U.S. Transfer Pricing Overview - BKD. Transfer Pricing ... Internal Revenue Code §6662 imposes an...
Transcript of U.S. Transfer Pricing Overview - BKD. Transfer Pricing ... Internal Revenue Code §6662 imposes an...
Agenda
US. Transfer Pricing (TP) Rules – Overview Overview of U.S. Documentation Requirements Required Documentation Penalties Tax Return Disclosure Requirements IRS TP Compliance Initiative Overview of TP Methods Best Method Analysis Final Intercompany Services Regulations Cost Sharing Regulations Advanced Pricing Agreements
U.S. Transfer Pricing Rules
Relevant Rules/RegulationsSection 482 of Internal Revenue Code and the
accompanying Treasury Regulations
U.S. Transfer Pricing Rules (cont.)
Arms length standard “In determining the true taxable income of a controlled
taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result)”(Treas. Reg. §1.482-1(b)(1))
Treasury Regulations §1.482 –Overview
1.482-1: Allocation of Income and Deductions among Taxpayers
1.482-2: Determination of Taxable Income in Specific Situations
1.482-3: Methods to Determine Income…Tangible Property 1.482-4: Methods to Determine Income…Intangible Property 1.482-5: Comparable Profits Method 1.482-6: Profit Split Method 1.482-7: Sharing of Costs 1.482-8: Examples of Best Method Rule 1.482-9: Methods to Determine Income…Service Transactions
Definition of Controlled
1.482-1(i)(4) “Controlled includes any kind of control, direct or indirect,
whether legally enforceable or not, and however exercisable or exercised, including control resulting from the actions of two or more taxpayers acting in concert or with a common goal or purpose. It is the reality of the control that is decisive, not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.”
Overview of U.S. Documentation Requirements TP documentation is required under U.S. tax lawsMust be in existence when tax return is filed
There is no documentation safe harbor for small taxpayers
Penalties will be assessed in cases of taxpayers without adequate TP documentation
TP documentation is requested as part of all general tax audits
U.S. does not follow OECD Guidelines Relevant law is Internal Revenue Code §482
Documentation prepared for other countries is not acceptable to the Internal Revenue Service (IRS)
Required Documentation
1. Overview of taxpayer’s business including economic and legal factors which affect pricing
2. Description of organizational structure covering all related party transactions
3. Any specific documents required by §482 regulations (e.g., cost-sharing agreements or market penetration)
4. Description of selected method and explanation of rationale for selecting method
5. Description of unselected methods considered and explanation of why they were not selected
Required Documentation (cont.)
6. Description of the controlled transactions, including terms of sale, and any internal data used to analyze those transactions
7. Description of comparables used, how comparability was evaluated and adjustments made
8. Explanation of economic analysis and projections used in developing method
9. Summary of relevant documents collected between the end of the tax year and the date the return was filed
10. General index of principal and background documents and recordkeeping of those documents
U.S. Transfer Pricing Penalties –Summary
Penalty Transactional Net Adjustment
Substantial Valuation (20% penalty)
Price or value is 200% or more (50% or less) than the correct amount
Net adjustment exceeds the lesser of $5 million or 10% of gross receipts
Gross Valuation (40% penalty)
Price or value is 400% or more (25% or less) than the correct amount
Net adjustment exceeds the lesser of $20 million or 20% of gross receipts
U.S. Transfer Pricing Penalties –Review of IRC §6662 Internal Revenue Code §6662 imposes an accuracy-related
penalty for an underpayment of tax attributable to improper transfer pricing (“valuation misstatement”) 20% penalty for substantial valuation misstatements: Claimed transfer price is more than 200% or less than 50% of the
arm’s length amount or Net §482 adjustment exceeds the lesser of $5 million or 10% of
gross receipts
40% penalty for gross valuation misstatements: Claimed transfer price is more than 400% or less than 25% of the
