Transfer Pricing Documentation FAQs

​Rödl & Partner Tax Matters Vol 2020 – 6, published April 29, 2020

In April 2020, the IRS released a list of frequently asked questions (“FAQs”) for transfer pricing documentation best practices. These FAQs are intended to assist taxpayers and their advisors in assessing the quality of their transfer pricing documentation to ensure compliance in the event of an IRS audit. With transfer pricing documentation in place, taxpayers can generally avoid substantial penalties that can be assessed during an IRS audit. Two important requirements that transfer pricing documentation should strive to meet are the following:

• Adequate and Reasonable: There should be adequate documentation and reasonable support for the transfer pricing method(s) selected as the so-called “Best Method(s)” in the analysis
• Timely: Transfer pricing documentation should technically be completed prior to the point in time when the tax return is filed and should be provided to the IRS within the requested timeline indicated on the IRS’s information document request (“IDR”)

With proper and timely documentation, the IRS audit process is a more efficient process for all parties involved. The IRS has observed in recent years that the quality of transfer pricing documentation has declined, opening taxpayers to additional penalties that could have been avoided with the appropriate level of attention given to meeting the documentation requirements. High quality transfer pricing documentation has the additional benefit of potentially allowing the IRS agent to quickly dismiss transfer pricing as an issue during an IRS audit. The timeline for an IRS examination can be unnecessarily extended if the revenue agent is forced to issue IDRs for items that would have been included in appropriately structured transfer pricing documentation.

In response to the observed decline in documentation quality, the IRS offers in the form of FAQs the following guidance to improve the quality of taxpayers’ transfer pricing documentation:

• Taxpayers and advisors should perform a self-assessment of weak points in their current transfer pricing documentation to proactively make adjustments.
• Taxpayers should exercise caution when determining the comparability of uncontrolled companies and transactions. The IRS has access to many of the same databases as taxpayers and may challenge the comparability of companies and/or transactions selected.
• Transfer pricing documentation should include robust descriptions of the nature of the taxpayer’s operations, related party transactions, and functional and risk profile. With a better understanding of the taxpayer’s operations, it is easier for the IRS to assess the arm’s length nature of the taxpayer’s results.
• Transfer pricing documentation should include an explanation of the data used in the analysis, descriptions of business risks, and how profits are allocated among all related parties.
• Data presented in the documentation should be clear and concise, particularly when summarizing related party transactions.

In summary, the recent release by the IRS of transfer pricing documentation FAQs in the midst of the COVID-19 pandemic reemphasizes the fact transfer pricing remains an issue of substantial focus for the IRS in its examination activities. As a result, all U.S. taxpayers with material related party transactions should take appropriate action to assess the quality and contemporaneous nature of their existing transfer pricing documentation to ensure that they are appropriately prepared in the event of an IRS examination.

If you have any questions, please contact your local Rödl & Partner representative.

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