Transfer Pricing: Audits, Appeals, and Penalties (Portfolio 891)

Tax Management Portfolio, Transfer Pricing: Audits, Appeals, and Penalties, analyzes transfer pricing recordkeeping requirements; audits, appeals and penalties; document requests and summonses; and Competent Authority consideration in transfer pricing cases.

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The Detailed Analysis consists of Chapters 1 and 2 of the Tax Management Transfer Pricing Portfolio Series.

Chapter 1, “Audits, Appeals, and Penalties,” discusses the effect on taxpayers of various IRS enforcement programs. The chapter also describes in detail the operation of field audits and review by the Appeals Office, and illustrates taxpayer strategies for dealing with the IRS in those contexts. It also discusses the penalties associated with §482 adjustments.
Chapter 2, “Document Requests and Summons Enforcement,” provides a detailed explanation of §982 document requests, designated summonses, §§6038A and 6038C summonses, and third-party summonses.

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Transfer Pricing: Audits, Appeals, and Penalties was authored by the following experts.
William G. Dodge, University of Georgia, Master of Accountancy (Tax) (1979); Walsh College, B.A. (1976); Director, Global Transfer Pricing Team; Co-Director, U.S. Transfer Pricing Team, Deloitte Tax LLP, Washington, D.C. Formerly Partner-in-Charge, U.S. Corporate Tax Group, Deloitte, London, England. Member, Tax Management Advisory Board (Transfer Pricing). Mr. Dodge is regular speaker at seminars and has worked in New York, London, and Tokyo where he served many of Deloitte's largest U.S. and non-U.S. clients.

George H. Soba, Esq., New York University School of Law, LL.M. (Taxation) (1982); University of Toledo College of Law, J.D. (cum laude) (1981); Franklin and Marshall College, B.A. (1978); Principal and Leader of Southeast Transfer Pricing Practice, Deloitte Tax LLP, formerly IRS Tax Counsel, Brooklyn District Counsel Office and Senior Attorney-Advisor in the Office of Associate Chief Counsel (International). Mr. Soba advises some of Deloitte Tax LLP's largest clients with respect to transfer pricing planning, documentation, audit defense, Advance Pricing Agreements, Competent Authority proceedings, and global tax rationalization. He frequently speaks at transfer pricing programs in both seminar and web-based programs.

Steven C. Wrappe, Esq., New York University School of Law, LL.M. (Taxation) (1988); University of Texas School of Law, J.D. (1985); University of Notre Dame, Bachelor of Business Administration (1980).

David B. Blair, Crowell & Moring LLP; Georgetown University (A.B. 1985); Cornell Law School (J.D. 1989, magna cum laude, Order of the Coif); member, District of Columbia Bar, Massachusetts Bar, Federal Bar Association; former Trial Attorney, Tax Division, U.S. Department of Justice.

Kevin L. Kenworthy, Miller & Chevalier Chartered; University of Oklahoma (B.A. 1982, with distinction); Southern Methodist University School of Law (J.D. 1985, Order of the Coif); member, District of Columbia Bar, Oklahoma Bar.

Megan McLaughlin Kirmil, Ernst & Young LLP; University of North Carolina at Chapel Hill (B.A. 1999, with highest distinction); University of Virginia School of Law (J.D. 2002); member District of Columbia Bar.

Kathryn Morrison Sneade, Miller & Chevalier Chartered; University of Virginia (B.A. 2001, with highest distinction, Phi Beta Kappa; J.D. 2004); member, District of Columbia Bar, Virginia Bar, American Bar Association's Section of Taxation.


