In an attempt to improve the quality of transfer pricing documentation, the IRS has released transfer pricing FAQs encouraging taxpayers to “step up their game”
Taxpayers that engage in intercompany transactions with foreign affiliates are all too familiar with the process of selecting and applying methods for determining arm’s-length pricing, and drafting contemporaneous documentation supporting their positions. The process has become even more challenging as taxpayers attempt to comply with OECD country-by-country (CBC) reporting. While having contemporaneous documentation does not automatically protect against penalties on transfer pricing adjustments, documentation reflecting adequate and reasonable analyses historically has prevented penalties from being imposed or sustained.
Apparently frustrated at the quality of taxpayers’ transfer pricing documentation, and responding to criticism regarding its administration of the applicable penalties, the IRS has released “Transfer Pricing Documentation Frequently Asked Questions (FAQs),” available at the link below. The FAQs provide guidance on questions including the benefit of robust transfer pricing documentation, the guiding principles of an arm’s-length analysis, and areas in which the IRS believes taxpayers could do a better job of documenting their methods and analyses. The FAQs lean toward a “carrot” approach as opposed to a “stick” approach, suggesting that if taxpayers improve the quality of their transfer pricing documentation the IRS will be able to dismiss transfer pricing issues earlier in an examination cycle, saving both the IRS and the taxpayer time and resources.
The FAQs could be a response to the commoditization of transfer pricing documentation, which often uses boilerplate language that remains static year-to-year even as facts change. Perhaps this is a result of some taxpayers choosing the “lowest common denominator” for CBC reporting purposes, or it may reflect some taxpayers’ view that IRS international examiners ignore their documentation. Whatever the reason, there is no “one-size-fits-all” approach in this area. Effective documentation requires that taxpayers critically evaluate each intercompany arrangement and tailor the method and analysis used in light of third party data and applicable law. Bespoke and persuasive documentation can benefit taxpayers substantially by avoiding lengthy and burdensome examinations, unwarranted adjustments with associated penalties, and possible disputes down the road.
