USA Law and Practice Contributed by: Kevin Spencer, Kim Marie Boylan, Nicholas Wilkins and Christina Culver, White & Case LLP
• Negligence penalty ‒ a 20% penalty applies if the IRS determines that a taxpayer acted carelessly, recklessly or with intentional disregard for the law. • Non-economic substance penalty ‒ a 20% pen - alty applies where a transaction lacking economic substance is disclosed. The penalty increases to 40% if the transaction lacking economic substance is not disclosed. Mitigating Risk of Transfer Pricing Penalties The net adjustment penalty is most seen in practice. Although penalties can be onerous, taxpayers can mitigate exposure or defend against transfer pricing penalties. Where a taxpayer discovers errors in its tax return before being contacted by the IRS, it can file an amended return. If the amended return corrects the issues giving rise to the tax underpayment and pays all associated taxes, the amended return miti - gates much of the penalty exposure. However, in the context of transfer pricing penalties, it is often difficult to anticipate IRS adjustments on audit. Defending against penalties on audit focuses on pre- emptively maintaining quality documentation. Section 6664 (c)(1) of the Code provides that an accuracy- related penalty will not be imposed on any portion of an underpayment if the taxpayer shows there was reasonable cause for that portion and the taxpayer acted in good faith with regard to that portion. The extent of a taxpayer’s effort to assess its tax liability properly is generally the most important factor. The IRS also considers the following factors: • taxpayer’s background; • reliability and availability of data and reasonable- ness of data analysis; • correct application of the chosen Section 482 method; • whether the taxpayer obtained a contemporane - ous, quality transfer pricing study; and • size of the adjustment in relation to the overall transaction. Documentation should explain the taxpayer’s business and its intercompany transactions, provide an analysis of methods and explain why the chosen method was selected, and provide an economic analysis.
The Code provides specific documentation require - ments to avoid the net adjustment penalty. Section 6662 (e)(3)(B) of the Code requires that a taxpayer’s use of the chosen method was reasonable, the tax - payer has documentation on the application of its cho - sen method, and the taxpayer provides the documen - tation to the IRS within 30 days of a request. Treasury Regulation Section 1.6662-6 (d) further describes the documentation needed to meet the Section 6662 (e) (3)(B) exception to the net adjustment penalty. If a tax - payer meets the requirements of Treasury Regulation Section 1.6662-6 (d), it is deemed to have established reasonable cause with regard to a transactional pen - alty or a substantial understatement penalty as well. 8.2 Transfer Pricing Documentation The USA has some limited country-by-country report - ing (CbCR) requirements. It does not require taxpayers to prepare master or local files. CbCR requirements apply to US persons that are the ultimate parent of a US multinational enterprise (MNE) and have revenue of USD850 million or more for the reporting period. Under Section 6038A of the Code, impacted taxpay - ers must file a Form 8975 annually by the extended due date of income tax returns (October 15th for cal - endar year corporate groups). 9. Alignment With OECD Guidelines 9.1 Alignment and Differences The USA views its Section 482 transfer pricing rules as consistent with the OECD Transfer Pricing Guide - lines. The most recent 2022 United States Transfer Pricing Country Profile provided by the USA to the OECD states that “US transfer pricing regulations are consistent with the [Guidelines]”. Although they are broadly in alignment, there are differences between the OECD Transfer Pricing Guidelines and the Sec - tion 482 rules. For instance, the USA does not require taxpayers to file master or local file CbCR. 9.2 Arm’s Length Principle Section 482 transfer pricing rules provide a variety of specified methods for determining whether an intercompany transaction was conducted at arm’s length. In general, the rules do not depart from the arm’s length principle, but there are certain exceptions
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