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LB&I International Practice ServiceProcess Unit – OverviewIPS LevelNumberTitleUIL CodeShelfN/ABusiness OutboundVolume1Income ShiftingUIL Code9411Part1.7Other Transfer Pricing IssuesLevel 2 UIL9411.07ChapterN/AN/ALevel 3 UILN/ASub-ChapterN/AN/AUnit NameReview of Transfer Pricing Documentation by Outbound Taxpayers--Document Control Number (DCN)ISO/PUO/P 1.7 02(2014)Date of Last Update01/27/16Number--Note: This document is not an official pronouncement of law, and cannot be used, cited or relied upon as such. Further, this document may not contain acomprehensive discussion of all pertinent issues or law or the IRS's interpretation of current law.

DRAFTTable of Contents(View this PowerPoint in “Presentation View” to click on the links below)IntroductionProcess OverviewDetailed Explanation of the ProcessProcess ApplicabilitySummary of Process Steps Step 1 - Overview of USP's Business Step 2 - Organizational Structure Step 3 - Documentation Required by the Regulations Step 4 - Method Selected Step 5 - Alternative Methods22

DRAFTTable of Contents (cont’d)(View this PowerPoint in “Presentation View” to click on the links below) Step 6 - Controlled Transactions Step 7 - Comparables Step 8 - Economic Analysis Step 9 - Summary of Data after Year End Step 10 - Background Documents Step 11 - General IndexDefinitionsTraining and Additional ResourcesGlossary of Terms and AcronymsIndex of Related Issues33

DRAFTIntroductionReview of Transfer Pricing Documentation by Outbound TaxpayersTaxpayers may enter into a wide variety of transactions involving tangibles, intangibles and/or services with controlled parties. Toshow that the transactions are priced at arm’s length, taxpayers may provide contemporaneous documentation. Thecontemporaneous documentation must be in existence at the time taxpayer filed its tax return and also be provided to the IRS within30 days of being requested if taxpayer is seeking to avoid the IRC 6662(e) and (h) penalties.The purpose of this Process Overview Unit is to serve as an introduction to the review of a taxpayer’s transfer pricing documentation(“TPD”). Review of the TPD serves a couple of important purposes. First, the Transfer Pricing Audit Roadmap uses the TPD in thePlanning Phase (Pre-Examination Analysis) to note areas that require further development, confirmation or inquiry. The review of theTPD is then used in the initial TP risk analysis and development of a preliminary working hypothesis. Second, the review of the TPD isessential to determine if it meets the requirements of IRC 6662(e) penalty avoidance.If, as the statute permits, the taxpayer has not prepared IRC 6662(e) documentation, exam would issue a written informationdocument request at the beginning of the audit for relevant information regarding the taxpayer’s transfer pricing practices. Such noncontemporaneous TP documentation may establish that the taxpayer’s controlled party transactions meet the arm’s length standardbut it cannot prevent imposition of the TP penalties if the IRS determines that the transactions are not at arm’s length prices.If a taxpayer does not have contemporaneous documentation (also known as 6662(e) documentation or transfer pricingdocumentation) or the TPD is deemed deficient and the Service concludes that a transfer pricing adjustment is appropriate, thetaxpayer may be subject to transactional or net adjustment penalties under IRC 6662(e) and (h). These regulations containreasonable cause and good faith requirements in order for taxpayers not be subjected to such penalty provisions. To meet thereasonable cause and good-faith requirements (if taxpayer is subject to the transactional penalty) or to have amounts excluded fromthe calculation of the net section 482 adjustment (if taxpayer is subject to the net adjustment penalty), the taxpayer must maintain andprovide the IRS with documentation sufficient to establish that the taxpayer reasonably concluded that the chosen pricing method wasthe best method and its application provided the most reliable measure of an arm's-length result, given the available data. Additionally,if the taxpayer chose an unspecified method but a specified method was potentially applicable, the taxpayer must establish that noneof the specified methods was likely to be the best method and provide a more reliable measure of an arm’s length result.4Back to Table Of Contents4

DRAFTIntroduction (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersThe following documentation should be provided to the IRS via the mandatory transfer pricing information document request (IDR): Overview of business; Organizational structure; Documentation specifically required by IRC 482 and the regulations thereunder; Description of method chosen; Explanation of methods not chosen; Description of controlled transactions; Description of the comparables; Explanation of economic analysis; Relevant year-end data, and Index.!CAUTION: Background documents are not specifically required under the mandatory IDR. However, background documentsshould be requested as needed.5Back to Table Of Contents5