Detailed Analysis

Chapter 12: TRANSFER PRICING, AUDITS, APPEALS, AND PENALTIES by William Dodge, George H. Soba, Esq., Deloitte Tax LLP, Washington, D.C., and Steven C. Wrappe, Esq., Ernst & Young LLP, Washington, D.C.
 12:I. Introduction

A. Continued IRS Emphasis on Transfer Pricing Examinations and Adjustments

B. Changed U.S. Enforcement Environment

C. Overview of the IRS Transfer Pricing Audit Process

D. Effect of the Transfer Pricing Penalty Documentation Requirements

1. Overview of the Penalty

2. Effect on IRS Approach to Examinations

3. Effect on Taxpayer Strategies

4. Other Documentation Concerns

12:II. Field Audit: Preparation

A. Authority to Conduct a Transfer Pricing Audit

B. Selection of Taxpayers for Transfer Pricing Audits

C. The Coordinated Industry Cases Program

D. Resources Available to IRS Team Managers

1. The Planning File

2. Economist Program

3. Engineering Program

4. International Enforcement Program

5. Industry Specialization Program

6. International Field Assistance Specialization Program (IFASP)

7. Field Service, International

8. Outside Consultants and Specialists

E. IRS Pre-Audit Strategy

1. Three-Step Planning Process

a. Formulating the Scope of the Examination and Holding Planning Meetings

b. Preliminary Review of Taxpayer's Books and Records for Areas of Non-Compliance

c. Development of Audit Procedures

d. Directive to Request Transfer Pricing Documentation

2. Taxpayer Involvement in the IRS Planning Process

3. The Examination Plan

a. Part One, Taxpayer Information Section (Examination Arrangements)

b. Part Two, The Service Management Information Section (Examination Programs)

c. Part Three, Examination Procedures Section (Examination Assignments)

4. Taxpayer Access to IRS Examination Plan

F. Taxpayer's Pre-Audit Strategy

1. Proactive Transfer Pricing Planning

2. Assessing Transfer Pricing Adjustment Exposure in Prior Taxable Years

a. Review Readily Available Information

b. Quantify Transfer Pricing Exposure

c. Privileges

3. Develop a Transfer Pricing Strategy

4. Assemble Taxpayer Examination Team

5. Documentation Review

a. Post-1993 Tax Years

b. Options for Post-1993 Tax Years when Documentation Does Not Exist or Is Incomplete

c. Pre-1994 Tax Years

6. Developing Preliminary Strategies for Resolution

a. Appropriate Documentation; Defensible Results

b. Poor Documentation; Defensible Results

c. Poor Documentation and Results

d. Contentious Issues

e. Impact on Future Years

f. Advance Pricing Agreements

G. Pre-Examination Conference

1. Timing

2. Taxpayer Strategies

H. Examination Plan

12:III. Field Audit: Information Gathering and Analysis

Introductory Material

A. Information Document Requests

1. Requests for Transfer Pricing Documentation

2. Other Information Document Requests

3. Requests for Interviews of Taxpayer's Employees

4. Taxpayer Strategies

5. Summonses

B. Requests for Documents from Third Parties

1. Unrelated Third Party Information

2. Information Obtained from Foreign Related Parties

C. Formal Document Requests

D. Document Retention and Production under Sections 6038A and 6038C

E. Designated Summonses

F. IRS Use of Competent Authority Procedures During Examination

1. Revenue Service Representatives

2. Treaty Based Information Sources

G. IRS Priority of Information Gathering Procedures

12:IV. Field Audit: Examination and Assessment

Introductory Material

A. Extending the Statute of Limitations

B. Examination Process

1. In General

2. The IRS Transfer Pricing Analysis

a. IRS Audit Guidelines and Regulations

b. Understanding the Taxpayer's Business

c. Function and Risk Analysis

d. Tangible Property Transactions

e. Intangible Property Transactions

3. Economist's Report

4. Technical Advice Memorandums (TAMs) and Field Service Advice

5. "Draft" Proposed Adjustments

C. Appeals Early Referral Procedures

D. Formal Notification of Proposed Adjustment

E. Accelerated Issue Resolution (AIR) Agreements

1. Availability of AIR Agreements

2. Procedure for Requesting AIR Agreements

3. Processing an AIR Request

4. Withdrawal from the AIR Process

5. Form and Content of Agreement

6. Effect of IRS Approval

7. Competent Authority Issues

F. Revenue Agent's Report and the 30-Day Letter

G. The 90-Day Letter

H. Taxpayer Strategies for Settlement with the Field

1. General

2. Increased Discretion and Authority of Field to Settle

12:V. Appeals

A. Strategic Considerations

1. To Appeals or To Court?

2. Presentation to Appeals Officer

B. Appeals Settlement Practices

1. Hazards of Litigation Standard

2. Types of Settlements

3. Limits on Settlement Authority

a. Issues and Cases Appeals May Decline to Settle

b. Potential Competent Authority Cases

C. Simultaneous Appeals/Competent Authority Consideration

1. In General

2. Availability of Simultaneous Appeals Procedure

3. Time for Requesting Simultaneous Appeals Procedure

a. Requests when Initially Filing for Competent Authority Assistance

b. Requests after the Case Has Been Accepted by Competent Authority for Assistance

