Magazine article The CPA Journal

Transfer Prices in the Real World - 10 Steps Companies Should Take before It's Too Late

Magazine article The CPA Journal

Transfer Prices in the Real World - 10 Steps Companies Should Take before It's Too Late

Article excerpt

The time to prepare for the next transfer-pricing audit is now, before the notice of audit. In fact, multinational taxpayers now have no choice. They must plan their transfer prices and document their planning process before the transactions occur, for the following reasons:

* If individual transfer prices or the whole transfer-pricing structure are not defensible, there is no time to correct them. Disputes are won on facts, and it is impossible to change bad facts once an audit has started.

* Reconstructing the company's position years from now will be difficult or impossible. Necessary documents will have been lost. Reasons for an embarrassing result will have been forgotten. Worst of all, critical persons will have left the company, and it will be impossible to fill the gaps. Gathering the necessary documents in advance can preclude enormous trouble in the future.

* The January 1993 proposed and temporary regulations under IRC Sec. 482 require contemporaneous planning and documentation as a means of justifying transfer prices to the IRS. The process itself has become significant. According to IRS Associate Chief Counsel (International) Robert J. Culbertson, documentation provides the substance for the comparability principle and serves as support for taxpayers that want to take advantage of flexibility. Documentation is what makes the arm's-length standard work.

George N. Carlson of Arthur Andersen stated the following in Deja Vu All Over Again: The New Section 482 Regulations:

Concurrent with the setting of any transfer price, it will be essential for a taxpayer to 1) identify the intercompany transaction; 2) analyze the functions and the risks of the entities participating in the transaction; 3) develop support for a transfer price, normally including evidence on comparable transactions between unrelated parties; 4) select the appropriate (best) method; and 5) set the transfer price. If one were inclined to view the regulations as a "compact" between government and business, flexibility is what is being offered to businesses, but documentation is what is required.

* The taxpayer can avoid the 20% and 40% penalties under IRC Sec. 6662 if it makes a "reasonable effort" to determine its proper tax liability accurately, and if it can show it had a "reasonable belief" its transfer-pricing methodology produced an arm's-length result. It is now clear these tests can be satisfied, and large penalties avoided, by proper documentation and by reliance on professional tax advisors at the time prices are set.

Here are 10 steps to take before the next audit.

STEP 1: Before the beginning of a business cycle, meet with your outside advisors and agree on a game plan. Preparing for a transfer price audit is no different from preparing for any other adventure: the adventurers get together and agree on where they are going, how they will get there, and what they take.

Before the beginning of a business cycle (annual, seasonal or other), the company's senior tax executive and any other managers responsible for transfer pricing should meet with the company's outside tax counsel and tax accountants. The purpose of the meeting is to discuss 1) what method to use to set the company's transfer prices, 2) what financial results this method is likely to produce, 3) what information will be needed to provide the best support for these prices, and 4) who will be responsible for implementing any changes and gathering necessary information. If economists should be engaged to develop competitive data or an industry study, arrangements should be made at this time.

This is also the time to consider whether to seek an Advance Pricing Agreement (APA) with the IRS. The company's outside tax attorneys and accountants should advise how long they believe the process will take, how much it might cost, and whether a favorable agreement is likely. Some practitioners are wary of APAs, and at this writing fewer than 50 APAs have been entered. …

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