DRAFTProcess OverviewReview of Transfer Pricing Documentation by Outbound TaxpayersThis Process Unit focuses on the documentation provided when there is an outbound transaction of tangible goods, intangibles, andservices. However, similar documentation is also required for inbound transactions. During the Planning Phase of the examination(Outlined in the Transfer Pricing Roadmap), as part of the exam teams overall Pre Examination Analysis, the IE in consultation with aneconomist (also TPP) will request (via Mandatory Transfer Pricing IDR), review and analyze the taxpayers IRC 6662(e) transfer pricingdocumentation in order to gain a better understanding of the taxpayers transfer pricing transactions and note areas that require furtherdevelopment, confirmation or inquiry. This analysis of the TPD is critical in the overall assessment and hypothesis developed by the IEand Economist (also TPP) when formulating the audit plan. The analysis may be accomplished in a series of steps as further definedin this Practice Unit,. These steps are focused around the 10 principal documentation requirements contained in Treas. Reg. 1.6662 6(d)(2)(iii)(B). The exam team needs to consider whether the documentation meets the requirements under the regulations or isdeficient and thus potentially subjecting the taxpayer to penalties under IRC 6662(e) and (h). It is important to remember that theoverall objective of IRC 6662(e) is to improve compliance with IRC 482 by encouraging taxpayers to document their transfer pricingtransactions and to provide that documentation to the IRS in a timely manner. Here is a depiction of the transaction.Intangible PropertyTangible GoodsServicesUSPPaymentForeign Sub“CFC” US Parent (USP) owns 100% of Foreign Sub (CFC). USP sells tangible goods to CFC. Additionally, USP licenses intangible property and provides services to CFC. USP has TPD prepared by an outside consultant.6Back to Table Of Contents6

DRAFTDetailed Explanation of the ProcessReview of Transfer Pricing Documentation by Outbound TaxpayersAnalysisThe purpose of a taxpayer’s TPD is to show that its transactions with related parties are priced consistently with the arm’s lengthstandard. To do this it must select and apply the “best method” as described in the 482 regulations. To be the best method, themethod selected must not only produce the most reliable measure of an arm’s length result, but also be the most reliable application ofthe method. In other words, you could have two or more applications of the same method but one such application is more accurate interms of certain key factors (comparability, data and assumptions etc.), resulting in a better (more reliable) application of the methodand, thus, making that application the “best method.”The purpose of this Unit is to serve as an introduction to the review of a taxpayer’s TPD. The documentation should show that thetaxpayer reasonably concluded that the transfer pricing methodology chosen and applied met the best method rule (i.e., it provides themost reliable measure of an arm’s length result). In addition, taxpayers should document how they selected their method, why it’s thebest method, and the reasons they rejected other possible methods (specified and unspecified).!CAUTION: Although Treas. Reg. 1.6662-6(d)(2)(iii)(B) specifies ten principal documents, a taxpayer supplying all principaldocuments does not preclude the Service from applying the transactional or net adjustment penalty provisions where thetaxpayers TPD is deficient or where the requirements under the reasonable cause and good faith exception for the transactionalpenalty or the requirements to exclude amounts from net section 482 adjustments have not been met. Alternatively, completedocumentation may not require all principal documentation to be provided. You need to analyze whether the documentsprovided give you a complete understanding of taxpayer’s controlled transactions.CONSULTATION: Recommended that you consult with the Info Gathering IPN if you are applying penalties.This Process Unit Overview does not cover how to select the “best method.” For selecting the best method see the Practice Unitentitled “Overview of IRC 482,” DCN: ISO/9411.07 01 (2013). Additionally, this process unit does not cover “comparability.” Forinformation on how to do a comparability analysis (including functional analysis) see Practice Unit entitled “Comparability Analysis forTangible Goods Transactions-Outbound,” DCN: ISO/PUO/V 1 01(2014).7Back to Table Of Contents7

