In this second article in our Looming Transfer Pricing Exams & IRS Preparedness Measures series, we highlight and summarize the essential aspects of the IRS’s Transfer Pricing Examination Process (TPEP) Planning Phase.

The Planning Phase determines the scope and issues of the transfer pricing examination. The TPEP states, “Issues selected for examination should have the broadest impact on achieving compliance regardless of the size or type of entity.” Important steps in the Planning Phase are: 1) the Initial Transfer Pricing Risk Assessment, 2) issuance of the Initial Transfer Pricing Information Document Request (IDR), 3) IRS internal planning meetings, 4) development of the exam plan, timelines and milestones, and 5) the opening conference, which is the final step of the Planning Phase and marks the transition to the Execution Phase.

Evolving Guidance

As mentioned in our article Review of and Insights on the IRS Transfer Pricing Examination Process, published by Tax Notes International on 18 March 2019, from time to time the IRS updates and revises the TPEP. At the time of publication of the Tax Notes International article, the TPEP had most recently been revised as of August 2018. The current updated TPEP (“updated TPEP”) refers to Publication 5300 (5-29-2019), Revised 06 June 2019. The updated TPEP increases emphasis on certain practices (e.g., issue team collaboration with certain other LB&I programs and prior year exam cycle teams) and contains significant additional material, consisting mostly of resources listed as “Helpful References” located at the end of most TPEP sections. For example, the first new Helpful Reference resource in the updated TPEP is Internal Revenue Manual (IRM) section 4.46.1.1.3 (12-13-2018) “Roles and Responsibilities” located in updated TPEP section I.(A.) “Issue Team Member Collaboration and Coordination.” IRM 4.46.1.1.3 generally discusses the issue-based examination process, and IRM 4.46.1.1.3(1) specifically states that the issue-based exam process is intended to be a collaborative process where all parties work together to resolve issues at the earliest appropriate point in an exam.

Initial Risk Assessment

Issue teams, which are staffed from the IRS’s Transfer Pricing Practice (TPP), Cross Border Activities (CBA), or Geographic Compliance Practice Area personnel, are to conduct an Initial Transfer Pricing Risk Assessment (“initial risk assessment”) to identify specific controlled transactions between the U.S. taxpayer and its affiliates warranting examination. This initial risk assessment is outlined as an eight-part process spanning over five pages in the TPEP and includes extensive analysis and research to be performed by the issue team. Issue teams are instructed to use the information provided on IRS Form 8975, Country-by-Country Report (CbCR) and the accompanying Schedules A (Tax Jurisdiction and Constituent Entity Information) to assess high-level transfer pricing risks, BEPS related risks, and for economic and statistical analysis. The TPEP instructs issue teams to compute key financial ratios for multiple years, make industry comparisons, and consider whether there is potential cross-border income shifting that is contrary to the arm’s length standard.

The initial risk assessment also involves a review of tax return information, documents from prior exams, and publicly available information such as taxpayer websites, investor relations materials, SEC filings, and information from research services. The updated TPEP lists three additional workpaper items for the issue team to review: 1) Legal advice, 2) Taxpayer protests and examination’s rebuttals, and 3) Examination historical notes. Also, the updated TPEP advises the issue team to meet with the prior examination cycle team, if possible. The updated TPEP’s additional focus on prior exams – both in additional workpapers that must be reviewed and its stated instruction to meet with the prior exam cycle team – is a noteworthy set of measures to increase LB&I knowledge on particular taxpayers and their transfer pricing, and to minimize the loss of insight that often results from personnel turnover that is inherent in taxpayer exam teams between tax exam cycles.

The TPEP informs taxpayers that the issue team will collaborate with the Advance Pricing and Mutual Agreement (APMA) program regarding transactions between the U.S. taxpayer and related parties in U.S. treaty-partner countries that may generate adjustments for which a taxpayer may request U.S. Competent Authority (CA) assistance. Also, the issue team will consider obtaining foreign-based documentation (BEPS Action 13 master files, local files and CbCRs)^[1] from treaty partners using collateral requests, information requests pursuant to treaties, and the Simultaneous Examination Program.

The updated TPEP strengthens the language regarding collaboration between the issue team and APMA program, stating that the issue team “must consult with the APMA program when reviewing a taxpayer’s intercompany transactions involving a treaty partner, regardless of whether the taxpayer currently has a MAP or APA case in APMA or whether APMA has an active relationship with the treaty partner.” The updated TPEP also lists two additional Helpful Resources in section I.(C.)(2.), “Collaborating with Advance Pricing Mutual Agreement Program.” The first is a memorandum for LB&I employees with the subject title “Interim Guidance on Mandatory Issue Team Consultations with APMA for Examination of Transfer Pricing Issues Involving Treaty Countries” issued 19 February 2019 (“Issue Team / APMA Memo”). The second is the attachment to this memo with the title “Instructions for LB&I Examination Consultations with APMA” (“Issue Team / APMA Memo Attachment”).

