Navigating the transfer pricing audit process can be complex and time-consuming for multinational organizations. Understanding the various stages, procedures, and timelines involved is essential for any organization to minimize the risk of tax assessments, penalties, and reputational damage.
One of the first considerations for multinational organizations is the statute of limitations. A general statute of limitations of three years from the tax return filing date applies for transfer pricing assessments, but this can be extended to six years for substantial understatement of income. Fraud and misrepresentation are not subject to the statute of limitations. Therefore, organizations must ensure that they maintain accurate transfer pricing documentation and records to avoid being subject to extended audit periods and potential penalties.
The IRS has a team of agents specially trained in economic analysis, and the risk of transfer pricing scrutiny during audits is high. A transfer pricing audit roadmap issued by the IRS in 2014 has been replaced by the Transfer Pricing Examination Process (TPEP), which provides guidance for auditors on procedures to be followed in the planning, execution, and resolution of transfer pricing audits. The TPEP emphasizes the importance of early collection of facts, collaboration between team members of different disciplines, and relevant discussions with the taxpayer during the audit.
During the risk assessment phase of the audit, audit teams are encouraged to use information on Country-by-Country (CbC) reporting from Form 8975 to analyze high-level transfer pricing and BEPS-related risk. The teams will analyze functions, assets, and risks, and review relevant financial information. Throughout the execution phase of the audit, reassessment meetings will be held to discuss new information, adjust the working hypothesis, determine whether issues should be pursued or closed, or add new issues.
As part of a standard review of their US tax returns, multinational organizations are likely to be required to demonstrate affirmatively the arm’s length nature of their transfer pricing. The audit teams request the transfer pricing documentation in an IDR issued at the commencement of the audit. Personnel involved in preparing transfer pricing documentation may be interviewed to obtain further information.
If the IRS wants to see foreign-source documents, it may use the formal document request (FDR) procedure under Section 982 of the IRC. This enables the IRS to collect data from outside the US that may be relevant to the tax position of the US taxpayer. The taxpayer must produce the information required by the FDR within 90 days, or they may not be able to introduce any foreign-based documentation relating to the request in the event of future litigation.
Under Section 7602, the IRS may issue a summons in the course of its work to check the correctness of tax returns or determine the US tax liability. A summons could be issued either to the taxpayer or to a third party with the objective of obtaining information or testimony in relation to an issue. The IRS must follow certain notification procedures, and the summons will be considered valid if it is conducted for a legitimate purpose, the material sought is relevant to the purpose, the material is not already held by the IRS, and the correct administrative procedures have been followed.
The IRS may also use a procedure provided for in Section 6503(j), known as a designated summons, where a corporate taxpayer has not cooperated with the IRS by providing requested information. The statute of limitations is suspended during a period in which the IRS and the taxpayer are in litigation in relation to compliance with the designated summons.
To assist audit teams in conducting transfer pricing examinations, the IRS has compiled instructions for its personnel, including best practices and processes consistent with IRS Publication 5125. Organizations should familiarize themselves with the audit process and the various procedures and timelines involved to ensure they comply with the regulations and minimize the risk of tax assessments, penalties, and reputational damage.