DRAFTProcess ApplicabilityReview of Transfer Pricing Documentation by Outbound TaxpayersReview taxpayer’s documents and public information to determine if there are significant controlled transactions.CriteriaRequest taxpayers TPD by issuance of the IRC6662(e) Mandatory Transfer Pricing IDR with theinitial examination contact letter. The required 30day taxpayer response time starts with the issuanceof the letter.Identify significant controlled transactions fromreview of the taxpayer’s TPD. This review is part ofthe Planning Phase outlined in the Transfer PricingRoadmap under Pre Examination analysis. Theroadmap is a comprehensive toolkit outlining theaudit steps all examiners should use during thePlanning, Execution and Resolution phases of theirexamination. The roadmap is not intended as atemplate, every transfer pricing case is unique, theexam team needs to exercise its judgment abouthow to best utilize these guidelines.Prior to receipt of the TPD, use the 30 day period toperform company background, overview analysisand tax return review.Resources 6103 Protected ResourcesTransfer Pricing Roadmap.Form 5471- Schedules C, F and M.Form 8858- Schedules C and FForm 8865- Schedules B, L and NForm 1120 - Schedule M-3, andUncertain Tax Positions (UTP)Disclosures. Tie the financials tothe tax return and note anydifferences.International Information Returns(IIR) system.Prior exam cycle files.Organizational ChartsTransfer Pricing Roadmap.TPD obtained from the TransferPricing IDR enables anunderstanding of the Multi-NationalEnterprise (MNE) structure, theactivities performed, transactionmateriality, and general risks of thetransaction.8Back to Table Of Contents8

DRAFTProcess Applicability (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersReview taxpayer’s documents and public information to determine if there are significant controlled transactions.CriteriaAt receipt of the TPD, map Forms 5471, 8858 and8865 to the TPD. Are there transactions missingfrom the TPD? Are there “exceptional profits”offshore in the foreign affiliates potentially indicatinga U.S. shifting of income in non-arm’s lengthtransactions with such foreign affiliates?Review the general ledger and financial statementsfor expenses relating to the production of goods,such as manufacturing costs, depreciation of plants,R&D expense, warranty expenses etc.Perform ratio analysis based on the financialinformation.Resources6103 Protected Resources Taxpayer websites for additionaldiscussions about the taxpayer’sactivities. Annual Reports/FinancialStatements for confirmation that theinformation matches the TPD. Income statement and balancesheet for expenses.9Back to Table Of Contents9

DRAFTSummary of Process StepsReview of Transfer Pricing Documentation by Outbound TaxpayersProcess StepsThe Treasury Regulations provide a list of principal and background documents that need to accurately and completely describe thebasic transfer pricing analysis conducted by USP.Step 1Review Overview of USP’s Business.Step 2Review USP’s Organizational Structure.Step 3Review any documentation explicitly required by the regulations under IRC 482.Step 4Review the description of the method selected and explanation of why that method was selected.10Back to Table Of Contents10

DRAFTSummary of Process Steps (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersProcess StepsThe Treasury Regulations provide a list of principal and background documents that need to accurately and completely describe thebasic transfer pricing analysis conducted by USP.Step 5Review the description of the alternative methods and explanation of why they were not chosen.Step 6Review the description of the controlled transactions and any internal data used to analyze the transactions.Step 7Review the description of the comparables that were used, how comparability was evaluated, and what (if any)adjustments were made.Step 8Review the explanation of the economic analysis and projections used for developing the method.11Back to Table Of Contents11

DRAFTSummary of Process Steps (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersProcess StepsThe Treasury Regulations provide a list of principal and background documents that need to accurately and completely describe thebasic transfer pricing analysis conducted by USP.Step 9Review the description or summary of any relevant data that USP obtains after the end of the tax year and before thefiling of its tax return.Step 10Review background documents.Step 11Review the general index of the principal and background documents.12Back to Table Of Contents12

DRAFTStep 1: Overview of USP’s BusinessReview of Transfer Pricing Documentation by Outbound TaxpayersStep 1An overview of USP’s business is the first principal document. The overview should include an analysis of the economic and legalfactors that affect the pricing of its property or services.ConsiderationsYou may obtain the following documents to get anoverview of USP’s business: Description of principal business segments,product lines, geographic markets, vendors,customers, and contractors Functional analysis identifying economicallysignificant activities undertaken or to beundertaken by the taxpayer, such as:– Conceptualization– Research and development– Product design and engineering– Manufacturing, production and processengineering– Product fabrication and extraction– Product assembly, packaging and labeling– Purchasing and materials management– Marketing, advertising and distribution functionsResources6103 Protected Resources Treas. Reg. 1.6662-6(d)(2)(iii)(B)(1) –documentation requirement Treas. Reg. 1.482-1(d)(3)(i) –functional analysis Transfer Pricing IDR Functional Analysis Questionnaire Transfer Pricing Roadmap IRM Exhibit 4.61.3-4 – TransferPricing Functional AnalysisQuestionnaire Practice Unit, “Comparability Analysisfor Tangible Goods Transactions –Outbound,” DCN: ISO/PUO/V 1 01(2014) Taxpayer Presentation Interview Notes13Back to Table Of Contents13

