The IRS describes several specific areas of transfer pricing documentation that could benefit from improvements: the FAQs published by the IRS appear to contain a long experience of the IRS that the documentation 6662 (e) it receives during audits is insufficient. The consequences of insufficient documentation on transfer pricing are that the IRS poses more transfer pricing problems and that investigations take longer. FaQs describe specific areas that taxpayers can focus on. A pre-price agreement (APA) is a prior agreement between a tax payer and a tax authority on an appropriate transfer pricing method (TPM) for a number of transactions involved during a specified period („covered transactions“). In addition, current economic volatility may face challenges in meeting current transfer pricing structures. While FAQs do not change the applicable material or sanction law, taxpayers must have solid documentation and verify that their facts and results are consistent with this documentation. Another important topic in FAQs is that, in appropriate cases, transfer pricing documentation must take into account the results of both parties in a transaction – sometimes referred to as „bipartisan analysis.“ This theme of allocating the system`s earnings, not just the results for the tested part, builds on the OECD Erosion and Profit Shifting (BEPS) core project and is gaining importance in audits around the world. FAQs review transfer pricing documentation and related punitive rules and provide an overview of best documentation practices. The full text of the FAQ is also available below. For example, a U.S. company sells heavy machinery that it buys from its foreign parent. An audit of the U.S. trader`s tax return shows that he suffered significant losses in 2017, a controlled year.
These losses are a first indicator that the Intercompany prices paid by the U.S. trader could have been too high. Further analysis of the actual functions, assets and risks divided between the related parties is needed to determine whether the losses were due to poor pricing or business circumstances. Based on an intercompany agreement reached in 2016, prices are set, so the U.S. distributor would expect a return of X% of sales under normal sales conditions. In 2017, the company`s demand for heavy machinery unexpectedly declines, and the U.S. distributor sells fewer machines than expected. The application of the tariff policy means that this reduction in sales volume results in losses for the U.S. distributor. Suppose the pricing policy in the Intercompany agreement is consistent with arm length behavior, and the loss was caused by an unexpected change in business conditions, not by intercompany prices for non-arm length.
In this case, the documentation should explain in detail how the unforeseen circumstances of the business caused the observed financial results and how the losses were not caused by intercompany prices. This approach would address a major problem in transfer pricing analysis and facilitate effective review. On the other hand, it would be counterproductive for the taxpayer to manipulate his group of comparable businesses rather than looking at the circumstances that caused the loss. For example, the taxpayer could, in his documentation, perform an analysis that includes companies that are not really comparable to the trader, but which make the distributor`s results a matter of the profitability of a comparable company. This approach would lead to additional cycles of requests for disclosure documents (IDRs) and a lengthy analysis of the reliability of comparable companies selected by the subject, which could significantly lengthen the review period.