • Requiring large corporations to file their tax returns earlier.
  1. LB&I’s Compliance Management Operations Program

In February 2010, LB&I initiated a multiyear pilot, the Compliance Management Operations (CMO) program, to test whether a more comprehensive approach for identifying and selecting for audit the returns of taxpayers smaller than Coordinated Industry Case (CIC) taxpayers, i.e., those classified as Industry Cases (IC). Under the CMO approach, tax returns and specific issues are selected for audit centrally and then assigned to an examiner.

The benefits of CMO to LB&I include an increased ability to recognizing emerging areas of noncompliance by reviewing returns at a global scale that would not be evident at the individual-return level; greater capacity to respond in a timely manner to areas of compliance risk by identifying and building cases with specific issues; and delivery of higher risk cases to the field as determined by application of rules and filters and upfront risk assessments. Moreover, by centralizing the risk assessment process, improved efficiencies and specialization are allowed (compared with field level assessments), especially when coupled with collaboration with Issue Practice Groups (IPGs) and International Practice Networks (IPNs).

The CMO pilot has garnered very positive feedback and good results. There has been improvement in examination results per staff hour, reduction in months in process, reduction in total examination time, and reduction in pre-opening conference examination time. In addition, the enhanced feedback process between CMO and the field enables the field to improve its own issue selection process.


Risk assessment is critical to selecting taxpayers and the issues to be audited in a manner that conserves resources, reduces burden, and enhances certainty. The IRSAC commends LB&I for its previous efforts to enhance its approach to auditing large corporations — namely, moving away from a taxpayer-based approach (i.e., CIC versus IC) to an issue-based approach. Risk analysis can be done more efficiently, for example, by reviewing publicly available data regarding the taxpayer, using transparency tools such as (revised) Schedule UTP, Uncertain Tax Positions, and expanding its centralized approach to analyzing the compliance risk associated with large corporations.

Although even the most comprehensive, successful risk assessment program will never supplant the need for hands-on, thorough examinations, the subgroup is convinced that LB&I can benefit significantly from further refining its risk assessment efforts. Indeed, improved risk assessment techniques will not only allow LB&I to be smarter and more selective in identifying taxpayers and issues to be examined. Properly designed, these efforts can have a prophylactic effect, positively influencing taxpayer behavior. Thus, the IRSAC endorses one of the principles underlying many of the requirements of the Sarbanes-Oxley Act: The very act of asking questions has the potential for changing the landscape.

1.  The review of the OECD’s 2013 report and developments in Australia, Canada, and New Zealand confirms two things: First, there is no one-size-fits-all approach to risk assessing taxpayers. Practices vary from country to country. The differences can be explained by a multitude of factors, ranging from the size and sophistication of the business community, to the technological wherewithal of the tax authorities, to cultural norms, to resource constraints. Second, the growing global consensus is that governance — the presence and testing of a tax control framework — should be an integral part of tax authorities’ risk assessment protocols.

Apropos the first point, two observations about Australia’s efforts bear mention. First, the IRSAC endorses the decision of ATO to recognize formally the fundamental differences — especially in respect of the effectiveness of a company’s Tax Control Framework — between publicly held and other taxpayers. Although a change in nomenclature similar to that in Australia (from “Large Business” to “Public Groups”) may not be necessary, the tax authority’s effective leveraging of the enhanced scrutiny paid to publicly held companies by their independent authorities as well as other governmental bodies (such as the Securities and Exchange Commission) is critical. In addition, as intriguing as ATO’s External Compliance Assurance Process is (and as much as the IRSAC agrees that the United States could better rely on the work done by independent auditors), we do not recommend that LB&I currently devote resources to a similar process. Stated candidly, the potential merits of ECAP notwithstanding, we do not believe sufficient political or public support for such as initiative exists (or could be generated) to justify the effort. Indeed, even in Australia, the announcement of the ECAP pilot prompted “fox guarding the hen house” headlines.

Secondly, given the increasingly important role that governance plays in the board room, the IRSAC endorses LB&I’s taking more into account a large company’s commitment to good tax governance in its refining its risk assessment protocol. In line with the recommendations in last year’s IRSAC report, we recommend that the IRS revise Schedule UTP to collect additional information from large corporations on their tax governance practices and, indeed, that it consider expanding the class of taxpayers required to file the schedule.

