U.S. Transfer Pricing Overview. Presented by Will James BKD, LLP

Transcription

1 U.S. Transfer Pricing Overview Presented by Will James BKD, LLP

2 Agenda US. Transfer Pricing (TP) Rules Overview Overview of U.S. Documentation Requirements Required Documentation Penalties Tax Return Disclosure Requirements IRS TP Compliance Initiative Overview of TP Methods Best Method Analysis Final Intercompany Services Regulations Cost Sharing Regulations Advanced Pricing Agreements

3 U.S. Transfer Pricing Rules Relevant Rules/Regulations Section 482 of Internal Revenue Code and the accompanying Treasury Regulations

4 U.S. Transfer Pricing Rules (cont.) Arms length standard In determining the true taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm s length with an uncontrolled taxpayer. A controlled transaction meets the arm s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm s length result) (Treas. Reg (b)(1))

5 Treasury Regulations Overview : Allocation of Income and Deductions among Taxpayers : Determination of Taxable Income in Specific Situations : Methods to Determine Income Tangible Property : Methods to Determine Income Intangible Property : Comparable Profits Method : Profit Split Method : Sharing of Costs : Examples of Best Method Rule : Methods to Determine Income Service Transactions

6 Definition of Controlled (i)(4) Controlled includes any kind of control, direct or indirect, whether legally enforceable or not, and however exercisable or exercised, including control resulting from the actions of two or more taxpayers acting in concert or with a common goal or purpose. It is the reality of the control that is decisive, not its form or the mode of its exercise. A presumption of control arises if income or deductions have been arbitrarily shifted.

7 Overview of U.S. Documentation Requirements TP documentation is required under U.S. tax laws Must be in existence when tax return is filed There is no documentation safe harbor for small taxpayers Penalties will be assessed in cases of taxpayers without adequate TP documentation TP documentation is requested as part of all general tax audits U.S. does not follow OECD Guidelines Relevant law is Internal Revenue Code 482 Documentation prepared for other countries is not acceptable to the Internal Revenue Service (IRS)

8 Required Documentation 1. Overview of taxpayer s business including economic and legal factors which affect pricing 2. Description of organizational structure covering all related party transactions 3. Any specific documents required by 482 regulations (e.g., cost-sharing agreements or market penetration) 4. Description of selected method and explanation of rationale for selecting method 5. Description of unselected methods considered and explanation of why they were not selected

9 Required Documentation (cont.) 6. Description of the controlled transactions, including terms of sale, and any internal data used to analyze those transactions 7. Description of comparables used, how comparability was evaluated and adjustments made 8. Explanation of economic analysis and projections used in developing method 9. Summary of relevant documents collected between the end of the tax year and the date the return was filed 10. General index of principal and background documents and recordkeeping of those documents

10 U.S. Transfer Pricing Penalties Summary Penalty Transactional Net Adjustment Substantial Valuation (20% penalty) Price or value is 200% or more (50% or less) than the correct amount Net adjustment exceeds the lesser of $5 million or 10% of gross receipts Gross Valuation (40% penalty) Price or value is 400% or more (25% or less) than the correct amount Net adjustment exceeds the lesser of $20 million or 20% of gross receipts

11 U.S. Transfer Pricing Penalties Review of IRC 6662 Internal Revenue Code 6662 imposes an accuracy-related penalty for an underpayment of tax attributable to improper transfer pricing ( valuation misstatement ) 20% penalty for substantial valuation misstatements: Claimed transfer price is more than 200% or less than 50% of the arm s length amount or Net 482 adjustment exceeds the lesser of $5 million or 10% of gross receipts 40% penalty for gross valuation misstatements: Claimed transfer price is more than 400% or less than 25% of the arm s length amount or Net 482 adjustment exceeds the lesser of $20 million or 20% of gross receipts

12 U.S. Transfer Pricing Penalties Review of IRC 6662 (cont.) Taxpayers may avoid an accuracy-related penalty by showing: The taxpayer determined its transfer price in accordance with a specific method set forth in the regulations prescribed under 482 and the use of such method was reasonable The taxpayer has documentation (that was in existence as of the time of filing the return) which sets forth its transfer pricing method and which establishes that the use of such method was reasonable and The taxpayer provides such documentation to the IRS within 30 days of a request for such documentation

13 U.S. Tax Return Disclosures Disclosures Covered in Tax Returns? Short Answer Yes Disclosure Forms: Form 5471 U.S. Entity Owns Foreign Subsidiary Schedule M details the transactions between foreign entities Form 5472 Foreign Entity Owns U.S. Subsidiary Form should be filed with income tax return of the affected shareholder $10,000 penalty for failure to file per instance IRS has recently started to vigorously assess penalties for improper filings

14 IRS to Aggressively Review Transfer Pricing Issues Given the economic crisis, the IRS will vigorously investigate U.S. multinational enterprises, which are seen as shopping for best tax deals according to Commissioner Douglas Shulman Will need tax revenues to fund bailouts and other stimulus spending There will be increased public pressure of corporate taxpayers to adhere to not only the letter of the law, but the spirit of the law in their home country law

15 IRS Transfer Pricing Compliance Initiative Overview January 2003 IRS LMSB* Commissioner issued directive launching new transfer pricing compliance initiative Directive instructs agents to Request transfer pricing documentation at opening conference of all audits Enforce 30-day deadline for providing documentation Provide documentation to IRS International Examiner or IRS economist Penalties cannot be waived unless documentation was prepared & submitted timely and approved by Penalty Review Board * Large and Mid Size Business Division (now called Large Business & International Division) Companies with assets over $10 million

