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Documentation and APAs

As governments pay more attention to transfer prices, they demand more documentation from taxpayers. Under the IRC Section 6662 regulations, the IRS can impose 20 percent or 40 percent penalties if companies have substantial adjustments to their transfer prices, and lack adequate contemporaneous documentation of a reasonable effort to establish arm’s length prices.

Tax authorities have been building up their resources committed to transfer pricing and are preparing for audits and disputes to increase revenues. The IRS has hired additional international specialists with a focus on transfer pricing. The Canadian Revenue Agency has allotted substantial funds to deal with transfer audits. In Japan, there has been a yearly increase in the number of assessments. Italy has two types of audits, one of which is conducted by the tax police, and another conducted by the tax authority.

Many countries are establishing transfer pricing documentation requirements, recently China and France, in which failure to keep contemporaneous documentation will result in severe penalties. Transfer pricing documentation requirements are gaining momentum in the EU, prompting the EU Joint Transfer Pricing Forum to adopt a Code of Conduct that aims to standardize the documentation that multinationals must provide to tax authorities on their transfer pricing of cross-border intra-group transactions. In some countries that do not explicitly require comtemporaneous documentation, taxpayers are obligated to provide the information requested during examinations, and may be penalized, either explicitly or through adjustments,if they are not able to respond with complete information.

U.S. Section 6662 Documentation

ECS’ documentation reports for U.S. clients are designed to meet the requirements of Section 6662, bearing in mind that they may also be relevant for one or more foreign jurisdictions. ECS’ documentation reports range from providing relatively basic documentation for simple inbound or outbound sales to complex analyses documenting royalty rates, buy-ins for cost sharing agreements, and other intangible transactions.

  • ECS analyzed the royalty rates paid to a European parent company by U.S. manufacturing entities for use of the parent’s trademarks and technology. To demonstrate the reasonableness of the rates, ECS examined the prevailing rates in the industry and compared the profitability of the U.S. operations with the profitability of a sample of independent U.S. companies in the industry. ECS’ analysis provided the basis for the successful resolution of this issue.
  • A foreign-owned U.S. distributor with a history of contentious IRS examinations used its initial transfer pricing documentation report by a senior ECS professional to establish a cooperative dialogue that led the IRS to close the examination without proposing any change in transfer prices.
  • In one of the first IRS examinations of a year covered by a Section 6662 report, the senior ECS professional responsible for the report persuaded the IRS field team to accept the report's definition of the scope of the controlled transactions, selection of the best method, choice of comparables, and adjustments to those comparables, leaving only a small adjustment to the client's allocation of expenses between the controlled and uncontrolled transactions.

Non-U.S. Documentation

Reports that are intended to be given to non-U.S. governments are designed to take account of the relevant governments’ preferences in methodology and terminology. In preparing a documentation report, ECS chooses and applies the most appropriate method based on a thorough analysis of the intercompany transactions and available uncontrolled comparables, while remaining constantly mindful of the client’s budget and the likelihood that the documentation will be subject to government scrutiny. ECS has provided documentation for use in several countries/regions, including Mexico, Canada, Europe, India and Japan.

  • A multinational client wanted to implement a single approach that would be applied consistently on a worldwide basis. ECS prepared an analysis documenting the intangible property and risk-taking assumptions adopted by the client, and developed an approach to calculating resale gross margins that varied by country and product line. This analysis has provided the basis for the client’s successful responses to Customs and tax audits for more than a decade.
  • An ECS documentation report prepared for non-U.S. distribution subsidiaries of a U.S. multinational, using the OECD approved Transactional Net Margin Method ("TNMM"), was accepted by Japan’s National Tax Administration as the appropriate standard for testing the arm’s length nature of transfer prices paid by the company’s Japanese subsidiary.

Advance Pricing Agreements

Through an Advance Pricing Agreement (APA), companies can establish the arm’s length nature of their intercompany prices to avoid future disputes. Sometimes the APA process can also be used to resolve disputes over past years efficiently and economically. ECS’ reports provide the economic analysis necessary to demonstrate that intercompany prices are consistent with arm’s length expectations, a critical factor in obtaining an APA.

  • ECS provided the economic analysis used in reaching a bilateral APA for its client’s sales between the United States and Canada. ECS’ analysis demonstrated that the prices paid by the Canadian entity to the affiliated U.S. supplier were consistent with those paid in third party transactions.
  • ECS provided the economic analysis of third party license and supply agreements that became the basis for an APA allowing foreign affiliates to use technology developed by the U.S. parent company.

Relevant ECS Professionals

Jerrie Mirga [bio][email]
Valerie Amerkhail [bio][email]
Andrew Bostian [bio][email]

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