arm’s length amount or Net §482 adjustment exceeds the lesser of $20 million or 20% of
gross receipts
U.S. Transfer Pricing Penalties –Review of IRC §6662 (cont.) Taxpayers may avoid an accuracy-related penalty
by showing: The taxpayer determined its transfer price in accordance
with a specific method set forth in the regulations prescribed under §482 and the use of such method was reasonable
The taxpayer has documentation (that was in existence as of the time of filing the return) which sets forth its transfer pricing method and which establishes that the use of such method was reasonableand
The taxpayer provides such documentation to the IRS within 30 days of a request for such documentation
U.S. Tax Return Disclosures
Disclosures Covered in Tax Returns? Short Answer – Yes
Disclosure Forms:Form 5471 – U.S. Entity Owns Foreign Subsidiary Schedule M details the transactions between foreign
entities Form 5472 – Foreign Entity Owns U.S. Subsidiary
Form should be filed with income tax return of the affected shareholder
$10,000 penalty for failure to file per instance IRS has recently started to vigorously assess
penalties for improper filings
IRS to Aggressively Review Transfer Pricing Issues Given the economic crisis, the IRS will vigorously
investigate U.S. multinational enterprises, which are seen as “shopping for best tax deals” –according to Commissioner Douglas ShulmanWill need tax revenues to fund bailouts and other
stimulus spendingThere will be “increased public pressure of corporate
taxpayers to adhere to not only the letter of the law, but the spirit of the law in their home country law”
IRS Transfer Pricing Compliance Initiative – Overview January 2003 IRS LMSB* Commissioner issued
directive launching new transfer pricing compliance initiative
Directive instructs agents to Request transfer pricing documentation at opening
conference of all audits Enforce 30-day deadline for providing documentation Provide documentation to IRS International Examiner or
IRS economist Penalties cannot be waived unless documentation was
prepared & submitted timely and approved by Penalty Review Board
* Large and Mid Size Business Division (now called Large Business & International Division) –Companies with assets over $10 million
IRS Transfer Pricing Compliance Initiative - Results IRS continuing to audit more small & mid-size
companies as part of mandate IDRs now requests “transfer pricing studies” as
opposed to listing TP documentation requirements under Section 6662
IRS enforcing the requirement that TP documentation be contemporaneous
IRS interviewing individuals who prepared the documentation and taxpayer personnel
Challenging taxpayer’s documentation
IRS Transfer Pricing Compliance Initiative – Results (cont.) Imposition of penalties Reviewing Form 5471/5472s for data consistency IRS will audit a taxpayer for subsequent tax year if
they find an adjustment Can no longer ignore U.S. TP documentation
requirementsDocumentation should be kept current
IRS will add 2,000 staff to its international group over the next few years to expand audit coverage Will include transfer pricing economists
IRS Transfer Pricing Compliance Initiative – Areas of Focus Inbound companies with low profitability All companies with cost sharing arrangements Companies with amended tax returns Services transactions Transfers of intangible property for nil or
insufficient compensation
Overview of Transfer Pricing Methods Tangible PropertyComparable Uncontrolled Price MethodResale Price MethodCost Plus MethodComparable Profits MethodProfit Split MethodOther Unspecified Methods
Overview of Transfer Pricing Methods (cont.) Intangible PropertyComparable Uncontrolled TransactionComparable Profits MethodProfit Split MethodOther Unspecified Methods
Overview of Transfer Pricing Methods (cont.) Services Methods
Comparable Uncontrolled Services Price Gross Services Margin Cost of Services Plus Comparable Profits Method Profit Split Method Unspecified Methods
Best Method Analysis
“The arm’s length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm’s length result.” (Treas. Reg. §1.482-1(c)(1)).
No hierarchy of methods Need to document why the method chosen is the
“best method” and why other methods were not applicable
Best Method Analysis (cont.)
