Transfer pricing documentation for the small and mid-size company.

• Author: Kral, Mark E.

Background

The IRS's powers have steadily increased since Sec. 482 was amended by the Tax Reform Act of 1986. The changes made to Sec. 482 and the regulations thereunder have given the Service greater power to recharacterize transactions between related parties involving the transfer of tangible goods, services and intangibles.

Final Sec. 482 regulations issued on July 8, 1994 require taxpayers to gather documentation that supports the transfer prices used in their related-party transactions of both tangible and intangible property prior to the transactions, rather than years later during an IRS exam. Although the transfer pricing provisions apply to all taxpayers regardless of size, the documentation burden will fall especially hard on the small and mid-size companies that are also required to comply. However, many of the small or mid-size companies cannot afford the help of an outside consultant to assist them in the gathering of the documentation to defend against the assessment of penalties for noncompliance. Although a safe harbor exception is available for "small" taxpayers, very few companies will meet the eligibility tests. This leaves the small and mid-size companies scrambling to comply in a costefficient manner.

To force taxpayers to comply with the documentation requirements, Congress has added legislation providing authority and penalties to enforce these requirements (Secs. 6038A and 6662).

Required documentation

Taxpayers must choose and document the "best method," the one that provides the most accurate arm's-length result. Therefore, small and mid-size companies must select a specified method (detailed by the regulations) or unspecified method (unique method) and justify the selection.

Temp. Regs. Sec. 1.6662-6T(d)(2)(iii) requires that two types of documents must be maintained--principal documents and background documents. The regulations specifically require nine types of principal documents, which should describe in a complete and accurate manner the basic transfer pricing analysis conducted by the taxpayer to support the transfer pricing method used.

1. An overview of the taxpayer's business. This should include a narrative description of the company's history, product(s) produced, and explanations of specific factors or conditions that may have contributed to positive or negative financial results.

2. A description of the taxpayer's organizational structure. This should include organizational charts, personnel lists of...