(The Transfer Pricing Examination Process was recently updated by the Department of Treasury – June 2018. TaxConnections posts this valuable eight part a series to keep you informed of these changes.)

Execution Stage

1. Issue IDRs and/or Summonses

The issue team will request any additional information not obtained during the Planning Phase, including:

• Follow-up on the financial statement orientation, transfer pricing/supply chain orientation, Treas. Reg. Sec. 1.6662-6(d)(2)(iii) documentation, and other data and information necessary to test the working hypothesis and the best method assessment. Clarify any items that do not reconcile or that have missing
information.

Issue IDRs or summonses for factual development, including requests for interviews, plant tours, and site visits:
• Follow the requirements for issuing IDRs in accordance with the LB&I Directive on IDR Enforcement Process
• Collaborate with LB&I Division Counsel when drafting IDRs that may potentially require a summons – Requesting third-party information is not subject to the IDR process and may
require a summons in the first instance (e.g. requests for documents from or interviews of third-parties may require third-party summonses)

Best Practices: The issue team should coordinate IDR requests with the entire case team to avoid duplicate IDR requests. Open communication between the taxpayer and the examination team throughout the process is critical. Conduct weekly or bi-weekly
discussions between the examination team and the taxpayer to support communication and ensure common expectations regarding audit progress, IDRs, and timelines.

At this stage, the examination team should explain the Advance Pricing Agreement (APA) program to the taxpayer and explain its benefits as a tool to achieve certainty in transfer pricing transactions.

Helpful References:

IRM 25.5 – Summons
IRM 4.46.4.1 – Overview of the Execution Phase
IRM 4.11.57 – Third Party Contacts
Rev. Proc. 2015-41 – APMA advance pricing agreements
IRM Exhibit 4.46.3-4 – Transfer Pricing Compliance Processes

2. Review Intercompany Agreements

The issue team should perform a review and analysis of relevant intercompany agreements:

• Collaborate with LB&I Division Counsel to understand legal terms and content of intercompany agreements:
– Determine relevant parties
– Identify important terms of the agreement
– Identify compensation and forms of payments
– Assess the contractual risks assigned to the controlled parties
– Determine if the conduct of the parties is consistent with the written agreements
– Identify any discrete legal issues

3. Conduct Functional Analysis

A functional analysis identifies the economically significant activities performed regarding the transaction. An economically significant activity is one that, at arm’s length, materially affects the following:

• The price charged in a transaction
• The profits and/or losses from a transaction

The issue team must perform a functional analysis, including a review and analysis of the accounting data.

Review IRM Exhibit 4.61.3-4 – Transfer Pricing Functional Analysis Questionnaire and consider performing the following actions, as appropriate:

• Identify functions performed by each entity, with respect to the controlled transaction under analysis
• Identify risks assumed by each entity with respect to the controlled transaction under analysis and verify that the conduct of parties is consistent with the way in which risk is allocated in the intercompany agreement(s)
• Identify assets utilized by each entity
• Identify title flow, product flow, services performed, and money flow
• Identify value drivers of the business or transaction
• Work with the taxpayer to identify key personnel for interviews and site tours
• Work with the taxpayer to identify and plan site tour(s)
• Work with the issue team to prepare for interviews and tours. If foreign travel is required, start the administrative process early and follow the procedures on the International Travel Office website
• Consider the need for a court reporter at interviews. The “Court Report Services Request” form should be initiated by the Issue Manager and signed by both the Issue Manager (if applicable) and the Case Manager. Upon completion, the request is then forwarded to both the Issue Territory Manager and the Territory Manager for approval. Please allow 45 days to process

A functional analysis is a critical aspect of any transfer pricing examination and is best conducted as a team with robust internal communication, and ongoing discussions with the taxpayer to further understand its business operations.

Best Practice: The issue team must consider the potential for other issues to maximize the efficiency and effectiveness of the examination. In planning and performing a functional analysis, consider information needed for any Subpart F, effectively
connected income, permanent establishment, or other implications.

Helpful References:
IRM Exhibit 4.61.3-2 – Development of IRC section 482 Cases – General Audit Procedures and Techniques
IRM 4.61.3 – Development of IRC Section 482 Issues
IRM Exhibit 4.61.3-1 – On-site Visitations
IRM 4.61.3.5.1 – Functional Analysis
IRM 4.10.3.3 – Interviews: Authority and Purpose
IRM. 4.10.3.3.6 – Requests to Audio Record Interviews

C. Taxpayer Meetings
The issue team should meet periodically with the taxpayer to confirm material facts developed during the examination:
• Consider a full, open discussion/presentation with the taxpayer – preferably including the relevant personnel from the taxpayer’s business operations – regarding the team’s working hypothesis(es) and preliminary findings
• Issue additional IDRs, as necessary

Best Practice: A written agenda should be prepared for every taxpayer meeting and shared with the taxpayer in advance. Designate a dedicated note taker for these meetings.

D. Mid-Cycle Risk Assessment
Risk assessment is a continuous process. The issue team must use their professional judgment to determine which issues will continue to be examined or modified in scope as facts and information about the relevant transfer pricing issues are developed. New information discovered by LB&I during an examination may necessitate expanding or modifying the Examination Plan and timeline, including adding new issues or alternatively, closing one or more of the transfer pricing issues under examination.

• Reassess the risk analysis and refine the working hypothesis based on an analysis of information gathered and reviewed to date
• Determine which transactions warrant further analysis
• Determine which transactions should be eliminated/added to the work plan
• Consider additional IDRs, as necessary
• Reevaluate the need for additional internal resources and outside experts
• Document, organize, and outline transactions determined to warrant further development or analysis based on information gathered to date
• Consider the impact of any other potential audit adjustments on the transfer pricing issues under consideration. Communicate with the other issue teams, as necessary
• Document and update the audit steps taken, facts discovered, and risk reassessment in the audit file and in a potential NOPA and Economist Report
• Discuss the preliminary findings with the taxpayer and engage in a meaningful discussion about any missing facts or any misinterpreted facts that materially influence the preliminary findings

The issue team should prepare a mid-cycle risk analysis to reflect the results of the updated risk reassessment:

• Conduct an internal meeting with the issue team to discuss the progress of the audit steps taken, concerns or delays and proposed plan to address them, recommendation and timing for next steps, and any potential resolution options

– Consider whether the Letter 1853-P should be updated and sent to the taxpayer
– Update timelines and milestones as necessary, including in IMS which would include entering an “Actual Completion Date” for all closed issues
• Secure managerial approvals
• Discuss mid-cycle risk analysis with the taxpayer

Helpful Reference:
IRM 4.46.3.2 – Risk Analysis Process

(This Is Part V of VIII On Department of Treasury- Transfer Pricing Examination Process And Updates. Click To Part IV)