Bold Shift in IRS Approach to Transfer Pricing Controversies

International Tax Alert

U.S. taxpayers should prepare for major changes in IRS transfer pricing audits.  New procedures, sharpened objectives, accelerated taxpayer decision points, and revised resolution opportunities will result from a confluence of just-issued IRS guidance.  All will require refined handling of audits and sophisticated analysis of strategic options.  The IRS seeks to markedly alter the dynamics and outcomes of transfer pricing audits, and taxpayers will need to plan and react accordingly.

The key IRS documents are the "Transfer Pricing Audit Road Map" (available on; the "Road Map"), released on February 14, 2014, and upcoming revisions to the "Competent Authority Revenue Procedure," released in draft form in December 2013 (Notice 2013-78; the "CA Rev Proc").  The substantive and strategic hand of the new Transfer Pricing Office within the Large Business & International division, and its field-based Transfer Pricing Practice, are evident.  Over the past year, the Transfer Pricing Practice, composed of some 70 experts divided into three geographic regions, has become embedded in the Field, providing coordinated, substantive guidance, assisting with risk assessment, and participating directly in individual cases to varying degrees.

The Road Map reframes the IRS Examination approach in an attempt to increase efficiency and effectiveness and focus resources on the most important cases.  With publication of the Road Map, the IRS has taken a bold step in clearly and candidly enunciating what it expects from Field personnel and from taxpayers with respect to transfer pricing audits.  For taxpayers, this is an opportunity to prepare in advance of audit, with visibility into likely IRS approaches. 

The Field is directed to thoroughly traverse a taxpayer's transfer pricing landscape, construct a malleable "working hypothesis," risk assess the situation, fully develop the facts, write clearly, and seek a "reasonable result."  The Field's efforts are to be front-loaded, with up to six months of advance review and focused planning before the audit begins.  Collaboration with the taxpayer, and sharing of the Field's analyses and its understanding of the facts, are emphasized.  While concisely written (26 pages), the Road Map incorporates by reference various additional administrative guidance, and sends some very clear messages.  A few aspects of note – some positive, some problematic:

  • Early orientation sessions – comprehensive presentations that anticipate IRS areas of inquiry – will provide an opportunity for the taxpayer to frame its viewpoints.  Indeed, an understanding of the whole process suggests the importance of a proactive stance by taxpayers.

  • Early, routinized, financial analysis by the Field – ratio analysis, effective tax rate calculations, and industry comparisons via the Capital IQ database, inter alia – may (intentionally or otherwise) invite a formulaic approach to issue development.  And taxpayers should be on notice that their websites will be scrutinized.

  • Early involvement of specialists in various areas – economics, industry dynamics, transfer pricing law and methodologies, competent authority/treaty, APAs, data analysis – will add expertise but also many "cooks" to the decision-making process.

  • Despite public statements regarding case and issue selection, the Road Map itself does not emphasize the filtering process, apart from one welcome directive: "It is critical that, in every case, the team address in full the taxpayer's analysis – the taxpayer may well have the more compelling position on the issue." 

  • The timing for developing the working hypothesis and the risk assessment – and the distinction between them – is blurred.  The Road Map would more aptly be constructed as a "decision tree," with some branches ending if either the initial risk assessment or the working hypothesis fails to bear fruit.
  • Generally speaking, a 24-month audit period, following 6 months of planning, is envisioned.  This seems long for a purportedly streamlined process, without much evidence of flexibility to suit a particular case (e.g., shortening or terminating an audit in appropriate circumstances), and may send mixed messages to the Field. 

  • Although comments on this organic document are broadly solicited, it's a bit disquieting that these are to be submitted to the TPO's "Income Shifting Issue Practice Network".