Specifically, to the extent possible, the revisions to the schedule should focus on the existence and support for the company’s tax control framework, and should be framed as yes-or-no questions, such as the following:

  • Does the Chief Tax Officer make periodic presentations to the board of directors or one of its designated committees?
  • Has the board provided guidance to management and the tax department as to the level of tax risk that should be taken by the company?
  • Is there in place appropriate review and sign-off procedures for material transactions, thereby ensuring that significant tax risks are elevated to the board?
  • Has the company reported a material weakness or financial restatement related to tax matters in the last two years?
  • Is the company’s internal audit function involved in reviewing the tax function?
  • Has the taxpayer been a party to a recent merger or acquisition or other development that has or may cause a significant change in tax department personnel or availability of tax reporting data?

In addition, the IRSAC believes that questions that are subjective in nature (e.g., are the company’s internal control adequate?) or particularly freighted (e.g., is the company’s tax strategy consistent with its overall business strategy? does the company have a history of overaggressive tax planning?) should generally be avoided in revising Schedule UTP, especially in light of our recommendation (below) that risk assessment occur on a centralized (CMO-focused) basis. This recommendation is consistent with the OECD’s conclusion that the cooperative compliance concept depends on an objective assessment of the relationship between taxpayers and tax authorities. Moreover, a decision not to include such questions on the revised Schedule UTP does not mean that that risk assessment personnel should ignore information otherwise available (e.g., from public available documents or prior examinations) that touch on the same concepts or behaviors.

The existence of a strong tax control framework within a company, of course, does not mean that a taxpayer, perhaps especially a very large company, should necessarily be given a “pass” by LB&I. However, it does suggest that the amount of time given to testing, for example, the integrity of the taxpayer’s systems can prudently be limited. In this way, LB&I can effectively leverage the efforts of internal and external auditors, as well as in some cases the SEC and the Public Company Accounting Oversight Board, and devote its personnel and resources to examining tax issues of greater significance.

More fundamentally, the absence of a strong tax control framework should properly send a strong signal to LB&I that a taxpayer may merit a closer look. Indeed, one reason the IRSAC believes that Schedule UTP should be revised is that the form can provide the IRS with information about groups of taxpayers that, primarily because of limited resources, may previously have escaped scrutiny.

With respect to revised Schedule UTP, we reiterate the recommendation in our 2013 report that LB&I work with a large group of taxpayers currently participating in the CAP program. As explained in last year’s IRSAC report, “The taxpayers who participate in the CAP program have a demonstrated level of transparency and desire to improve the examination program, and importantly, a working relationship with the IRS.” We acknowledge that the information we have had access to — publicly released reports from other tax authorities and anecdotal reports from companies and practitioners in other countries — may not be as complete (or candid) as that the IRS may able to secure through its country-to-country exchanges. Accordingly, we recommend that LB&I work through the OECD and other intergovernmental bodies, as well as with their counterparts in other countries, whose experiences and insights may support design changes not yet announced or forecast publicly. To the extent confidentiality concerns allow, the information should be shared with the CAP taxpayers involved in the project.

2.   The IRSAC recommends that LB&I’s risk assessment protocol should be implemented on a centralized basis, as an expansion of its CMO program. The CMO pilot has demonstrated the promise of developing a cadre of specialists that would could build up their expertise (not only in tax matters but in financial analysis), develop rapport with subject matter experts in the IPGs and IPNs, and professionally analyze the data collected.

