United States: Transfer Pricing Audits Under The New Transfer Pricing Examination Process

Last Updated: July 24 2018
Article by Thomas Linguanti and Daniel M. Sosna

Serving as a roadmap for how the Internal Revenue Service intends to conduct transfer pricing examinations, the recently released Transfer Pricing Examination Process guide provides a set of processes and practices for the planning, execution, and resolution of transfer pricing audits. Taxpayers should familiarize themselves with the guide at the start of a transfer pricing examination in order to learn what to expect—and what is expected of them—in each phase.

The Treaty and Transfer Pricing Operations (TTPO) group of the Large Business & International (LB&I) division of the Internal Revenue Service (IRS) issued a memorandum (LB&I-04-0618-012) on June 29 announcing the release of the Transfer Pricing Examination Process (TPEP) guide for use in transfer pricing examinations. According to the announcement, the TPEP guide is not a rigid checklist of required steps, but rather a set of “best practices and processes” intended to assist with the planning, execution, and efficient resolution of transfer pricing examinations consistent with the LB&I Examination Process (LEP). The TPEP guide has replaced the Transfer Pricing Audit Roadmap (the Roadmap), issued in 2014, which also provided a set of recommended audit procedures to guide transfer pricing examinations.

The backdrop to the release of the TPEP guide should be familiar to taxpayers with transfer pricing issues. The goal of a transfer pricing examination is to “determine an arm’s length result under the facts and circumstances of the case,” which by necessity requires a “thorough analysis of functions, assets, and risks along with an accurate understanding of relevant financial information.” To ensure that resources are utilized effectively, LB&I is now using “data analytics” to help it identify those issues with the most significant risk for taxpayer noncompliance. Nonetheless, given the sheer size and complexity of today’s transfer pricing examinations, the TPEP guide is intended to supplement that effort and be used by auditors and taxpayers alike to help streamline the audit process, ensure the efficient use of resources, and facilitate the timely resolution of transfer pricing issues.

Like the Roadmap, the TPEP guide is broken into three phases: planning, execution, and resolution. Taxpayers will receive the TPEP guide at the start of a transfer pricing examination. Because it provides important insights into how the IRS views transfer pricing examinations and imposes certain obligations on taxpayers during a transfer pricing audit, it is imperative that taxpayers become familiar with the new TPEP guide and understand what is expected of them during each phase.

Planning Phase

The first phase of the TPEP guide determines the scope of the transfer pricing audit. During the “planning phase” the taxpayer is expected to work with the “issue team” assigned to the specific transfer pricing examination to develop an issue-focused examination plan, including audit steps, proposed timelines, and communication agreements, to ensure the timely resolution of the transfer pricing examination.

The planning phase devotes significant attention to an “initial transfer pricing risk assessment.” Risk assessment is a “continuous process that occurs throughout the audit,” the purpose of which is to identify controlled transactions warranting additional examination and to gather and analyze information relevant to those transactions. This effort, in turn, culminates in the development of a “preliminary working hypothesis” intended to guide the overall transfer pricing examination. Under the TPEP guide, the preliminary working hypothesis is a “fluid concept” that is supposed to evolve as additional information is obtained over the course of the audit. The issue team is directed to develop its initial working hypothesis by taking into consideration numerous factors, including whether the taxpayer’s overall tax position benefits from “income shifting,” industry averages/benchmarks (if available), the use of hybrid entities within the taxpayer’s global structure, and the taxpayer’s worldwide effective tax rate and overall profitability.

The initial transfer pricing risk assessment process also includes a review of the taxpayer’s prior year workpapers and tax returns/forms. Particular attention is paid to Form 8975 (the Country-by-Country Report), which the TPEP guide describes as a “tool intended to provide useful information to analyze high level transfer pricing risk” and “Base Erosion and Profit Shifting (BEPS) related risk.” Similarly, the TPEP guide notes that Schedule UTP can be used to help identify controlled transactions warranting additional scrutiny. Moreover, in order to obtain additional information concerning the taxpayer’s history, background, and business operations, the issue team will review the taxpayer’s publicly filed documents (e.g., Form 10-Ks) and undertake a “complete . . . internet search of the taxpayer’s name.” In accordance with the IRS’s renewed emphasis on the sharing of information across borders, when the issue involves a treaty country the issue team is directed to collaborate with the Advance Pricing Mutual Agreement (APMA) program and “will consider obtaining information or foreign-based documentation from treaty partners” pursuant to treaties or other mechanisms.

