Welcome to Transfer Pricing Documentation Season
Authorities are increasing their focus on transfer pricing to prevent multinational corporations (“MNCs”) from shifting income into lower tax jurisdictions. Thus, it is prudent to prepare contemporaneous transfer pricing documentation annually.
Understanding which rules and regulations apply to transfer pricing documentation in the United States is critical. U.S. Internal Revenue Code ("IRC") § 482 and the Treasury Regulations thereunder ("Section 482 Regulations") govern the regulations that apply to the pricing of intercompany transactions. The U.S. also requires contemporaneous documents under IRC § 6662 and the Section 482 Regulations. A contemporaneous transfer pricing documentation study is intended to provide a substantial portion of items (1) through (8) of the "principal documents" that Treasury Regulations § 1.6662-6(d)(2)(iii)(B) indicates are needed when the tax return is filed. Taxpayers must also maintain principal documentation relating to subparts (9) and (10) of Treasury Regulation § 1.6662-6(d)(2)(iii)(B) plus any necessary background documentation.
Contemporaneous documentation is a transfer pricing report that a taxpayer prepares before he/she files the federal tax return. Preparing a transfer pricing report is not required under the Section 482 Regulations; however, IRS agents commonly request a copy of the taxpayer's contemporaneous documentation. Having a thoroughly prepared, contemporaneous documentation study eliminates the risk of an IRS transfer pricing penalty, which can add 20-40% if the taxpayer provides this documentation within 30 days of an IRS request. Two penalty-protection criteria that the study needs to fulfill are (1) it provides a reasonable basis of support for the taxpayer’s transfer pricing; and (2) it is completed before the tax return is filed.
Without the aforementioned documentation, the IRS can impose penalties and a tax adjustment, depending on the significance of the misstated transfer prices. An MNC must make a reasonable, good-faith effort to apply the Section 482 Regulations when it prepares contemporaneous documentation in order to receive penalty protection. Taxpayers should carefully review the statement of facts in the documentation to ensure that the information accurately reflects the functions, risks and assets of their business for that particular year. This provides the MNC penalty protection in the event of an IRS examination. For additional information, please visit our Transfer Pricing page.