The Competent Authority Revenue Procedure (assuming it is finalized substantially in accordance with the draft) will markedly reposition and increase the role of U.S. Competent Authority ("CA") in U.S.-initiated transfer pricing cases.  Recognizing CA's inevitable role, the Examination process will for the first time be shaped by U.S. CA's input and dictate, and the traditional role of IRS Appeals will be markedly changed.  This push to get more quickly to the heart of double-taxation issues will significantly change taxpayers' procedural options and will call for different strategic analyses.   The new structure also largely eliminates a taxpayer's ability to seek reduction of adjustments in multiple venues – the so-called two bites at the apple. 

Much of this will be accomplished by accelerating, and restricting, access to CA: 

  • For example, a taxpayer will not be able to take a case to CA after signing a Form 870 with the Field unless U.S. CA was consulted and agreed to the terms in advance.  The CA Rev Proc also empowers U.S. CA to tell the Field to change (or withdraw) its position.  Early consultation with and input from U.S. CA is part of the Road Map described above.

  • If a taxpayer instead protests the adjustment to Appeals, the taxpayer will only be able to spend a short time there – until 30 days after the opening  Appeals conference – before deciding whether it ever wants CA assistance.  If so, it must immediately involve CA by either a direct approach to U.S. CA or invocation of the joint Appeals/CA process known as the Simultaneous Appeals Procedure.  Preparing for this decision and the related submission will be tightly compressed and accordingly challenging.  

  • Finally, a taxpayer who pursues an Appeals case through a Form 870AD settlement agreement, Appeals Mediation, or Appeals Arbitration will be barred from access to CA, even for the limited purpose of asking U.S. CA to politely seek correlative relief from the counterpart country without negotiation of the amount.

A separate change in case resolution dynamics at the audit stage is the opening of the Fast Track Settlement Process to transfer pricing cases – provided that U.S. CA is a participant.  This mechanism will bring together Field case development, hazards-of-litigation settlement authority, Appeals mediation skills, and U.S. CA insight regarding the CA process and players, all within a 120-day turnaround.  This process may present a valuable "one-stop-shopping" opportunity, but will require skillful navigation by both the IRS and the taxpayer. 

The revised CA procedures will also offer new opportunities and attitude toward comprehensively resolving a broad swath of a taxpayer's transfer pricing-related matters.  U.S. CA will be able to initiate CA coverage of future years, related issues, and additional countries.  Moreover, U.S. CA will be able to enforce this expansion by rejecting the taxpayer's original request if the taxpayer does not agree to these expansions.  While this broader sweep may prove beneficial in many cases, sensitive related issues, years or countries may be at risk in others.

Other related developments of which taxpayers should be aware include the extension of CA assistance to cover taxpayer-initiated positions, penalties, and interest, as well as proposed new procedures for APAs (IRS Notice 2013-79).   Detailed analysis of the revised CA and APA procedures can be found in a Caplin & Drysdale article available on our website in early March.

Overall, taxpayers should expect major changes in the transfer pricing audit process, affecting their related strategic considerations.  The IRS innovations are ambitious in scope.  But inspiration needs to be matched by implementation.  Rolling out these changes in an organization as large and deep as the IRS will surely be challenging, and the road could be uneven.  However, current IRS leadership is strong and dedicated to these changes, and taxpayers should take them seriously.

For more information about developments regarding transfer pricing controversies and APAs, the potential impact of the OECD BEPS initiative, or other issues concerning transfer pricing or international taxation, please contact:

Patricia G. Lewis


J. Clark Armitage


Peter A. Barnes


Neal M. Kochman


For half a century, Caplin & Drysdale has been a leading provider of a full range of tax, tax controversy, and related legal services to companies, organizations, and individuals throughout the United States and around the world.  With offices in New York City and Washington, D.C., the firm also provides counseling on matters relating to bankruptcy, creditors' rights, political activity, exempt organizations, complex litigation, employee benefits, private client services, corporate law, and white collar defense.  For more information, please visit us at

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This communication does not provide legal advice, nor does it create an attorney-client relationship with you or any other reader. If you require legal guidance in any specific situation, you should engage a qualified lawyer for that purpose. Prior results do not guarantee a similar outcome.

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