The Issue Team / APMA Memo heavily emphasizes the requirement (effective for transfer pricing exams opened starting 19 February 2019) that [transfer pricing] issue teams must consult with APMA on exams with the potential to generate transfer pricing adjustments involving a country with which the U.S. has a double tax treaty (regardless of whether the taxpayer has an APA or MAP case).  While the Issue Team / APMA Memo discusses at length how the issue team benefits from consulting with APMA, the primary rationale for this issue team-APMA consultation requirement is to minimize issue team-initiated adjustments that subsequently lead to a Mutual Agreement Procedure (MAP) cases. A secondary rationale is to help APMA learn from the experiences and knowledge of issue teams, which is helpful for APMA’s MAP case negotiations. The Issue Team / APMA Memo Attachment contains internal IRS administrative and procedural steps to set up the consultation and it briefly discusses general APMA-focused topics to be shared with the issue team.

Issue teams are also instructed to develop a working hypothesis on the transfer pricing issue identified in the initial risk assessment. The working hypothesis is described as a “fluid concept,” which will include an issue statement that will be proved or disproved as additional information is obtained.

If the initial risk assessment determines that there is taxpayer transfer pricing compliance risk, and TPP or CBA resources are assigned to the exam, then, per the updated TPEP and IRM 4.61.3.4.3.1 (12-13-2018), a TPP and/or CBA Practice Area employee will prepare and issue the Initial Transfer Pricing Documentation IDR, pursuant to IRC § 6662(e) and Treas. Reg. § 1.6662-6(d)(2)(iii). If TPP or CBA resources are not assigned to the exam, then the Initial Transfer Pricing IDR will not be issued.

Initial Transfer Pricing Documentation IDR

Required Initial Transfer Pricing IDR documentation includes principal documents, which should be included in a taxpayer’s contemporaneous transfer pricing documentation report(s), and certain background documents as requested, such as geographic, legal and personnel organizational charts, worldwide geographic and segmented accounting data, and financial statements. The taxpayer has 30 calendar days to respond with the requested documentation, as required by statute, and the 30-day response period starts with the date the Initial Transfer Pricing Documentation IDR is issued.^[2] The issue team is instructed to use this 30-day period to perform analysis of currently available information, which should include prior tax returns and financial statements. The issue team is also instructed to review the taxpayer’s transfer pricing documentation for the year at issue prior to the taxpayer orientation meetings.

Opening Conference

The planning phase concludes with the issue team participating in the formal opening conference with the taxpayer. Opening conference discussion items may include, but are not limited to: the TPEP, potential IRC § 6662(e) penalties, preliminary scope and examination timelines, IDR processes, the potential need for site visits and interviews, resolution processes, IRC § 6038A rules and procedures governing foreign-based transfer pricing documentation, MAP and statute of limitation protections on foreign affiliate returns, the potential for double taxation, and expectations for meetings such as the financial statement orientation meeting (to be held, “ideally,” within 30 days of the opening conference), the transfer pricing/supply chain orientation meeting (to be held after the financial statement orientation meeting), and issue discussion meetings. Taxpayers who are preparing for an opening conference discussion would be well advised to refer to the updated TPEP, section I(G.) “Opening Conference” for the full listing of potential agenda topics and associated Helpful References.

The next installment of our series of articles on Looming Transfer Pricing Exams & IRS Preparedness Measures will boil down the TPEP’s Execution Phase (which spans 10 updated TPEP pages) to essential preparedness takeaways in an easily digestible blog format.

If you have any questions or would like more information on the issues discussed in this article, please contact the authors:

Guy Sanschagrin, Principal in Charge of Transfer Pricing and Valuation Services, WTP Advisors (Minneapolis, MN, USA) guy.sanschagrin@wtpadvisors.com

Doug Schwerdt, Transfer Pricing and Valuation Specialist, WTP Advisors (Houston, TX, USA)  doug.schwerdt@wtpadvisors.com

Read Blog Post Part 1 In This Series

[1] BEPS Action 13, “Transfer Pricing Documentation and Country-by-Country Reporting,” contains revised standards for transfer pricing documentation incorporating a master file, local file, and a template for country-by-country reporting of revenues, profits, taxes paid, and certain measures of economic activity.

[2] Prior to 2014 it was common for the IRS to extend IDR deadlines beyond 30 days. However, as a result of IRS LB&I directives issued in 2013 and 2014, revenue agents now have limited discretion to extend an IDR deadline by at most 15 business days if a taxpayer fails to respond or provides an incomplete response to an IDR.