Magazine article The CPA Journal

How to Avoid Penalties for Transfer Pricing Violations

Magazine article The CPA Journal

How to Avoid Penalties for Transfer Pricing Violations

Article excerpt

Many related parties transfer goods or services between or among themselves. Challenges by the IRS to the prices underlying such transactions may lead to transfer price adjustments (TPAs). TPAs may, in turn, lead to the assessment of penalties--calculated on the portion of any underpaid taxes attributable to a TPA that exceeds certain thresholds--for either "substantial" or "gross" valuation misstatements. While transfer pricing issues ordinarily are thought of as involving international transactions only, it should be noted that the issues apply to domestic transactions as well.

Before the 1993 tax act, one of the thresholds was so high that few small and medium-sized companies were affected. However, Congress has lowered that threshold, thereby greatly expanding the number of such companies that may now be subject to the penalties.

BEFORE THE 1993 TAX ACT

Before RRA '93, IRC Sec. 6662 included the following provisions:

1. A 20% penalty could be assessed for a "substantial valuation misstatement" (SVM). An SVM occurred when either one of the following conditions existed:

(a) The original transfer prices were either (i) 20% or more than, or ii) 50% or less than, the prices eventually determined by the IRS to be correct (the redetermined prices) or

(b) The TPA exceeded $10 million.

For example, a taxpayer might have reported a transfer price of $50 per unit of a product sold to a related entity. There would be an SVM if-

(a) the IRS determined that the price was (i) $100 or higher (200% or more than $50) or ( $25 or lower (50% or less than $50) or

(b) the total adjustment to the transfer price exceeded $10 million.

2. A 40% penalty could be assessed for a "gross valuation misstatement" (GVM). A GVM occurred when either one of the following conditions existed:

(a) The original transfer prices were either (i) 400% or more than, or (ii) 25% or less than, the redetermined prices or

(b) The TPA exceeded $20 million.

3. The calculation of the TPA would ignore any portion of the redetermined prices where the taxpayers could establish both of the following:

(a) There was a reasonable cause for the calculation of the original transfer prices and

(b) The taxpayers acted in good faith.

POST-RRA '93

RRA '93 does not change the aforementioned percentage thresholds. …

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