Salans Vox Tax Transfer Pricing Documentation Survey - Part 3

USA
By Robert G. Rinninsland, The Ruchelman Law Firm (New York)

#1 Yes IRC 6662 and the resulting Treasury Regulations require taxpayers to support their transfer pricing methodology for "controlled transactions" as defined under US transfer pricing law and regulations.

#2 US transfer pricing rules call for "contemporaneous" documentation to support transfer pricing methodology for controlled transactions entered into for each taxable year. The documentation must be kept with the file for that year's tax return. Documentation requirements apply for the first taxable year of the controlled transaction. Retroactive documentation might be appropriate or necessary in some circumstances. While this will be accepted by the IRS it is given less weight than contemporaneous documentation. As a practical matter, detailed transfer pricing documentation can persuade the IRS that a transfer pricing adjustment is not necessary. Accordingly, the practice is that even if a taxpayer previously failed to contemporaneously document their transfer pricing, for an open (to audit) tax year, it should consider preparing documentation if it expects an examination of that year.

#3 No

#4 The IRS has informally said that (a) companies with intercompany transactions in excess of USD 5 million can expect to have an IRS international examiner review their intercompany transactions and (b) companies with sales in excess of USD 10 million can expect to have an IRS economist review their intercompany transactions.

The economist is brought into a case at the request of the international examiner. Therefore, a taxpayer can face a transfer pricing adjustment that may or may not have been derived by an economist. An economist entering a case will have responsibility for either drafting, or reviewing the international examiner's draft of the proposed transfer pricing adjustment.

If the audit is in the domain of the large and mid-size business division ("LMSB") and there is a transfer pricing issue, then international examiners are instructed that it is mandatory to request the IRC 6662 documentation.

For non-LMSB cases, a referral for economic assistance is mandatory if the issue has a potential deficiency of over USD 500 000 or will have significant precedential value.

#5 US transfer pricing rules in general, including documentation requirements, apply to all "controlled transactions". In this regard, the concept of control is broadly construed to mean any type of control, however exercisable or exercised, including control resulting from actions of two or more taxpayers acting in concert or with a common goal (profit making) or purpose. Thus any transactions between a permanent establishment and an associated enterprise that are considered "controlled transactions" will be subject to normal US transfer pricing scrutiny.

#6 As a general matter US state and local tax authorities are concerned about the creation of tax-motivated corporate structures employing related-company transactions to reduce corporate income tax liabilities. This concern has caused these jurisdictions to adopt legislation and foster other administrative and judicial initiatives to deny deductions for certain related company expenses. However, application of transfer pricing rules in the state and local context has been inconclusive from the state and local tax authority perspective. They have thus focused on other means of dealing with controlled transactions most notably in expansion of their definition of a "unitary" business subject to state tax nexus in general and calculation of state taxable income by reference to the apportionment of property, sales and payroll in particular. Where transfer pricing principles are applicable in a given state and local tax jurisdiction, the federal documentation requirements apply as a practical matter.

#7 No proper transfer pricing documentation protects taxpayers from penalties that could be imposed with respect to material transfer pricing adjustments. The adjustments themselves can still be made.

#8 A basic APA is an agreement between the IRS and the taxpayer whereby at the request of the taxpayer the IRS reviews and agrees to WisCo's transfer pricing methodology.

The APA describes the factual nature of the related party transactions, the appropriate pricing methodology and the expected range of results from applying the methodology to the transaction.

If the taxpayer applies the agreed upon methodology, the IRS will not adjust transfer prices for the term of the APA.

The APA will include a set of critical assumptions that, if followed, will not result in an examination of transfer pricing in the future.

The IRS's APA team will grant a pre filing meeting to the taxpayer to receive any input from the IRS before filing for an APA.

Although APAs have traditionally been the purview of large companies, the IRS has issued streamlined procedures to make the process more cost efficient for smaller companies.

Practical issues with the APA program relate to administrative expense and reluctance of taxpayers to voluntarily provide the necessary information to the IRS to obtain an APA. The first concern should be weighed against the expense of providing annual contemporaneous documentation. The latter concern should be weighed against the ultimate requirement for the taxpayer to provide this information anyway if it is a large enough taxpayer to be a target of the IRS's LMSB.