In determining the best method, need to consider the following:Degree of comparability between controlled and
uncontrolled transactionsQuality and completeness of the underlying data and
assumptions used in the analysis
Final Intercompany Services Regulations
On July 31, 2009, IRS issued final regulations governing intercompany services transactions
Largely consistent with temporary intercompany services regulations issued in 2006
Effective for tax years beginning after July 31, 2009 Services must convey a direct benefit to the
recipient of the serviceServices serve to enhance recipient’s commercial
position orRecipient would be willing to pay for the same
activity or perform the activity itself
Final Intercompany Services Regulations (cont.) SCM (cost safe harbor election) – cost can be charged
for routine (low level) administrative services Specified Covered Services – services listed in Revenue
Procedure or Low-margin Covered Services – median mark-up of
comparables is 7% or less To qualify for the SCM, the following must also be met: Services must also not contribute to the key competitive
advantages, core capabilities or fundamental success of the group (‘business judgment test’)
Service must not be a specifically excluded service Taxpayer must maintain required documentation
Final Intercompany Services Regulations (cont.) Specifically excluded services, which do not qualify for
the SCM include:Manufacturing Production extraction, exploration or processing of
natural resources Construction Reselling, distribution, acting as a sales or purchasing
agent or acting under a commission or similar arrangement
Research, development or experimentation Engineering or scientific Financial transactions – including guarantees Insurance or reinsurance
Final Intercompany Services Regulations (cont.) Services which are not beneficial should not be
allocatedProvides an indirect or remote benefitDuplicative ShareholderPassive association
Final Intercompany Services Regulations (cont.) Implications Need to ensure compliance with the final intercompany
services regulations Review against current practices for intercompany services
The charge-out of stock options could potentially be unacceptable in other jurisdictions
More documentation is now required for intercompany services arrangements (e.g., intercompany agreements and compliance with SCM)
In recent audits, the IRS has focused on cost base of the services fee, how the costs were allocated and how they tie into the general ledger
Temporary Cost Sharing Regulations
On December 31, 2008, the IRS and U.S. Treasury released temporary cost sharing regulationsHad an effective date of January 5, 2009 and can be
applied retroactively for all open tax yearsTemporary regulations have same weight as final
regulations Will likely be finalized without any significant
changes Replaces the 1995 cost sharing regulations
Temporary Cost Sharing Regulations (cont.) Cost sharing arrangement (CSA) is an arrangement in
which controlled participants share the costs and risks of developing cost shared intangibles in proportion to their reasonably anticipated benefit shares
In order to qualify as a CSA, the following must be met: Cost Sharing Transactions Administrative requirements fulfilled Platform Contribution Transaction (PCT) (buy-in payment)
is determined Divisional Interests for the intangibles must be reliable,
non-overlapping, perpetual and exclusive
Temporary Cost Sharing Regulations (cont.) Investor Model is the fundamental concept for
determining results that would have been realized under an arm’s-length CSA and for addressing the relationships and contributions of each CSA participant
PCT valuation methodologies Income Method Residual Profit Split Method Comparable Uncontrolled Transaction Market Capitalization Acquisition Price Method Unspecified Methods
Temporary Cost Sharing Regulations (cont.) Periodic adjustmentsApplies to all transfer pricing methods used to
determine PCT Allows IRS to make an adjustment to the PCT if the
PCT was not correct due to the forecasts used at the time Taxpayer cannot make adjustment PCT will likely be analyzed by IRS since cost sharing is a
Tier 1 issue IRS has the benefit of hindsight
Temporary Cost Sharing Regulations (cont.) ImplicationsCSAs are no longer as attractive as in the pastThe investor model and periodic adjustment will
likely mean that more of the returns accrue to the participant making the PCT contribution
Historical CSAs (those before January 5, 2009) needed to be documented by July 6, 2009 to qualify for treatment under the 1995 CSA regulations
Advanced Pricing Agreements
Agreement Types (Rev. Proc 2006-9) Unilateral BilateralMultilateral
Filing Fees Large Taxpayers - $50,000 Small Taxpayers - $22,500 Gross Worldwide Income < $200M annually Small Transactions < $50M annually Intangible Transactions < $10M annually
$35,000 for Renewals