The planning phase emphasizes significant taxpayer participation. In particular, the taxpayer is expected to attend an “opening conference” with the issue team to discuss, among other topics, the LEP and the three phases of the process (planning, execution, and resolution), the new TPEP guidelines, the preliminary scope of the transfer pricing examination and general timelines, and the potential need for interviews and site visits. The issue team will also share with the taxpayer its initial risk analysis and preliminary working hypothesis for discussion.

In addition, the issue team will note its “expectation” for a taxpayer-led “financial statement orientation meeting.” This meeting, ideally to be scheduled within 30 days of the opening conference, will require that the taxpayer compile segmented financial statements and records and identify key employees responsible for accounting records. Similarly, the issue team may request a “transfer pricing/supply chain orientation.” This presentation, which occurs after the financial statement orientation meeting, is intended to provide the issue team with a “comprehensive” overview of the taxpayer’s “business operations, key functions, worldwide structure, . . . and transfer pricing policies.”

At the conclusion of the opening conference, the issue team will establish an estimated audit timeline with key milestone dates for completion of the transfer pricing examination. The examination plan, timeline, and initial risk assessment are then provided to the taxpayer.

Execution Phase

The “execution phase” of the TPEP guide is focused on fact and issue development. The issue team is expected to have regular “interactive discussions” with the taxpayer to develop the facts and resolve areas of factual disagreement. In accordance with the new LB&I directive on transfer pricing examinations, and in contrast to the requirements of the Roadmap, the initial transfer pricing information document request (IDR) is no longer required in all cases. Nonetheless, extensive use of the IDR process remains, and through that process the issue team is expected to become knowledgeable about the taxpayer’s organizational structure, history, business, and value-drivers, and to gain a full and complete understanding of the controlled transactions under examination. “Open communication” between the issue team and taxpayer and “weekly or bi-weekly” discussions and periodic meetings to discuss the IDR/audit process, facts of the case, and the issue team’s preliminary findings are deemed “critical.” Ongoing communication between the taxpayer and the issue team is intended to facilitate the flow of information and help the issue team “reassess/adjust working hypothesis(es)” and “determine which transactions warrant further development or whether issues should be closed.”

The issue team is also tasked with preparing a “mid-cycle risk assessment” to reflect the results of its ongoing risk assessment. This, in turn, is intended to impact the overall working hypothesis of the examination because the issue team is expected (at least in theory) to update and refine its thinking about the transfer pricing issues under audit as additional information is obtained. Further to that goal, the issue team and Practice Network members, LB&I division counsel, and respective managers will hold regular “reassessment meetings” to discuss the audit’s progression, any resource issues, and the need (if any) for outside experts. These discussions are also to include an assessment of the taxpayer’s best method selection and whether the taxpayer’s characterization of the transaction is appropriately framed. If the issue team ultimately determines that the transaction as structured differs from the taxpayer’s characterization and/or the taxpayer’s method is not the best method to price the controlled transaction, the issue team must seek approval to use a different method from the TTPO Transfer Pricing Review Panel “as early as possible.” Along the same lines, the TPEP guide states that transfer pricing penalties “should be considered whenever adjustments are made to a tax return.” The decision whether to assert penalties is an iterative process and rests primarily with the issue team, with input from LB&I counsel.

During the execution phase the issue team works with economists and other experts to prepare an economic analysis consistent with the examination’s working hypothesis. Once a draft Economist Report is completed, the issue team will schedule a meeting with the taxpayer to discuss the preliminary analysis.