The APA is binding on the IRS and the taxpayer as long as facts and circumstances do not materially change.

Multi-lateral APA's between the IRS and other governmental authorities are possible either pursuant to applicable tax treaty provisions or as an exercise of IRS administrative discretion. Success of the multi-lateral APA procedures has been subject to the same concerns as for other tax authorities.

#9 There are no specific requirements as to the means of storage of TP documentation. It can be in any form as long as it is readily available to the IRS upon request.

#10 Transfer pricing documentation must be submitted to the IRS within 30 days of their request.

#11 Transfer pricing documentation requirements apply to all "controlled" transactions. This would include transactions involving sales of tangible property, making of loans, performing of services, and sales or licenses of intangible property. In addition certain extraordinary transactions, most notably actual or deemed transfers of intangible property or shares of subsidiaries are subject to "fair market value" treatment which in turn is based on transfer pricing methodology and documentation.

#12 Transfer documentation should be provided in English. If documentation is not in English, a certified translation into English must be made.

#13 The burden of proof is on the taxpayer to demonstrate proper transfer pricing for the "controlled" transactions.

#14 Proper transfer pricing documentation is set forth in US tax law. The documentation must provide a business description, a thorough analysis of the intercompany transactions, a detailed functional analysis of the relevant parties, a review of the transfer pricing methods resulting in the method chosen, and an economic analysis showing the arm's length nature of the transfer pricing. More specifically, the documentation must show:

1. an overview of the business, including an analysis of the economic and legal factors impacting the pricing of its intercompany transactions;
2. a description of the organisational structure covering all parties involved in the intercompany transactions;
3. a description of the pricing method selected and an explanation of why that method was chosen.
4. a description of the alternative methods that were considered and an explanation of why they were not selected.
5. a description of the control transactions and any internal data used to analyse those transactions.
6. for any comparables used, a description, an explanation of evaluation comparability and an explanation of any adjustments made; and
7. the economic analysis.

#15 From a tax administration standpoint, it is desirable to centralise transfer pricing policy and related documentation. This insures timely and accurate responses to the IRS audit questions.

#16 The IRS is aware of the recognised databases and in fact expects them to be used in the economic analysis required as part of the transfer pricing documentation.

#17 External comparables are generally preferred but internal comparables may be acceptable depending on facts and circumstances.

#18 US transfer pricing rules focus on the application of the proper method of pricing to the "tested party" as defined but usually the related party who is the least complex in nature and thus, presumably the easiest to benchmark. If the tested party is a non-US entity, the IRS will expect the appropriate non-U.S. comparables to be used. If the tested party is a US entity, US comparables should be used.

#19 The US transfer pricing documentation rules include specific penalty provisions.

If the IRS determines that (a) an intercompany transfer price was less than 50% or more than 200% of arm's length price or (b) the transfer pricing adjustment increases taxable income by USD 5 million or more, the penalty equals 20% of the additional tax.

The penalty increases to 40% if (a) the intercompany transfer price was less than 25% or more than 400% of an arm's length price or (b) the transfer pricing adjustment is $20 million or more.

The penalties apply automatically whenever IRS adjustments exceed the numerical thresholds. The 20% penalty applies to adjustments of income by USD 5 million or more, while the 40% penalty applies to adjustments of income of USD 20 million or more.

There is statutory authority to avoid the penalties. The only authority is to satisfy certain safe harbour requirements of reasonable cause and good faith.

Reasonable cause and good faith can be met only if the taxpayer can demonstrate, by contemporaneously documenting its transfer pricing practices, that they acted reasonably in selecting and applying a transfer pricing method.

#20 US treaty policy attempts to mitigate double taxation of transfer pricing adjustments by seeking mutual agreement provisions and associated enterprises articles that permit the Competent Authorities to resolve issues of double taxation without time limits regarding notification.

