Multinationals must be able to defend their intercompany pricing to any relevant national tax authority, including the Internal Revenue Service (IRS). While the IRS may have been the most active tax authority examining transfer pricing issues 20 years ago, most of our trading partners have seen their national tax authorities initiate active transfer pricing reviews. The limited good news is that most national tax authorities claim to honor the arm's-length standard as their criteria for evaluating whether your intercompany prices will be respected. Multinationals, however, are concerned that more aggiessive national tax author-ides in a wider number of global jurisdictions will take different views as to how this arm's-length standard will apply in their specific situation.
On Feb. 14, 2014, the IRS released its Transfer Pricing Audit Roadmap, which is a 26-page document advertised as a "practical, user-friendly toolkit" for IRS transfer pricing specialists as well as other members of IRS Examination. The roadmap's introduction starts with the ominous tone that IRS examinations of the transfer pricing policies of any particular multinational under scrutiny are complex projects requiring up-front planning where the "proper development of a transfer pricing position may take as much as 2-3 years or more."
We shall note, however, that the overarching theme of this roadmap traces back to very old-fashioned and sensible concepts, which should encourage multinationals to document the arm's-length nature of their intercompany policies properly.
Multiple Phases and Tests
The introduction to the roadmap emphasizes that transfer pricing issues turn on the facts surrounding the intercompany pricing issue. The roadmap encourages IRS Examiners to construct a compelling story of what drives the multinational's financials based on the functions, assets and risks of the related party entities involved in the intercompany transactions at issue. If the taxpayer's financial results are reasonable and its transfer pricing methodology fits the fact profile, the roadmap suggests IRS Examination should not pursue the issue. If, however, the taxpayer's results are "at odds with common sense and economic reality," the roadmap suggests the transfer pricing issues deserve further scrutiny.
The roadmap lays out a three-phase process of any inquiry into a multinational's transfer pricing: Planning, including pre-examination and initial risk analysis; Execution, including information-gathering and issue development; and Resolution.
The planning stage, however, includes having the Examination team review any transfer pricing documentation the multinational has prepared. Ideally, this documentation provides the taxpayer's compelling story as to why its methodology fits the facts and why its financial results are reasonable. If the IRS Examination team is convinced by the multinational's documentation report, the execution and resolution stages would not be necessary.
If the taxpayer does not provide a convincing documentation report, the IRS team may proceed to the next stages. The execution stage envisions the Examiner...