c. Requests for Cases Pending in Court

4. Form of Simultaneous Appeals Request

5. Role of Appeals under SAP

6. Role of Competent Authority under SAP

7. Denial or Termination of SAP

8. Experience with SAP

D. Mediation of Nondocketed Cases

1. Availability of Mediation

2. Parties to the Mediation

3. Agreement to Mediate

4. Selecting the Mediator

5. The Mediation Process

6. Mediation and Arbitration of Docketed Cases

a. Mediation

b. Arbitration

E. Coordination of Dispute Resolution Procedures

F. Documentation of Settlement

1. Waivers of Restriction on Assessment and Collection

2. Closing Agreements

3. When to Discuss Form of Agreement

G. Fast Track Settlement Program

12:VI. Case Study

Introductory Material

A. Facts

1. Organizational Structure

2. Products

3. Market

4. Activities and Functions

a. Maker

b. Seller

5. Seller's Operations - Financial Data

6. Maker's Transfer Pricing Practices

B. Commencement of Audit: 1990 and 1991 Tax Years

1. The Preâ€"Examination Meeting: October 1993

2. The Examination Begins: December 1993

C. IRS Information Gathering, Analyses, and Proposed Adjustments: January 1994

1. Information Gathering

2. IRS Analysis Begins: August 1994

3. Seller Prepares 1994 Transfer Pricing Documentation: March - June 1995

D. Seller's Response to IRS: July 1995

E. IRS Consideration of Seller's Response: October 1995

F. Seller Receives the 30-Day Letter: December 1995

G. Seller Files Protest with IRS Appeals: January 1996

H. First Meeting with Appeals: May, 1996

I. Seller Considers its Options: Late May 1996

J. Second Meeting With Appeals: June 1996

K. Simultaneous Appeals/Competent Authority Process: July 1996

L. APA Pre-filing Meeting: August 1996

M. APA Negotiations: January 1997

N. Competent Authority Negotiations: February 1998

O. Conclusion

12:VII. Related Issues

A. Collateral Adjustments

1. Correlative Allocations

2. Conforming Adjustments

B. Blocked Income

12:VIII. Penalties Relevant to Section 482 Adjustments

A. Accuracy-Related Penalties; Overview

B. Transfer Pricing Penalties in Detail

1. Overview of Valuation Misstatement Penalties

2. Substantial Valuation Misstatement

a. In General

b. 1993 Proposed Regulations

3. Gross Valuation Misstatements

4. Reasonable Cause and Good Faith Exceptions

a. OBRA - 93 Changes to Reasonable Cause and Good Faith Defense

b. Differing Standards Applied to Transactional and Net Adjustment Penalties

c. 1994 Temporary Regulations on Reasonable Cause and Good Faith Defense (post-1993 Years)

(1) Production of Contemporaneous Documents

(2) Choice of Specified vs. Unspecified Method

(3) Selection and Use of Third Party Data

(4) Reliance on Professionals

(5) Reliance on Prior IRS Approved Methods

d. Reasonable Cause and Good Faith Defense Before OBRA -93

e. Commentary

5. Coordination Between Transactional and Net Adjustment Penalties

C. Substantial Understatements of Income Tax

1. Substantial Authority

2. Disclosure for Purposes of Section 6662(d)

D. Negligence or Disregard of Rules and Regulations

E. Fraud Penalty

F. Strategies

Chapter 13: TRANSFER PRICING DOCUMENT REQUESTS AND SUMMONS ENFORCEMENT by Joseph R. Goeke, Esq., Gregory L. Barton, Esq., and Richard T. Morrison, Esq., Mayer, Brown & Platt, Chicago, Illinois