US transfer pricing tax law contemplates correlative adjustments within a US multinational group to reflect transfer pricing adjustments for earnings and profits purposes even if such adjustments are not recognised by the other relevant tax authority. US taxpayers are allowed, within limitations provided within the US foreign tax credit tax regime, to re-claim as foreign tax credit, additional taxes that would be imposed on a foreign related party as a result of a transfer pricing adjustment.

#21 The top marginal US federal corporate tax rate is 35%. Additional state and local income taxes (after benefit for deduction of federal taxes) generally result in a combined US federal, state and local tax rate of about 40%.

Newsflashes

China

• After several drafts, the enterprise income tax treatment for enterprise restructuring was published on 30 April 2009.
• The amended Interim Regulations on the Business Tax of the PRC and its implementation rules came into force on 1 January 2009. A significant change is that regardless of the place where a service is rendered, Chinese business tax must be paid if either the service provider or receiver is in China.
• China has strengthened the tax administration of non-resident service providers. Non- resident enterprises with permanent establishments in China are required to make annual enterprise income tax filing and clearance from 2008.

Czech Republic

The Czech Parliament adopted an amendment to the Czech VAT Act excluding the purchase of passenger cars used for business activities from VAT. The changes apply from 1 April 2009 until 30 March 2009. The initiative is an economic stimulus measure for the Czech economy, now suffering the effects of the global recession. Previously, VAT exemptions applied to commercial transport vehicles.

France

• The tax treaty between France and the USA was amended by a Protocol signed in January 2009, and will probably enter into force before the end of the year. The major change is the abolition of withholding tax applicable to certain intra-group dividend distributions (under conditions) and to royalties (art. 10 and 12). Other reforms concern the residence criteria of see-through entities.
• France recently concluded a tax Protocol with Switzerland (11 June). The Protocol includes an exchange of information clause modelled on the OECD model clause (art. 26). This contains an administrative assistance provision, leading observers to comment that this signifies the end of Swiss bank secrecy with France. Upon entry into force (planned for 1 January 2010) tax administrations can exchange information about the implementation of the tax treaty dispositions and the application of internal tax laws. The relevant tax authorities can also, under certain procedural conditions, demand details from Swiss banks of individuals investing in their institutions.
• Following the OECD's condemnation of harmful tax practices and the inclusion of notorious tax havens in a "grey zone" list, France successfully put pressure on Gibraltar, British Virgin, Jersey, Guernsey, Monaco and Luxembourg and signed exchange of information agreements. Similar agreements are being negotiated with Singapore and Austria.

Poland

• Amendments to the Polish CIT Act came into force on 1 January 2009. They bring into Polish law the OECD convention of 23 July 1990 on the elimination of double taxation in connection with the adjustment of profit of associated enterprises and also the OECD Code of Conduct on the same subject. Under the amended Article 11 of the Polish CIT Act domestic entrepreneurs making transactions with foreign related business partners will now be able to adjust their income where transaction prices were questioned by foreign tax authorities for non-compliance with the arm's length principle (so called "corresponding adjustment"). The above rules are also applicable to the permanent establishment of foreign companies. Corresponding adjustment applies provided that the double taxation treaty with a given country anticipates such possibility.
• The Ministry of Finance published guidelines for the Tax Inspections Offices for 2009. The guidelines provide that tax inspectors should pay particular attention to transactions between related parties, the current experience of the tax authorities showing that "taxpayers are avoiding taxation by transferring profits between relating parties".
• Since January 1 2009, additional information attached to financial statements must include details of every related party transaction that does not meet the arm's length principle. The term "related parties" has a broad meaning in this case. It includes other members of management and supervisory boards. It is noteworthy that the above requirements also apply to financial statements for the year 2008. It should be emphasised that taxpayers must analyse transactions in detail in order to comply with the new requirements. Information gathered for the purpose of preparing standard TP documentation may not be sufficient in this respect, as Polish CIT regulations do not require the TP documentation to directly indicate whether the transactions meet the arm's length principle. The new regulation significantly increases the tax risk connected with transactions with related parties, as the tax authorities can now use the information disclosed in the financial statements during tax inspections.