In terms of what information the CMO should avail itself of, there is an enormous amount of information available in the public domain or that can be derived from filed returns, including revised Schedule UTP and from asking pre-audit questions as well as from reviews of audit history (e.g., adjustments, litigation, and transactions). Among the issues are:

  • Relationship with IRS generally
  • Staff capability based on audit history
  • Amount of tax consulting and counsel fees
  • Uncertain Tax Positions
  • Tax haven investments or transactions
  • Significant related party international transactions
  • SEC filings if applicable
  • Audited financial statements
  • Acquisition merger and disposition activity
  • Industry posture and experience
  • Tax rate continuity analysis including competitor comparisons
  • Timing versus permanent taxable income adjustments
  • Incentive claims and audit history, competitor comparisons
  • Press reports and investment community analyses

3.   Although the IRSAC believes the IRS, as part of its risk assessment process, should collect additional information about a company’s tax control framework as well as other aspects of its tax posture, we have significant reservations about making interviews with the company’s tax director or other representatives (as is currently done in Canada) an integral part of the risk assessment process. First, we question whether the IRS has the resources required to conduct the in-person interviews and appropriately analyze the information for the broader range of LB&I workload. It is better, we submit, to collect the information centrally and to have it analyzed by trained screeners, as envisioned by our CMO-focused recommendation. Of course, as CMO expands, the training and, ultimately, perhaps the grade of its personnel may have to be enhanced.[4]

Focusing its risk assessment efforts on the CMO will permit LB&I to leverage its expertise. The insights and intuition of someone who reviews, say, ten or twenty times as many cases as another person will undeniably be more sophisticated and insightful. This approach will also avoid possibly impairing the IRS’s relationship with the taxpayer’s representatives who may become defensive or guarded during the interview; something that is especially important given the role that intermediaries, particularly, in-house advisers, play in ensuring compliance. In this latter regard, we suggest that risk assessing a limited number of CAP taxpayers is fundamentally different from risk assessing the entire LB&I population or only CIC taxpayers. Indeed, whereas CAP taxpayers accept enhanced transparency as a requirement of self-selecting their way into the volunteer program, a significant percentage of LB&I taxpayers are not in this program for legitimate reasons originating with LB&I or the taxpayer, including the respective parties “resource bandwidth.”


Executive Summary

LB&I asked for the Subgroup’s assistance in identifying ways to increase efficiency in the resolution of issues at the examination level. The exam team will often seek the assistance of expertise within the IRS, including functional experts, technical experts, and issue experts. It is important that there be an understanding as to who “owns” the IRS position on an examination issue when these varied parties all have input. In this report, the Subgroup focuses on opportunities for better educating taxpayers and IRS employees on resolution of issues when these various experts are involved in the analysis of an issue.


LB&I has a knowledge management network that includes Issue Practice Groups (“IPGs”) for domestic issues. IPGs are designed to provide examination teams the technical information and advice they need to manage their cases efficiently, consistently, and with a high degree of technical proficiency. IPGs are designed to foster effective collaboration and the sharing of knowledge and expertise across LB&I and Chief Counsel. LB&I views the IPGs as balancing the need for consistency while recognizing that there is no “one size fits all” approach to examining and resolving issues.

The IPGs reflect LB&I’s premise that consistent treatment and proper tax administration is best served in a collaborative environment. IPGs are a resource for examiners, managers, and executives to use during audits and in managing compliance priorities. Agents are encouraged to consult IPGs, especially when they encounter issues with which they are not familiar or when dealing with complex technical issues.

In addition, the IRS has developed significant expertise in such areas as international compliance, engineering, and economics, among others. The advice of these experts will often be sought during the course of an examination. Often, these experts will be integral members of the exam team, working on site.

The IRSAC supports the IRS’s leveraging of existing technical expertise across the agency in developing the IRS position on examination issues. The IRSAC believes the effectiveness of the IPG network and other experts can be enhanced by appropriate communication and interaction between the IRS and taxpayers. Providing pathways for communication between taxpayers and the IRS can avoid misunderstandings (especially about the underlying facts), enhance the knowledge and understanding of both the IRS and taxpayers, and thereby facilitate agreement (or, at a minimum, crystallize what is not agreed) on complex issues.

It behooves both the IRS and taxpayers to have the proper parties discussing the IRS’ position on the issues.