The final step of the execution phase is the acknowledgement of facts (AOF) IDR. The AOF IDR is a statement of facts related to an “unagreed issue.” It is issued to the taxpayer along with a request for the taxpayer to acknowledge that the facts as stated are accurate. A response is voluntary on the part of the taxpayer and the overall utility of the exercise is questionable in light of the IRS’s general unwillingness to revise its view of the facts based on taxpayer feedback. Nonetheless, the issue team is supposed to consider “all relevant facts, including those from the taxpayer’s response to the [AOF] IDR, . . . before issuing a final [Notice of Proposed Adjustment (NOPA)] and Economist Report,” and therefore taxpayers should take the time to review the AOF and, at a minimum, make note of any incomplete and/or mischaracterized facts.

Resolution Phase

The final phase of the TPEP guide involves “early and frequent discussions with the taxpayer” with the goal to reach “agreement, if possible, on the tax treatment of each issue examined.” During the “resolution phase” the issue team and the taxpayer are intended to meet to discuss the results of all issues, including the facts as presented in the AOF IDR, prior to the NOPA and Economist Report being issued in final form. This meeting is intended to promote “open dialogue” between the parties to determine “whether a principled resolution can be reached.” The issue team and the taxpayer should also discuss alternative dispute resolution mechanisms, such as Early Referral to Appeals (Rev. Proc. 99-28) and Fast Track Settlement (Rev. Proc. 2003-40).

If the issue is agreed, the issue team will adhere to the appropriate case-closing procedures to close the issue. If the issue is unagreed, then the issue team will issue a final NOPA and Economist Report. Per the Appeals Judicial Approach and Culture guidelines, the issue team will request that the taxpayer extend the period of limitations on assessment if fewer than 365 days remain. After the final NOPA and Economist Report are issued, the issue team prepares the 30-day letter and case-closing workpapers. The taxpayer will then have the opportunity to submit a protest. If the protest “contains new factual information, raises new factual disputes, or presents new economic or legal theories,” the issue team should “re-engage the examination process” and issue “additional IDRs” prior to the transfer of the matter to the jurisdiction of IRS Appeals. In that situation, the issue team is also directed to “re-evaluate the timeline and reset the [audit] milestone dates, as appropriate.” Once the case is transferred to IRS Appeals, the issue team will contact the appeals officer and request permission for the issue team to attend the taxpayer’s portion of the IRS Appeals presentation (see IRM

Finally, when the transfer pricing issue under examination involves a treaty country, taxpayers may request US Competent Authority (US CA) assistance immediately after the amount of the proposed adjustment is communicated to the taxpayer in writing. If the request for US CA assistance is accepted by the APMA program, it assumes jurisdiction over the specified transfer pricing issues. Generally, US CA issues accepted for consideration are not subject to the concurrent jurisdiction of IRS Appeals. Another possibility, however, is for taxpayers to request Simultaneous Appeals Procedure (SAP) review. SAP provides the means to obtain concurrent review of a disputed issue by both IRS Appeals and the US CA. The end result is a nonbinding position, which the US CA may or may not take into account in negotiating with the treaty partner. Taxpayers should note, though, that with respect to a US CA issue initially under the jurisdiction of IRS Appeals, the US CA will decline to provide assistance unless the taxpayer effectively severs the issue from its protest and then timely files a US CA request with respect to the issue.


The TPEP guide is an updated roadmap for how the IRS intends to conduct transfer pricing examinations, starting from the identification of issues and related risk assessment analysis, to the formulation of a working hypothesis and supporting fact-gathering efforts, and through to the resolution of transfer pricing issues. Taxpayers would be well advised to become familiar with the TPEP guide in order to best present their transfer pricing methodologies within the appropriate business context and maximize the probability of a successful transfer pricing examination. Moreover, in light of the emphasis on open and active communication, taxpayers should be prepared to engage in continuous dialogue with the issue team through each phase of the process. Engaging constructively with the issue team will not only help to facilitate an orderly and efficient examination, but also presents taxpayers with a meaningful opportunity to influence the direction of the audit toward a successful resolution.

This article is provided as a general informational service and it should not be construed as imparting legal advice on any specific matter.

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