Spain

• The Spanish government recently enacted the Royal Decree 3/2009, governing several urgent tax and financial measure which also introduced new insolvency procedures. The measures were introduced in the context of the economic downtown. The most significant of these reduces the statutory interest rate from 5.5% to 4%. Similarly, the approved reduction scheme to gradually waive research and development deductions has been repealed.
• Law 3/2009 also introduces new structural measures for companies planning to transform their legal form into a different one (i.e. a corporation into a limited liability company) or planning to carry out restructuring transactions (ie. mergers, spin off, global assignment of assets and liabilities).
• The Spanish Official Gazette published (April 11) the Double Taxation Treaty concluded between Spain and Moldova Republic for the avoidance of tax evasion and double taxation on income and wealth tax.

Ukraine

• Taxation of Funds Received by a Rep-resentative Office from its Head Office

In letter № 326/7/16-1517 dated 12.01.2009 the State Tax Administration of Ukraine confirmed its previous position regarding the taxation of funds received by a representative office (being a permanent establishment) in Ukraine from its head office. Specifically, such funds must be treated as taxable income for the representative office for corporate profit tax purposes.

• Ukrainian Parliament Grants Tax Incentives for Industries Producing and Utilising Biofuels

On 21 May 2009 the Ukrainian parliament passed the law "On Amending Certain

Ukrainian Laws with respect to Encouraging the Production and Use of Biofuel" (signed by the President on 16 June). The law, in particular, provides for the following tax incentives, starting from 1 January 2010:

• 10-year corporate profit tax exemption.
• Bonus tax depreciation for new fixed assets.
• 9-year VAT and customs duty exemption for alternative energy equipments and biofuel producing equipments.
• Until 1 January 2014, a zero excise duty rate for ethyl spirit used in bioethanol production and bioethanol used in biofuel production, zero excise duty rate for the production of bio motor fuel and for biofuels that form a component of motor fuel.

Please note that to become effective the law will need to be signed by the Ukrainian President.

USA

• President Obama released the details of his international tax reform proposals

On May 4 2009, President Obama and Treasury Secretary Geithner unveiled two components of the Administration's plan relating to US international tax reform. The first component relates to certain changes to the deferral of foreign earnings and the foreign tax credit rules. The second component generally relates to abusive uses of accounts located in tax havens. The reforms to come will include:

• Closing Foreign Tax Credit Loopholes
• Using Savings To Make Permanent The Tax Credit for Investing in Research and Experimentation at Home
• Eliminating Loopholes for "Disappearing" Offshore Subsidiaries
• Cracking Down on the Abuse of Tax Havens by Individuals
• Devoting New Resources for IRS Enforcement to Help Close the International Tax Gap

• Foreign Bank Account Reporting Form

Substantive tax law in the US took a back seat in Q2 to a filing requirement that, until this year, was little known by many tax advisers and most taxpayers. The form, Form TD F90-22.1 (Report of Foreign Bank and Financial Accounts), is commonly referred to as the "FBAR Form" and is used by US persons to report ownership of, a financial interest in, or signatory authority over, a foreign bank account or a foreign financial account. In October 2008, the FBAR Form was revised to broaden the web of the filing obligation and the scope of information that must be reported. The form must now be used for all filings beginning 1 January 2009.

The Internal Revenue Service announced a uniform voluntary compliance program that will allow noncompliant taxpayers to come forward and face a uniform penalty structure. FBAR forms for 6 years must be filed, if income in those accounts for that 6-year period is unreported, amended tax returns are required. The additional tax will be subject to interest and a 20% penalty. Finally, in lieu of all other penalties that could be imposed, a penalty equal to 20% of the highest amount in the account during the 6-year period will be imposed. The voluntary disclosure period ends 23 September 2009. Without the voluntary compliance program, noncompliant taxpayers face significant penalties. These include a civil penalty of up to USD 10 000 for non-wilful failures to file the form and a stiffer penalty equal to the greater of USD 100 000 or 50% of the amount of the balance in the account each year for wilful failures. Criminal penalties are also provided.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.