During January 2018, the Commissioner of the IRS’s Large Business and International (“LB&I”) Division1 (“Commissioner”) issued five instruction memoranda for examiners that will affect the IRS’s approach to its transfer pricing examinations. These instructions provide examiners with guidance as they engage in the review of taxpayers’ transfer pricing positions and are designed to help the IRS manage its transfer pricing examination workload. Each of the memoranda are explored in detail below:
1. Issue Selection and Scope of Analysis - Best Method Selection2 (Revised)
On January 29, 2018, the Commissioner issued guidance where IRS examiners need to “Obtain Treaties and Transfer Pricing Operations Transfer Pricing Review Panel approval before changing the taxpayer’s selection of a Treas. Reg. §1.482 method as the best method as supported in contemporaneous transfer pricing documentation or APA submission.”3
In the past, the IRS has examined each intercompany transaction under any of the specified methods available to it and often did it to increase profitability of the U.S. entity under examination. The new guidance will require that examiners “[start] with the taxpayer’s selection of the best method, the examination team should thoroughly analyze the taxpayer’s application of their selected method”4
before determining whether a new method should be considered. In the event that an examiner believes that a different method is required, the examination team would have to develop and document their argument and gain approval before proceeding with the lengthy analysis.
2. Issue Examination Scope - Appropriate Application of IRC §6662(e) Penalties5
On January 12, 2018, the Commissioner issued guidance to examiners to apply transfer pricing penalties where appropriate. Section 6662(e) allows the IRS to penalize taxpayers that are assessed an adjustment of a magnitude that meets certain thresholds, and transfer pricing penalties can be quite onerous. The penalty regime was put in place to encourage taxpayers to maintain adequate and timely transfer pricing documentation. The Commissioner writes that the failure to apply penalties has led a situation where taxpayers have less incentive to provide contemporaneous transfer pricing documentation. Further, the Commissioner reiterates that contemporaneous transfer pricing documentation does not provide a taxpayer penalty protection, as it must also be considered adequate and reasonable.
As such, the Commissioner states that penalties should apply in circumstances where a taxpayer relied on the unreasonable selection or application of a specified method and the net adjustment meets the penalty thresholds.
3. Mandatory Information Document Request (IDR) in LB&I Examinations6 (Interim)
On January 12, 2018, the Commissioner issued a procedural change to the IDR process for LB&I examinations. According to the new instructions, the mandatory transfer pricing IDR is no longer required for all new LB&I cases. This memorandum replaces instructions introduced in 2003 that required a mandatory transfer pricing IDR be issued on “all examinations when the taxpayer filed Form 5471 or 5472, or when the taxpayer engaged in cross-border transactions.”7
The new procedures require the mandatory transfer pricing IDR be issued in the following cases:
- For examinations arising under approved LB&I [transfer pricing] campaigns, examination team members will follow the specific guidance for the Mandatory Transfer Pricing IDR provided for within the campaign. If no such guidance is provided, the procedures under item 2, below, will apply.8
- For examinations with initial indications of transfer pricing compliance risk (considering the volume and type of transactions), Transfer Pricing Practice (TPP) and/or Cross Border Activities (CBA) Practice Area employees will issue the Mandatory Transfer Pricing IDR if assigned to the case. If TPP or CBA resources are not assigned as a consultant or team member to the case, the Mandatory Transfer Pricing IDR will not be issued.9
This memorandum is currently set to expire on January 12, 2020.
4. Issue Selection - Cost-Sharing Arrangement Stock Based Compensation10
On January 12, 2018, the Commissioner issued instructions to stop opening issues related to stock-based compensation (“SBC”) included in cost-sharing arrangement (“CSA”) intangible development costs. In this memorandum, the Commissioner is abiding by the Tax Court’s ruling in Altera Corp. v. Commr, 145 T.C. 91 (2015). The IRS is appealing the Tax Court’s ruling to the Ninth Circuit court but will abide by it until the appeals process if exhausted.
5. Issue Selection - Reasonably Anticipated Benefits in Cost Sharing Arrangements11
On January 12, 2018, the Commissioner issued instructions to stop adjustments to CSAs based on changing a taxpayer’s reasonably anticipated benefits (“RAB”) shares to a single RAB share in the event that a taxpayer uses multiple RAB shares. Often, when a party to a CSA makes an acquisition with valuable intangible property (“IP”), it may make the IP available to the foreign participant through a platform contribution transaction (“PCT”). The Commissioner states that, in some cases, the expected share of expected benefits from the new IP may be substantially different than the RAB share of the existing IP and, as such, require the use of a different RAB share. The Commissioner does not have instructions as of the time of publishing and, instead, directed examiners to allow the use of multiple RAB shares in cases where the positions are based on documented valid facts until a Service-wide position is finalized.12
What This Means to You
The Commissioner issued these instructions under the weight of a burdensome transfer pricing caseload with increasingly limited resources. Taken together, the new instructions should reduce the number of new transfer pricing cases, increase the speed of a transfer pricing examination, and encourage taxpayers to proactively maintain adequate and reasonable transfer pricing documentation. We believe that these changes are vital for companies under a transfer pricing examination as the IRS will be more likely to resolve an examination in a timely manner, and we welcome any effort to that end.
EKS&H’s International Advisory Group helps companies navigate through complex tax issues in the areas of transfer pricing and international tax compliance. To learn more, please contact Kari Thiessen at firstname.lastname@example.org, or call us today at 303-740-9400.
LB&I includes companies with greater than $10 million in assets.
LB&I-04-0118-006, “Revised Instructions for LB&I on Transfer Pricing Issue Selection and Scope of Analysis - Best Method Selection”; https://www.irs.gov/businesses/corporations/instructions-for-lbi-on-transfer-pricing-selection-and-scope-of-analysis-best-method-selection
LB&I-04-0118-003, “Instructions for Examiners on Transfer Pricing Issue Examination Scope - Appropriate Application of IRC §6662(e) Penalties”; https://www.irs.gov/businesses/corporations/instructions-for-examiners-on-transfer-pricing-issue-examination-scope-appropriate-application-of-irc-ss6662e-penalties
LB&I-04-0118-001, “Interim Instructions on Issuance of Mandatory Transfer Pricing Information Document Request (IDR) in LB&I Examinations”; https://www.irs.gov/businesses/corporations/interim-instructions-on-issuance-of-mandatory-transfer-pricing-information-document-request-idr-in-lbi-examinations
LB&I-04-0118-005, “Instructions for Examiners on Transfer Pricing Issue Selection - Cost-Sharing Arrangement Stock Based Compensation”; https://www.irs.gov/businesses/corporations/instructions-for-examiners-on-transfer-pricing-selection-cost-sharing-arrangement-stock-based-compensation
LB&I-04-0118-004, “Instructions for Examiners on Transfer Pricing Issue Selection - Reasonably Anticipated Benefits in Cost Sharing Arrangements”; https://www.irs.gov/businesses/corporations/instructions-for-examiners-on-transfer-pricing-selection-reasonably-anticipated-benefits-in-cost-sharing-arrangements