  1. As a part of the opening conference, there should be an open discussion of the use of experts, including those in the IPG program. As part of this discussion, taxpayers should be informed that, as appropriate, experts may be consulted by the exam team on specific issues.
  2. When the exam team contacts an expert to discuss the application of the law to the facts, the taxpayer should be informed that such contact has been made and what specific issue is being addressed.
  3. It should be made clear to both the IRS and the taxpayer that, notwithstanding the involvement of the expert, the team manager remains responsible for the management of the case and the issue. Thus, despite the involvement of the IPG and or other experts, the manager needs to be able to clearly state and support the IRS position.
  4. If the team manager is unable to support the IRS position to the taxpayer, then the taxpayer needs to follow the rules of engagement to escalate the issue to the appropriate level in order to receive a clear understanding of the IRS position. The taxpayer should first work with the team manager to accomplish the escalation.
  5. If the team manager cannot or will not facilitate the escalation of the issue, the taxpayer must know whom to contact to get the desired explanation or clarification.



Executive Summary

Taxpayers participating in the real-time review program known as the Compliance Assurance Process (CAP) seek to achieve financial certainty sooner than business taxpayers that undergo typical post-filing examinations. Although the same goal of early certainty may prompt taxpayers with significant international transactions to enter the Advance Pricing Agreement (APA) program to resolve transfer pricing matters, these agreements can take several years to negotiate. As a result, the taxpayer’s goal of achieving financial certainty sooner is thwarted. This report explores several options to facilitate financial certainty under the Compliance Assurance Process while the Advance Pricing Agreement process is still underway.   


The Compliance Assurance Process is a program for large corporate taxpayers in which they work collaboratively with an IRS team to identify and resolve potential tax issues before the tax return is filed each year. With major potential tax issues largely settled before Form 1120 is filed, taxpayers are generally subject to shorter and narrower post-filing examinations.

If, at the conclusion of the pre-filing stage of the CAP, all identified items and issues have been resolved, the IRS will provide the taxpayer with a Full Acceptance Letter, confirming that the IRS will accept the taxpayer’s return if it is filed consistent with those resolutions. In other words, if a post-filing review indicates that all material items and issues were disclosed and resolved, the IRS will issue a No Change Letter concluding the examination of the taxpayer’s books of account for purposes of IRC section 7605(b). In full acceptance situations, the post-filing review is generally completed within 90 days of the taxpayer’s filing its return.

If the taxpayer and the IRS cannot resolve all identified issues before the filing of the tax return, the IRS will issue a Partial Acceptance Letter. In this situation the post-filing review of the unresolved issues will resemble a typical examination. The examination will formally remain open while the taxpayer and the IRS work to resolve the remaining issues.

Taxpayers typically choose to participate in CAP because they can receive financial statement certainty relating to federal tax matters sooner than they would in a normal post-filing examination. The completion of an agreed examination is the most common way for a taxpayer subject to U.S. Generally Accepted Accounting Principles (U.S. GAAP) to attain certainty for “uncertain” tax positions for the examined year. 

U.S. GAAP (ASC 740) provides that, for financial reporting purposes, whether a company may recognize a benefit for any tax position is to be evaluated under a two-step approach. Step 1:  Recognition occurs when an entity concludes that a tax position, based solely on its technical merits, is more likely than not to be sustained upon examination. Step 2:  Measurement is only addressed if Step 1 has been satisfied (i.e., the position is more likely than not to be sustained). Under Step 2, the tax benefit is measured as the largest amount of benefit, determined on a cumulative probability basis, that is more likely than not to be realized upon ultimate settlement. When a tax position does not satisfy Step 1 and Step 2, a reserve for an uncertain tax position is established and remains on the entity’s books until a future event allows recognition of the benefit of the tax position.

Those tax positions failing to qualify for initial recognition are recognized in the first subsequent interim period that they (1) meet the more-likely-than-not standard, (2) are resolved through negotiation or litigation with the taxing authority, or (3) are precluded from being challenged because of the expiration of the statute of limitations.

Resolution with the taxing authority is referred to as “effectively settled,” and effectively settled through examination is deemed to have occurred when the following has occurred:

1. The taxing authority has completed all its required or expected examination procedures;

2. The entity does not intent to appeal or litigate any aspect of the tax position; and

3. It is considered “remote” that the taxing authority will reexamine the tax position assuming full knowledge of all relevant information related to the tax position (i.e., the chance of the event occurring is slight).

Applying these principles to a CAP taxpayer with a Full Acceptance Letter, effective settlement would occur upon the successful completion of the post-filing examination and receipt of the No Change Letter because, assuming the taxpayer fully disclosed all material positions, the likelihood of reopening the examination under current IRS policy would be remote.

