In the spirit of the October 15 extended return deadline festivities, I’d like to dedicate today’s post to clearing up some of the most common misconceptions and questions I hear regarding US Transfer Pricing Documentation. Let’s break down what is it, what it isn’t, and whether you should do it.
What it is: Treas. Reg. § 1.6662-6(d)(2)(iii) establishes the requirement that taxpayers to maintain documentation of their intercompany transactions sufficient to demonstrate “that, given the available data and the applicable pricing methods, the method (and its application of that method) provided the most reliable measure of an arm's length result.” In other words, it’s proof to the IRS that a company's transactions with its related parties (as reported and reflected in the relevant fiscal year's income tax filings) were conducted as they would have been with an unrelated entity.
The 6662 transfer pricing regulations also stipulate that such documentation must be contemporaneous with the filing of the corresponding tax return, and be provided to the IRS within 30 days of request. Failure to provide compliant and timely documentation exposes the taxpayer to “net adjustment penalties” of up to 40% for tax deficiencies resulting from mispricing of intercompany transactions. Most countries around the world have their own transfer pricing documentation requirements, meaning that intercompany documentation often has to meet the rules of multiple counterparty jurisdictions.
What it isn’t: US transfer pricing documentation is not required to be filed or submitted unless specifically requested by the IRS. Furthermore, there are no penalties automatically applied for failing to maintain contemporaneous documentation, although its absence provides the IRS with wider latitude to apply its own interpretation of the arm’s length standard and pricing methodologies.
Even fully-compliant transfer pricing documentation does not in itself guarantee that a taxpayer’s transfer pricing policies and practices will be accepted by the IRS or any other tax authority. It does provide factual and economic support for taxpayers as a “first line of defense” against audit adjustments and penalties.
Do you need it? Unlike certain other jurisdictions, the US transfer pricing regulations do not specify a materiality threshold for maintaining documentation. This means that a taxpayer must prepare documentation wherever intra-group transactions exist, or accept the risk that they will be unable to respond satisfactorily to an IRS request, increasing penalty risk.
Tax authority considerations aside, transfer pricing documentation is routinely requested as part of a multinational enterprise’s external audit process, as well as during due diligence related to mergers and acquisitions (M&A). It and can even be a very useful reference for internal process documentation.
Bottom Line: We strongly advise taxpayers with intercompany transactions to prepare compliant and contemporaneous transfer pricing documentation if any of the following conditions are met:
- The cost of any potential transfer pricing adjustments/penalties exceeds the cost of preparing transfer pricing documentation
- The Company has a history of tax authority audits/inspections
- Transfer pricing is within the scope of discussion/review for external audit
- The Company may be involved in a transaction which will entail tax due diligence
- The Company otherwise benefits from having its transfer pricing policies and practices outlined explained for stakeholders and/or shareholders
A final note of caution: while a taxpayer may reasonably make a calculated risk to forego US transfer pricing documentation, it is essential to monitor compliance requirements for other tax jurisdictions within the group. For example, if a US taxpayer has intercompany transactions with a Mexico affiliate and chooses not to prepare US transfer pricing documentation, obligations may still exist in Mexico, which has more defined thresholds for preparation and submission of transfer pricing documentation.
Happy filings!
Make a habit of sustained success.
