US IRS Updates on Transfer Pricing Penalties

The IRS has recently reaffirmed its commitment to closely scrutinizing both the documentation and methods used in transfer pricing cases, signaling a stronger stance on penalties for non-compliance. According to key IRS representatives, the agency is intensifying its focus on ensuring that taxpayers meet the necessary standards when reporting transfer pricing, particularly in light of recent developments and court cases.

IRS TO ASSESS BOTH DOCUMENTATION AND METHOD

In a recent address on September 18, 2024, an attorney with the IRS Office of Associate Chief Counsel (International), emphasized that taxpayers must ensure their transfer pricing documentation is up to date and comprehensive and advised that taxpayers consult the IRS’s FAQs on transfer pricing documentation to fully understand the agency's requirements. 

However, she stressed that providing sufficient documentation alone is not enough. To avoid penalties, the chosen transfer pricing method must also be reasonable and meet IRS standards. 

This announcement follows earlier comments publicly made by the Director of Field Operations for the IRS Transfer Pricing Practice, who noted that the IRS is increasingly willing to impose penalties, even when documentation is provided if it deems the documentation inadequate or the method unsound. He added that the IRS plans to hire around 70 new specialists, including economists, tax experts, and revenue agents, to strengthen the transfer pricing practice.

A HISTORY OF PENALTY ENFORCEMENT AND UPCOMING CHANGES

For several years, the IRS has signaled its intent to take a stricter approach to transfer pricing documentation and penalties. 

Recent transfer pricing disputes highlight the IRS's readiness to assert penalties. In high-profile cases involving companies such as Walgreens Boots Alliance and Eaton Corp., the IRS imposed penalties for inadequate transfer pricing documentation, further underscoring its commitment to enforcing stricter standards.

PENALTIES UNDER IRC SECTION 6662

The legal framework for transfer pricing penalties is outlined in IRC Section 6662, which imposes a 20% penalty on any underpayment of tax due to a substantial valuation misstatement. This penalty applies specifically to transactions involving parties described in IRC Section 482, either under the transactional penalty or through a new IRC Section 482 transfer price adjustment (the net adjustment penalty). If the valuation misstatement is deemed "gross," the penalty increases to 40%.

Taxpayers can protect themselves from penalties under IRC Section 6662(e)(3)(B) by following specific conditions. They must use a method outlined in the regulations, have documentation that supports their transfer pricing method, and provide this documentation to the IRS within 30 days of a request. Failure to meet these criteria increases the risk of penalties.

IMPLICATIONS FOR TAXPAYERS

The IRS’s renewed focus on transfer pricing and penalties should serve as a clear warning to taxpayers. The agency has made it clear that simply maintaining standard documentation may not be enough to avoid penalties. The quality of the documentation and the reasonableness of the transfer pricing method are both crucial factors that will be carefully scrutinized in any IRS audit or examination.

Given this, taxpayers should take proactive steps to ensure their transfer pricing policies and practices fully align with the IRS's evolving expectations. This includes thoroughly reviewing existing documentation to verify that it is comprehensive and compliant with the latest IRS guidelines. By doing so, taxpayers can better protect themselves from the risk of penalties under IRC Section 6662, even when standard documentation is in place.

The IRS's increasing focus on transfer pricing emphasizes the need for companies to be fully prepared for potential audits or examinations. Strengthening internal transfer pricing practices now could help avoid costly disputes and penalties in the future.

SOURCE/RECOMMENDED READ: 

• US IRS representatives say IRS will evaluate transfer pricing documentation and method when deciding on penalties (ey.com)

• IRS Transfer pricing documentation best practices frequently asked questions (FAQs) are accessible via this Link: Transfer pricing documentation best practices frequently asked questions (FAQs) | Internal Revenue Service (irs.gov)