In February 2014, the IRS Transfer Pricing Operations (TPO) team issued a Transfer Pricing Audit Roadmap. The roadmap is intended to assist IRS examination teams with identifying and auditing transfer pricing issues. The creation of this roadmap reflects the Service's increased focus on transfer pricing matters. The roadmap also gives us insight into which transfer pricing issues will be scrutinized more closely and what kind of documentation the IRS expects to be in place to support the taxpayer's position.
In light of the pragmatic revenue raising goals involved with transfer pricing audits, the TPO is focused on identifying high risk issues around intangibles, hybrid instruments and other perceived income shifting transactions. Also, taxpayers' worldwide effective tax rates and risk based assessments focusing on industry profitability ratios will be used to identify and select transfer pricing audit targets.
Transfer pricing is a facts and circumstances driven discipline. Therefore, transfer pricing audits will require significant time for fact finding and understanding the taxpayer's story, i.e. the functions, assets, risks involved and whether the facts provide persuasive support of the transfer pricing positions taken by the taxpayer.
Quality transfer pricing documentation provides the taxpayer the opportunity to tell a "compelling story" to the IRS and may provide protection from penalties if prepared contemporaneously. Even with transfer pricing documentation in hand, however, taxpayers should be prepared for examiners to request increasing amounts of background information and source documentation, such as intercompany agreements, financial and accounting data, employee details, and entity structure information. Transfer pricing audits are increasingly seeking an understanding of taxpayers' worldwide operations and tax positions.
Transfer pricing is an area of risk that is quickly escalating beyond just tax and finance departments as executives are increasingly recognizing the significant financial, controversy, and reputational risks to the business that must be strategically assessed and mitigated.
The transfer pricing audit roadmap is another step the IRS is taking in increasing its focus on transfer pricing. This development is coinciding with mounting foreign country focus on the same issue. Countries are increasingly prioritizing transfer pricing enforcement as a necessary tax base defense and probable revenue raiser. Media attention is bringing transfer pricing risk to the forefront for multinational executives, and global initiatives such as the OECD Base Erosion & Profit Shifting (BEPS) project reflect the global appetite for transparency and corporate responsibility.
Based on the new audit roadmap, taxpayers with any of the following characteristics have a higher risk of inquiry:
- Inbound taxpayers with sustained losses;
- Taxpayers involved in high risk or significant transactions with affiliates in tax havens;
- Taxpayers utilizing valuable intangible property (consider those with significant R&D); and
- Taxpayers with a high volume of related party transactions.
For more information on the Service's increased focus on transfer pricing issues, see our prior article, Transfer Pricing Enforcement Continues to Evolve at the IRS. To learn more about the transfer pricing roadmap or how to prepare adequate transfer pricing documentation, contact your local CBIZ Tofias tax advisor who will put you in contact with one of our transfer pricing specialists, or you may contact us here.
Claudia Mullen is a Manager in the Tax Group. She can be reached at 401.626.3241 or CMullen@cbiztofias.com.