Many CAP taxpayers are multinational enterprises whose uncertain tax positions will commonly include transfer pricing, i.e., the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise. For example, if a foreign subsidiary company sells goods to a U.S. parent company, the cost of those goods is the transfer price. Intercompany transactions, including transfer pricing, are eliminated for financial reporting purposes. Thus, any profit or loss from the intercompany transactions will not be recognized because the transactions are within a single financial reporting enterprise. In contrast, the foreign subsidiary and the U.S. parent are not consolidated for tax purposes and will typically file separate returns with their respective countries. Thus, the transfer price can affect the allocation of profit or loss between the countries and, consequently, the amount of tax reported and paid in each country. This allocation is often the subject of controversy with the taxing authorities. Thus, multinational taxpayers commonly have uncertain tax positions related to transfer pricing.

Taxpayers can reduce or eliminate controversy with transfer pricing though the Advance Pricing Agreement (APA) program. An APA allows the taxpayer and the tax authority to avoid future transfer pricing disputes by entering into a prospective agreement, generally covering at least five tax years, regarding the taxpayer’s transfer prices. APAs can be unilateral, involving a single country; bilateral, involving two countries; or multilateral, involving more than two countries. While not a requirement of the CAP program, CAP taxpayers are encouraged to seek APAs to cover recurring intercompany transactions because they will advance the goal of achieving early certainty. APAs, however, may take considerable time (between three and four years) to negotiate.

If a CAP taxpayer has a pending APA, the examination team will conduct the post-filing examination, but will hold the examination in suspense to allow for incorporation of any adjustments arising from the APA.  Thus, the examination will remain open and the IRS will not issue the No Change Letter. Thus, by the time an APA is completed, there may be five years open for examination. This means that the taxpayer will be unable to achieve the purpose for agreeing to enter CAP in the first place, that is, to obtain financial certainty sooner.


The LB&I Subgroup recommends the IRS make one of the following changes to the CAP program that will permit an examination involving an APA to be closed and a No Change Letter to be issued.  These alternatives all assume that a CAP taxpayer with a fully accepted return (or a partially accepted return with the APA as the only unresolved issue) that has satisfactorily completed the post-filing review.

1.  Modify the CAP Memorandum of Understanding to include a provision that the  

implementation of a final APA will not constitute a reopening of the examination under section 7605(b) and, further, that the IRS will not reexamine any other position in the closed year unless one of the reopening circumstances in Rev. Proc. 2005-32 is present.

2.   Modify the CAP Memorandum of Understanding to allow the taxpayer to elect to implement the APA by making a cumulative adjustment in the current CAP year. The adjustment will incorporate the net effect of the APA on past years to the present. If the time value of money is a concern, then Rev. Proc. 2002-18, Sec. 6.02(4), which concerns accounting method changes, provides a model to take into account the time value of money over a multi-year adjustment period.

[1] This IRSAC report adopts the standard American usage of not hyphenating the word “cooperative.”

[2] As part of ATO’s efforts, its Large Business & International Line became the Public Groups and International Line and is responsible for all public groups, all foreign-owned entities, and international strategies. (The Medium Business Line was renamed Private Groups and High Wealth Individuals, with realigned responsibility for private groups with turnover of more than $2 million as well as High Wealth Individuals; and all other groups are part of the Small Business and Individual Taxpayers Business Line.) The change was made to better reflect the external community where legal structure, reporting requirements, and governance arrangements shape and define how business operates.


[3]Additional information about ECAP — including detailed guidelines for auditors and information on the mandatory integrity-checking approach — https://www.ato.gov.au/Business/Large-business/In-detail/Compliance-and-governance/External-compliance-assurance-process/.


[4] An element of the risk-assessment programs in several countries whose practices are catalogued in the OECD Report are discussions with the taxpayer of how it can improve its risk rating. We suggest that LB&I would be better served by focusing its risk assessment efforts on “diagnosing” which taxpayers are high risk rather than concerning itself with, as part of the process, “treating” or “remediating” high-risk behavior. In our mind’s eye, the IRS’s enforcement efforts are the proper place to stress that latter goal.