Code Section 482 requires taxpayers that conduct related party sales and transactions to use arms-length pricing. Section 482 particularly applies to international transactions given the possibility to shift taxable income out of the United States by overcharging or undercharging in these transactions.
Taxpayers who violate these pricing rules can be subject to a 20% adjustment penalty, or at times a 40% adjustment penalty. However, if taxpayers at the time of the transaction make a good-faith effort to compute a fair arms-length price and properly document their efforts, even if the IRS later adjusts the pricing, the 40% penalty will not apply. Treasury regulations provide what documentation and analysis is required of the taxpayer. Generally, this documentation and analysis must be provided to the IRS within 30 days of an IRS request.
In a recent International Practice Unit (IPU) advice, the IRS provides steps for its auditors to take in regard to outbound Section 482 transactions. Taxpayers and advisers involved in Section 482 transactions should review it, both as to planning to avoid penalties and in dealing with an audit.
The IPU instructs the examiner to request the 10 documentary and analysis items that the regulations require to avoid the 40% penalty. The IPU notes that just because the taxpayer produces all 10 items does not mean they are automatically off the hook for a 40% penalty.
Aside from review of the 10 items, examiners are instructed to pull certain schedules from Forms 5471, 8858, and 8865 to locate missing controlled transactions. Since the IRS is going to do this, tax preparers and advisers should do the same, preferably before filing the Form 5472 and other tax return filings for the applicable year to make sure nothing is omitted.
Examiners are also instructed to review the taxpayer's financial statements to make sure they line up with the transfer price documentation being provided. Again, this is something that should be done by the tax preparers and advisers.
A hidden trap for taxpayers is the requirement under Treasury Regulations Section 1.6038A-3 to maintain certain backup records. These records are in addition to the 10 documentary items taxpayers are required to maintain for penalty avoidance. Since the examiner is directed to specifically ask for these items under the IPU, taxpayers and their advisors should establish procedures to maintain those records during the applicable statute of limitations period. These records include original entry books and transaction records, profit and loss statements, pricing documents, foreign country and third-party filings, ownership and capital structure records, records of loans, services, and other non-sales transactions, and records relating to conduit financing arrangements.
The IPU also points the examiner to other IRS guidance as to particular Section 482 issues and compliance.
The IPU provides specific analysis questions that the auditor should examine. Knowing these questions in advance will assist the taxpayer in preparing for an audit.
Review of Transfer Pricing Documentation by Outbound Taxpayers (ISO/PUO/P_1.7_02(2014)) (Mar. 4, 2016)