DRAFTStep 1: Overview of USP’s Business (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersStep 1An overview of USP’s business is the first principal document. The overview should include an analysis of the economic and legalfactors that affect the pricing of its property or services.Considerations Functional analysis identifying economicallysignificant activities undertaken or to beundertaken by the taxpayer, such as (cont’d):– Inventory management– Warranty administration– Transportation and warehousing– Managerial, legal, accounting and finance,credit and collection, training, and personnelmanagement services– Various stage of production– Various state of financing the production andinventory– Testing and quality control– Sales or internal use– Patent or other intangible development– Accounts receivable– Capital investmentResources6103 Protected Resources Treas. Reg. 1.6662-6(d)(2)(iii)(B)(1) –documentation requirement Treas. Reg. 1.482-1(d)(3)(i) –functional analysis Transfer Pricing Roadmap Practice Unit, “Comparability Analysisfor Tangible Goods Transactions –Outbound,” DCN: ISO/PUO/V 1 01(2014) Functional Analysis Questionnaire IRM Exhibit 4.61.3-4 – TransferPricing Functional AnalysisQuestionnaire14Back to Table Of Contents14

DRAFTStep 1: Overview of USP’s Business (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersStep 1An overview of USP’s business is the first principal document. The overview should include an analysis of the economic and legalfactors that affect the pricing of its property or services.ConsiderationsResources Description of contractual terms:– Form of consideration charged or paid– Sales or purchase volume– Scope and terms of warranties provided– Rights to updates, revisions or modifications– Duration of relevant licenses, contracts or otheragreements, and termination or renegotiationrights– Collateral transactions or ongoing businessrelationships between parties including ancillaryor subsidiary services– Extension of credit and payment terms Treas. Reg. 1.6662-6(d)(2)(iii)(B)(1) –documentation requirement Treas. Reg. 1.482-1(d)(3)(ii) –contractual terms Transfer Pricing Roadmap Practice Unit, “Comparability Analysisfor Tangible Goods Transactions –Outbound,” DCN: ISO/PUO/V 1 01(2014) Intercompany and Third PartyAgreements6103 Protected Resources15Back to Table Of Contents15

DRAFTStep 1: Overview of USP’s Business (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersStep 1An overview of USP’s business is the first principal document. The overview should include an analysis of the economic and legalfactors that affect the pricing of its property or services.ConsiderationsResources Description of risks assumed which could affect theprices that would be charged or paid, or the profitthat would be earned, such as:– Market risks, including fluctuations in cost,demand, pricing, and inventory level– Risks associated with research anddevelopment activities– Financial risks, including changes in currencyrates and interest rates– Credit and collection risks– Product liability risks– Warranty risks– General business risks relating to theownership of property, plant, and equipment– Advertising and marketing risks– Intangible risks Treas. Reg. 1.6662-6(d)(2)(iii)(B)(1) –documentation requirement Treas. Reg. 1.482-1(d)(3)(iii) – Risk Transfer Pricing Roadmap Practice Unit, “Comparability Analysisfor Tangible Goods Transactions –Outbound,” DCN: ISO/PUO/V 1 01(2014) RM 4.61.3.5.3 – Risk Analysis Intercompany and Third PartyAgreements6103 Protected Resources16Back to Table Of Contents16

DRAFTStep 1: Overview of USP’s Business (cont’d)Review of Transfer Pricing Documentation by Outbound TaxpayersStep 1An overview of USP’s business is the first principal document. The overview should include an analysis of the economic and legalfactors that affect the pricing of its property or services.Considerations Description of economic conditions that couldaffect prices or profits, such as:– Similarity of geographic markets– Relative size of each market and the extent ofthe overall economic development in eachmarket– Level of market (e.g. wholesale, retail,manufacture, etc.)– R