13:I. Introduction

A. IRS Authority and Normal Practice

B. IRS Information-Gathering Tools and Sources

C. Mechanics of Issuance of a Summons

D. Defenses to Summons Enforcement

E. The Issuance and Enforcement of Summonses

13:II. Section 982: Requests for Documents Maintained in Foreign Countries

13:III. The Designated Summons Under § 6503(j)

A. The Nature and Purpose of the Designated Summons

B. Section 6503(j): The Designated Summons and Its Effect upon the Statute of Limitations

1. The Statutory Definition of the Designated Summons

2. The Effect of § 6503(j) upon the Statute of Limitations

C. Current Developments and Debate

1. The Intended Scope of the Designated Summons Power

2. The Service's Use of the Designated Summons

3. The Response to Perceived Abuses of the Designated Summons Power

4. Protections Available to the Taxpayer

13:IV. Section 6038A Summonses

A. Information and Records Required Under § 6038A

B. Monetary and Criminal Penalties

C. The Avoidance of Monetary Penalties

D. Authorization of an Agent

E. Section 6038A Summons

F. Noncompliance Penalties

G. The Service's Use of the § 6038A Summons

13:V. Confidentiality and Protective Orders in an Audit Context

13:VI. Third-Party Summonses

Introductory Material

A. Service

B. Form

C. Duty of a Recipient

D. Issuing Summonses to Foreign Companies

E. Taxpayer Notice of Third-Party Summons

F. Taxpayer Notice of IRS Contact with Third Parties: § 7602(c)

G. Contesting of Third-Party Summonses by the Taxpayer

1. In General

2. Taxpayer Intervention in Third Party Summons Enforcement Actions; Petitions to Quash

3. Suspension of the Statute of Limitations

4. Restriction on Examination of Records

H. Third Party's Right to Receive Fees and Costs

I. Strategies for Handling Third-Party Summonses

J. Protecting Privileged Attorney Work-Product in the Hands of Third Parties

1. The Scope of the Work-Product Doctrine

2. Regulations Under § 6662(e)

Chapter 14: COMPETENT AUTHORITY CONSIDERATION IN TRANSFER PRICING CASES by Brian S. Gleicher, Esq., White & Case, Washington, D.C.

14:I. Introduction

14:II. Treaty Basis for Competent Authority Relief

A. General

B. U.S. Mutual Agreement Procedure Articles

C. OECD Mutual Agreement Procedure Article and Commentary

14:III. U.S. Implementation of the Competent Authority Procedure

A. Identity of the Competent Authority

B. Structure of the U.S. Competent Authority Office

C. Other Roles of the Competent Authority Process

D. Advance Pricing Agreements and the Role of Competent Authority

14:IV. Procedures for Requesting Competent Authority Assistance

Introductory Material

A. Filing of a Request by the Taxpayer

B. Time for Filing and Other Basic Requirements

C. Information Required in Request

D. User Fees

E. Pre-Filing and Other Conferences

F. Acceptance of Requests for Assistance

G. Small Case Procedure

14:V. Limitations on Applicability and Availability of Competent Authority Relief

