Road Map to a Transfer Pricing Controversy: Preparing for success in audits and litigation in a strict enforcement environment.

AuthorFisher, Miriam

In recent decades, the Internal Revenue Service has pursued numerous long-running and complex transfer pricing audits. Although many have been resolved administratively, or prior to trial, the IRS has a decidedly uneven record in its litigation of high-profile transfer pricing disputes, not infrequently finding itself in the loss column in the courtroom.

Not long after being sworn in as the new commissioner of the IRS in late 2018, Charles Rettig addressed this record by making it clear that the IRS was undeterred by its losses in court. He described litigating transfer pricing disputes as a key IRS enforcement strategy, because the agency perceives transfer pricing as an area where taxpayers often are not in compliance. He warned:

If we're in your neighborhood and that's your world, you will tighten it up going forward.... When we bring five transfer pricing cases and the court rules against us, you don't have a Commissioner who thinks we lost. We're going to wonder why we didn't bring ten. (1) Since his early comments, Rettig has emphasized the resources the IRS brings to bear in transfer pricing disputes, its expectations about taxpayer cooperation, and its willingness to litigate difficult cases if necessary. The Commissioner's "no backing down" message is echoed by other IRS leaders who have vowed the IRS will continue to litigate issues that remain unresolved.

This is the current environment for taxpayers facing transfer pricing disputes with the IRS. For these important high-dollar cases, the IRS is well resourced and determined and can be aggressive, procedurally and substantively. Its wealth of experience and organizational structure allows it to dedicate large multifaceted teams to handle transfer pricing audits and litigation. Coordination among global tax authorities has improved. The IRS is using new data and analytical tools, has access to economists and other experts, and does not hesitate to take forceful procedural stances and to assert penalties.

In light of this challenging environment, a taxpayer's best chance for a favorable outcome is to prepare for IRS scrutiny when planning transactions, specifically when preparing transfer pricing documentation, which will be the starting point of any examination. A well-supported valuation documented in accordance with the regulations and meeting the IRS' articulated expectations will go a long way toward starting an audit on the right foot.

Prior to an examination, it is important to preserve the transactional record, to marshal the information and key witnesses, and to shape the narrative that will ultimately support the taxpayer's position. Relevant information may come from years both prior to and after the transaction. It is also critical to understand how the IRS manages and conducts transfer pricing audits. During the examination, it is important to be responsive, proactive, and cooperative with the Exam team, working through issues to identify and define areas of agreement and dispute. Finally, a taxpayer must be prepared for the possibility that, in the case of a serious disagreement, penalties may be asserted, and the IRS may be willing to litigate.

Best Practices-Establishing the Taxpayer's Position

The key to navigating a transfer pricing audit successfully is preparation. That means properly establishing transfer pricing positions in accordance with both the governing regulations and IRS expectations. Although transfer pricing regulations are easy enough to identify, understanding IRS expectations for a transfer pricing audit can be more difficult. Fortunately, the IRS has provided resources to guide taxpayers in this regard. These resources include (among other items):

* "Publication 5300--Transfer Pricing Examination Process" (available at, a detailed guide to IRS field personnel in conducting transfer pricing examinations (known as TPEP);

* Industry Practice Units (IPUs), published by the IRS to assist examiners with general tax concepts and to assist with specific transactions. Transfer pricing IPUs are available at, including "Review of Transfer Pricing Documentation by Outbound Taxpayers" and "Review of Transfer Pricing Documentation by Inbound Taxpayers";

* LB&I Industry Directives, such as "Instructions for Examiners on Transfer Pricing Issue Examination Scope--Appropriate Application of IRC [section]6662(e) Penalties" (available at, which provides insight into the IRS' view of the documentation requirements and when penalties may be asserted; and

* LB&I's Transfer Pricing Documentation Frequently Asked Questions (FAQs) (available at, which provides a significant amount of detail around IRS expectations for transfer pricing documentation.

Taxpayers should review these materials thoroughly to understand the IRS perspective on establishing a transfer pricing position. The IRS penalty discussions are particularly useful because Internal Revenue Code Section 6662(e)(3) imposes a transfer pricing penalty only if taxpayers fail to document their transfer pricing positions adequately. Section 6662(e)(3), along with the accompanying regulations in Treasury Regulations Section 1.6662-6, requires that taxpayers 1) reasonably...

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