16 IRS Transfer Pricing Compliance Initiative - Results IRS continuing to audit more small & mid-size companies as part of mandate IDRs now requests transfer pricing studies as opposed to listing TP documentation requirements under Section 6662 IRS enforcing the requirement that TP documentation be contemporaneous IRS interviewing individuals who prepared the documentation and taxpayer personnel Challenging taxpayer s documentation

17 IRS Transfer Pricing Compliance Initiative Results (cont.) Imposition of penalties Reviewing Form 5471/5472s for data consistency IRS will audit a taxpayer for subsequent tax year if they find an adjustment Can no longer ignore U.S. TP documentation requirements Documentation should be kept current IRS will add 2,000 staff to its international group over the next few years to expand audit coverage Will include transfer pricing economists

18 IRS Transfer Pricing Compliance Initiative Areas of Focus Inbound companies with low profitability All companies with cost sharing arrangements Companies with amended tax returns Services transactions Transfers of intangible property for nil or insufficient compensation

19 Overview of Transfer Pricing Methods Tangible Property Comparable Uncontrolled Price Method Resale Price Method Cost Plus Method Comparable Profits Method Profit Split Method Other Unspecified Methods

20 Overview of Transfer Pricing Methods (cont.) Intangible Property Comparable Uncontrolled Transaction Comparable Profits Method Profit Split Method Other Unspecified Methods

21 Overview of Transfer Pricing Methods (cont.) Services Methods Comparable Uncontrolled Services Price Gross Services Margin Cost of Services Plus Comparable Profits Method Profit Split Method Unspecified Methods

22 Best Method Analysis The arm s length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm s length result. (Treas. Reg (c)(1)). No hierarchy of methods Need to document why the method chosen is the best method and why other methods were not applicable

23 Best Method Analysis (cont.) In determining the best method, need to consider the following: Degree of comparability between controlled and uncontrolled transactions Quality and completeness of the underlying data and assumptions used in the analysis

24 Final Intercompany Services Regulations On July 31, 2009, IRS issued final regulations governing intercompany services transactions Largely consistent with temporary intercompany services regulations issued in 2006 Effective for tax years beginning after July 31, 2009 Services must convey a direct benefit to the recipient of the service Services serve to enhance recipient s commercial position or Recipient would be willing to pay for the same activity or perform the activity itself

25 Final Intercompany Services Regulations (cont.) SCM (cost safe harbor election) cost can be charged for routine (low level) administrative services Specified Covered Services services listed in Revenue Procedure or Low-margin Covered Services median mark-up of comparables is 7% or less To qualify for the SCM, the following must also be met: Services must also not contribute to the key competitive advantages, core capabilities or fundamental success of the group ( business judgment test ) Service must not be a specifically excluded service Taxpayer must maintain required documentation

26 Final Intercompany Services Regulations (cont.) Specifically excluded services, which do not qualify for the SCM include: Manufacturing Production extraction, exploration or processing of natural resources Construction Reselling, distribution, acting as a sales or purchasing agent or acting under a commission or similar arrangement Research, development or experimentation Engineering or scientific Financial transactions including guarantees Insurance or reinsurance

27 Final Intercompany Services Regulations (cont.) Services which are not beneficial should not be allocated Provides an indirect or remote benefit Duplicative Shareholder Passive association

28 Final Intercompany Services Regulations (cont.) Implications Need to ensure compliance with the final intercompany services regulations Review against current practices for intercompany services The charge-out of stock options could potentially be unacceptable in other jurisdictions More documentation is now required for intercompany services arrangements (e.g., intercompany agreements and compliance with SCM) In recent audits, the IRS has focused on cost base of the services fee, how the costs were allocated and how they tie into the general ledger

29 Temporary Cost Sharing Regulations On December 31, 2008, the IRS and U.S. Treasury released temporary cost sharing regulations Had an effective date of January 5, 2009 and can be applied retroactively for all open tax years Temporary regulations have same weight as final regulations Will likely be finalized without any significant changes Replaces the 1995 cost sharing regulations

30 Temporary Cost Sharing Regulations (cont.) Cost sharing arrangement (CSA) is an arrangement in which controlled participants share the costs and risks of developing cost shared intangibles in proportion to their reasonably anticipated benefit shares In order to qualify as a CSA, the following must be met: Cost Sharing Transactions Administrative requirements fulfilled Platform Contribution Transaction (PCT) (buy-in payment) is determined Divisional Interests for the intangibles must be reliable, non-overlapping, perpetual and exclusive

31 Temporary Cost Sharing Regulations (cont.) Investor Model is the fundamental concept for determining results that would have been realized under an arm s-length CSA and for addressing the relationships and contributions of each CSA participant PCT valuation methodologies Income Method Residual Profit Split Method Comparable Uncontrolled Transaction Market Capitalization Acquisition Price Method Unspecified Methods

32 Temporary Cost Sharing Regulations (cont.) Periodic adjustments Applies to all transfer pricing methods used to determine PCT Allows IRS to make an adjustment to the PCT if the PCT was not correct due to the forecasts used at the time Taxpayer cannot make adjustment PCT will likely be analyzed by IRS since cost sharing is a Tier 1 issue IRS has the benefit of hindsight

33 Temporary Cost Sharing Regulations (cont.) Implications CSAs are no longer as attractive as in the past The investor model and periodic adjustment will likely mean that more of the returns accrue to the participant making the PCT contribution Historical CSAs (those before January 5, 2009) needed to be documented by July 6, 2009 to qualify for treatment under the 1995 CSA regulations

34 Advanced Pricing Agreements Agreement Types (Rev. Proc ) Unilateral Bilateral Multilateral Filing Fees Large Taxpayers - $50,000 Small Taxpayers - $22,500 Gross Worldwide Income < $200M annually Small Transactions < $50M annually Intangible Transactions < $10M annually $35,000 for Renewals

35 Questions?