Introductory Material

A. Applicability of Tax Treaty

B. Failure of Tax Treaty to Address Certain Cases of Double Taxation

C. Differences in Perspectives of Treaty Countries

D. Jurisdictional Limits to National Taxes

E. Eligibility for Requesting Assistance

F. Expiration of Statute of Limitations

G. U.S. Discretion to Accept a Request for Assistance

H. Other Grounds for Denial

I. Failure of Competent Authorities to Agree

J. Effect of Agreements or Settlements on Competent Authority Proceedings

14:VI. Considerations in Requesting Competent Authority Assistance

Introductory Material

A. Necessity

1. Availability of Foreign Tax Credit

2. Relief from Foreign-Initiated Transfer Pricing Adjustments

3. Tax-Free Repatriation

B. Issues to Consider in Requesting Competent Authority Assistance

1. Possibility of Further Audits or New Issues Being Raised in Subject Years

2. Possibility of Audit in Future Years

3. Confidentiality of the Competent Authority Process

4. Waiver of Attorney-Client Privilege

C. Probability of Success

1. Obtaining Full or Partial Relief

2. Relief Statistics

3. The Negotiating Environment

14:VII. Negotiation of the Agreement Between the Competent Authorities

A. Role of the Taxpayer

1. No Direct Taxpayer Participation

2. Active Indirect Taxpayer Participation

3. Inherent Tensions in the Process

B. Role of the U.S. Competent Authority

C. Development of U.S. Negotiating Position

1. Position Papers and Subsequent Negotiation

2. Consistency with Other Cases and with Competent Authority and APA Precedents

3. Role of OECD Guidelines

D. Schedule and Length of Process

E. Arbitration Alternative

14:VIII. Competent Authority Process in U.S.-Initiated Transfer Pricing Cases

Introductory Material

A. Importance of Consulting the Foreign Competent Authority

B. Paths to Competent Authority

1. Competent Authority Follows Appeals Consideration

2. Bypassing Appeals

3. Simultaneous Appeals Procedure

4. Coordination with Litigation

5. Rollback of APA

6. Granting of Unilateral Relief by the United States

C. Importance of Creating a Record

D. Shaping the IRS Negotiating Position

E. Providing Additional Information

F. Multi-Cycle Competent Authority Consideration

14:IX. Competent Authority Process in Foreign-Initiated Transfer Pricing Cases

Introductory Material

A. Importance of Consulting the U.S. Competent Authority

B. Paths to Competent Authority and Other Considerations

C. Filing a Protective Claim for Refund

14:X. Finalization of Competent Authority Agreement

A. Notification of Agreement Between Competent Authorities

B. Decision of the Taxpayer Whether to Accept the Agreement

C. Form 870 or Form 870-AD and Closing Agreements

D. Enforceability in Foreign Country

14:XI. Direct Costs and Benefits of a Competent Authority Agreement

A. Income Taxes

B. Interest on Tax Deficiencies and Refunds

C. Penalties

D. Foreign Exchange Gain and Loss

14:XII. Indirect Costs and Benefits of a Competent Authority Agreement

A. Conforming Adjustments

B. Rev. Proc. 99-32 Relief

C. Deduction of Interest on Tax Liability

D. Taxation of Foreign Exchange Gain or Loss


Working Papers

Finding Aid

Worksheet 1 Sections 6038, 6038A, and 6038C: Historical Perspective.

Worksheet 2 [Reserved]

Worksheet 3 Form 5472

Worksheet 4 Sample Authorization of Agent and Acceptance of Appointment to Act as Agent.

Worksheet 5 Enactment of § 6038A - § 339 of the Tax Equity and Fiscal Responsibility Act of 1982

Worksheet 11 International Audit Guidelines Handbook, Exhibits 4.61.3-1, -2 and -3 (On-Site Visitations, General Audit Procedures and Techniques, and Preservation of Findings)

Worksheet 12 Illustrative Form: Letter to IRS re Request for Examination Plan

Worksheet 13 Illustrative Form: Pre-Audit Agenda

Worksheet 14 Flow Chart Diagram: The Transfer Pricing Process

Worksheet 15 IRM International Audit Guidelines Handbook, 4.61.4, Information Gathering

Worksheet 16 Illustrative Forms: Information Document Requests Used in Transfer Pricing Examinations

Worksheet 17 Illustrative Form: Letter to IRS re Request for Competent Authority Assistance

Worksheet 18 Illustrative Form: Letter to IRS re Request for Competent Authority Assistance and Simultaneous Appeals Procedure

Worksheet 19 IRM International Audit Guidelines Handbook, Chapter 2, Information Reporting and Recordkeeping

Worksheet 21 [Reserved.]

Worksheet 31 Rev. Proc. 96-13, 1996-1 C.B. 616 (Procedure for Request for Assistance of U.S. Competent Authority before August 5, 2002)

Worksheet 32 Rev. Proc. 2002-52, 2002-31 I.R.B. ____ (procedure for request for assistance of U.S. competent authority on or after August 5, 2002)

Worksheet 33 Example of Net Effect of Competent Authority Settlements.

Worksheet 34 Hypothetical U.S.-German Competent Authority Settlement




Treasury Rulings