Temporary and Proposed Penalty Regs to Final Transfer Pricing Rules

 [4830-01-u]

 ACTION: Temporary Regulations.

 SUMMARY: These amendments to the regulations under 26 CFR part 1 provide guidance on the imposition of the accuracy-related penalty under Internal Revenue Code section 6662(e) for net section 482 transfer price adjustments. This action is necessary to conform the existing temporary regulations with changes to the section 482 regulations.

 EFFECTIVE DATE: January 1, 1994.

 FOR FURTHER INFORMATION CONTACT: Thomas L. Ralph at (202) 622-3880 (not a toll-free number).

 SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

These regulations are being issued without prior notice and public procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). For this reason, the collection of information contained in these regulations has been reviewed and, pending receipt and evaluation of public comments, approved by the Office of Management and Budget (OMB) under control number 1545-1426.

 For further information concerning this collection of information, and where to submit comments on this collection of information and the accuracy of the estimated burden, and suggestions for reducing this burden, please refer to the preamble to the cross- referencing notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register.

BACKGROUND

 Section 13236 of the Omnibus Budget Reconciliation Act of 1993 (Pub. L. 103-66, 107 Stat. 312) amended sections 6662(e) and (h) of the Code. On February 2, 1994, the IRS published temporary regulations and a notice of proposed rulemaking in the Federal Register (58 FR 5263) that proposed amendments to the Income Tax Regulations under sections 6662(e) and (h) and section 6664(c) of the Internal Revenue Code of 1986 (Code), as amended.

EXPLANATION OF PROVISIONS

 The principal purpose of these regulations is to conform the temporary regulations with the final section 482 regulations contained in this issue of the Federal Register. The regulations are amended primarily to conform the provisions to the revised best method rule contained in section 1.482-1(c) and the arm's length range rule contained in section 1.482-1(d). The temporary and proposed regulations provided, with respect to the specified method requirement and in circumstances in which no specified method is applicable, that the selection and application of a method is reasonable only if, given the available data and the applicable pricing methods, the taxpayer reasonably concluded that the method and its application of that method provided the most accurate measure of an arm's length result under the principles of the best method rule in section 1.482-1T(b)(2)(iii). In conformity with the final section 482 regulations, these temporary regulations substitute the term reliable for the term accurate.

 These regulations also clarify that if a taxpayer applies a specified or unspecified method, the taxpayer cannot reasonably conclude that the method it selected provided the most reliable measure of an arm's length result if it has not made a reasonable effort to evaluate the potential applicability of the other specified methods under the section 482 regulations in a manner consistent with the principles of the best method rule. This rule does not require that a taxpayer conduct an extensive analysis or detailed application of each method, but merely that, following a reasonably thorough search for relevant data, the taxpayer consider which method would provide the most reliable measure of an arm's length result given that data. In many cases the nature of the data located will make it possible to conclude that a particular method is inapplicable without further analysis.

 The regulations add a fifth factor to the analysis of whether a taxpayer reasonably concluded that its application of a specified method provided the most reliable measure of an arm's length result. This factor is relevant if the taxpayer uses a range of results to set its price. In such a case, the district director will consider whether the taxpayer arbitrarily selected a result that corresponded to an extreme point in the range of results. In many cases a point selected in this manner would not be likely to be closest to an arm's length result. The regulations provide that when the taxpayer uses "inexact" comparables, such as those described in section 1.482-1(e)(2)(iii)(B), one reasonable method of selecting a point in the range would be that provided in section 1.482-1(e)(3). Other methods also could be reasonable as long as they are intended to select a point most likely to be closest to an arm's length result.

 These regulations also specify, through examples in the text of the regulations, the type of documentation necessary if a profit split method is used. The significance of such documentation has been increased by the final regulations' elimination of certain proposed restrictions on the use of profit split methods.

