An attorney in the Office of Associate Chief Counsel (International) at the IRS provided some commentary on the IRS’s 2020 frequently asked questions (FAQ) document regarding transfer pricing documentation, which was released to incentivize US taxpayers to improve the quality of their transfer pricing documentation. The attorney iterated the IRS is now more willing to assess penalties in situations where US taxpayers with intercompany transactions do not have transfer pricing documentation or provide inadequate transfer pricing documentation to the IRS.
Levying Penalties on MNEs
The IRS official indicated the IRS is now more willing to levy penalties in situations where multinational enterprises (MNE) have poor or inadequate transfer pricing documentation. The US Government requires MNEs to prepare transfer pricing documentation that records their intercompany transactions on an annual basis. The preparation of robust transfer pricing documentation on an annual basis serves to eliminate penalties associated with the failure to prepare the required documentation.
The IRS official also indicated that MNEs often fail to provide enough details related to their risks when documenting their intercompany transactions. In a transfer pricing analysis, the entity that performs the valuable functions, takes on the preponderance of the business risks, and owns the intangible property is generally entitled to the majority of the profits involved in the intercompany transaction. Therefore, a thorough functional and risk analysis is required when analysing and documenting an intercompany transaction.
Action 9 of the Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) initiative analysed the concept of risk involved in an intercompany transaction. The 2015 BEPS deliverable, “Aligning Transfer Pricing Outcomes with Value Creation,” revamped the concept of risk in the OECD’s Transfer Pricing Guidelines for Multinational Enterprises and served to place an emphasis on analysing risks inherent in an intercompany transaction. The IRS official stated that taxpayers often emphasise the allocation of functions in their transfer pricing documentation but do not provide enough analysis of the risks. Going forward, the IRS will expect taxpayers to more thoroughly document their analysis of the risks involved in their intercompany transactions.
The IRS also will expect that US MNEs identify which legal entity’s employees are performing the various functions and managing the risks involved in the intercompany transactions.
Given the IRS’s willingness to audit US taxpayers’ transfer pricing arrangements and impose penalties in situations where the taxpayer does not have adequate transfer pricing documentation, MNEs should assess if they have adequate transfer pricing documentation for all tax years.
If you would like help reviewing your current transfer pricing documentation or if you are interested in the preparation of transfer pricing documentation that will meet the IRS requirements then please contact us or email William D. James, Principal - Transfer Pricing Leader at BKD.