CONTEMPORANEOUS DOCUMENTATION REQUIREMENTS AND TRANSFER PRICING PENALTIES
Note: This user guide is intended to help clarify the concepts and identify issues in the application of the U.S. regulations.
It does not constitute legal advice, and should not be relied on as such. For professional transfer pricing consulting services,
contact Economic Consulting Services at 202-466-7720.
A. Authority: IRC Section 6662(e)(1)(B)
Specific penalties for underpayments of tax due to
transfer pricing were added to the valuation
misstatement penalties of section 6662 by
the Omnibus Budget Reconciliation Act
("OBRA") of 1990. Penalty rates and thresholds were
specified in the legislation. The OBRA of 1993 lowered
the thresholds for application of these penalties. OBRA 1993 also added a
contemporaneous documentation requirement.
B. Overview of Section 1.6662-6
Section 1.6662-6 relates to transactions between
persons described in Section 482 and net Section 482 transfer price adjustments.
- Penalties
A penalty can be imposed on underpayment of taxes that results
from improper intercompany transfer prices.
The penalty is 20% of the underpayment of tax when:
-- The price claimed on the tax return is 200% or more than the arm's length price; or
-- The price claimed on the tax return is 50% or less than the arm's length price; or
-- The net Section 482 adjustment exceeds the lesser of: $5 million or 10% of gross receipts.
The penalty is 40% of the underpayment of tax when:
-- The price claimed on the tax return is 400% or more than the arm's length price; or
-- The price claimed on the tax return is 25% or less than the arm's length price; or
-- The net Section 482 adjustment exceeds the lesser of: $20 million or 20% of gross receipts.
Penalties can be avoided if a taxpayer meets both:
-- The specified method requirement (i.e., applies a Section 482 transfer pricing method in a reasonable manner); and
-- The documentation requirement (i.e., maintains sufficient documentation that the method used provides the most accurate
measure of an arm's length result under the principles of the best method rule, and provides that documentation to the IRS
within 30 days of a request for it).
- Documentation
Documentation must be in existence at the time the tax return is filed
(i.e., should generally be prepared on an annual basis). Documentation must be provided to the IRS within 30 days of a request
relating to a particular tax year. The required documentation is divided into two categories, (i)
principal documents and(ii)background documents, as described below:
Principal documents must include the following:
-- A summary of the taxpayer's business, including a breakdown of the economic and legal factors that affect the pricing of
its property or services;
-- A description of the taxpayer's organizational structure, including an organization chart covering all related parties
involved in transactions under Section 482;
-- Any documentation explicitly required by the regulations under Section 482;
-- A description of the different methods that were considered and an explanation of why they were not selected;
-- A description of the controlled transactions and any internal data used to analyze those transactions;
-- A description of the comparables that were used, how comparability was determined, and what (if any) adjustments were made;
-- An explanation of the economic analysis and projections relied upon in developing the method;
-- A description of any important data that the taxpayer acquires after the end of the tax year and before filing a tax
return, which would assist in determining if a taxpayer selected and applied a particular method in a
logical manner; and
-- A general index of the principal and background documents relied upon.
Background documents support
the assumptions, conclusions, and
positions contained in the principal
documents. Background documents do not have to be provided
to the IRS in response to a request
for principal documents. If the IRS subsequently requests the
background documents, a taxpayer
must provide them within 30 days of
the request.
C. Full Text of the Section 6662 Regulations
The Section 6662 regulations pertaining to transfer
pricing (i.e., 1.6662-6) are effective
February 9, 1996. The regulations
interpreting and applying Section 6662 are
organized as follows:
Table of Contents –
Reg. Sec.1.6662-0
1. Overview of the accuracy-related penalty –
Reg. Sec.1.6662-1
– Section 6662 imposes an accuracy-related penalty on any
portion of an underpayment of tax required
to be shown on a return.
2. Description of accuracy-related penalty
Reg. Sec.1.6662-2
3. Negligence or disregard of rules or regulations –
Reg. Sec.1.6662-3
– In general, if any portion of an underpayment of any
income tax is attributable to negligence or
disregard of rules or regulations, there is
added to the tax an amount equal to 20% of such portion.
4. Substantial understatement of income tax –
Reg. Sec.1.6662-4
– In general, if any portion of an underpayment of any
income tax is attributable to a substantial understatement of such income tax,
there is added to the tax an amount equal to
20% of such portion. The rules for determining when substantial authority
exists are set forth in § 1.6662–4(d). The
rules for determining when there is adequate disclosure are set forth in §
1.6662–4 (e) and (f).
5. Substantial and gross valuation
misstatements under chapter 1 –
Reg. Sec.1.6662-5
– In general, if any portion of an underpayment of any
income tax imposed is attributable to a
substantial valuation misstatement, there is
added to the tax an amount equal to 20% of
such portion. The penalty is increased
to 40% in the case of a gross valuation
misstatement.
6. Substantial and gross valuation
misstatements under chapter 1 (temporary)–
Reg. Sec.1.6662-5T
– Defines when there is substantial valuation misstatement
or gross valuation misstatement.
7. Transactions between persons described in
Section 482 and net Section 482 transfer
price adjustments –
Reg. Sec.1.6662-6
– Pursuant to section 6662(e) a penalty is imposed on any
underpayment attributable
to a substantial valuation misstatement
pertaining to either a transaction between
persons described in section 482 (the
transactional penalty) or a net section 482
transfer price adjustment (the net adjustment penalty). See descriptions
above on the penalties imposed and the
documentation required.
8. Omnibus Budget Reconciliation Act of 1993 changes to
the accuracy-related penalty –
Reg. Sec.1.6662-7
– This section provides rules reflecting the changes to the
accuracy-related penalty in Section 6662 made by the OBRA of 1993.
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