 These regulations add section 1.6662-6T(d)(2)(iii)(D), which provides that, if a taxpayer uses a profit split method or receives or makes a lump sum payment for the transfer of an intangible, then the taxpayer must annually document that fact on a statement attached to a timely filed income tax return. Similarly, these regulations add section 1.6662-6T(d)(3)(iii)(C), which provides that if a taxpayer applies an unspecified method, then the taxpayer must annually document that fact on a statement attached to a timely filed U.S. income tax return. A taxpayer that fails to comply with these documentation rules would not satisfy the documentation requirements of section 1.6662-6T(d)(2)(iii) and would therefore be unable to qualify for the exclusion from the calculation of a net section 482 adjustment provided under section 1.6662-6T(d).

EFFECTIVE DATE

 These regulations apply to taxable years beginning after December 31, 1993.

SPECIAL ANALYSES

 It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, an initial Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations, and, therefore, an initial Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, these temporary regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal author of these regulations is Thomas L. Ralph of the Office of the Associate Chief Counsel (International), Internal Revenue Service. However, other personnel from the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR Part 1

 Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

 Reporting and recordkeeping requirements.

Treasury Decision 8551

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1 -- INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

1.6662-6T also issued under 26 U.S.C. 6662. * *

Par. 2. Section 1.6662-0 is amended in the table of contents by adding the entries for section 1.6662-6T(d)(2)(iii)(D) and section 1.6662-6T(d)(3)(iii)(C) to read as follows:

SECTION 1.6662-0 TABLE OF CONTENTS.

* * * *

SECTION 1.6662-6T TRANSACTIONS BETWEEN PERSONS DESCRIBED IN SECTION 482 AND NET SECTION 482 TRANSFER PRICE ADJUSTMENTS (TEMPORARY).

* * * *

(d) * * *

(2) * * *

(iii) * * *

(D) Tax return documentation.

(3) * * *

(iii) * * *

(C) Tax return documentation.

* * * *

Par. 3. Section 1.6662-6T is amended as follows:

a. By revising the section heading;

b. By revising paragraph (d)(2)(ii);

c. By revising paragraphs (d)(2)(iii)(A) and (B);

d. By adding paragraph (d)(2)(iii)(D);

e. By revising paragraphs (d)(3)(ii)(B) and (C);

f. By adding paragraph (d)(3)(iii)(C).

The additions and revisions read as follows:

SECTION 1.6662-6T TRANSACTIONS BETWEEN PERSONS DESCRIBED IN SECTION 482 AND NET SECTION 482 TRANSFER PRICE ADJUSTMENTS (TEMPORARY).

* * * *

(d) * * *

(2) * * *

(ii) SPECIFIED METHOD REQUIREMENT. The specified method requirement is met if the taxpayer selects and applies a specified method in a reasonable manner. The taxpayer's selection and application of a specified method is reasonable only if, given the available data and the applicable pricing methods, the taxpayer reasonably concluded that the method (and its application of that method) provided the most reliable measure of an arm's length result under the principles of the best method rule of section 1.482-1(c). A taxpayer can reasonably conclude that a specified method provided the most reliable measure of an arm's length result only if it has made a reasonable effort to evaluate the potential applicability of the other specified methods in a manner consistent with the principles of the best method rule. However, it is not necessary for a taxpayer to conclude that the selected specified method provides a more reliable measure of an arm' s length result than any unspecified method. For examples illustrating the selection of a specified method consistent with this paragraph (d)(2)(ii), see section 1.482-8. Whether the taxpayer's conclusion was reasonable must be determined from all the facts and circumstances. The factors relevant to this determination include the following:

(A) The experience and knowledge of the taxpayer, including all members of the taxpayer's controlled group.

(B) The extent to which accurate data was available and the data was analyzed in a reasonable manner. A taxpayer must engage in a reasonably thorough search for the data necessary to determine which method should be selected and how it should be applied. Furthermore, a taxpayer must use the most current reliable data that is available before the return is filed. In this regard, the expense of collecting data relative to the dollar amount of the transactions in question is a factor that may be taken into account in determining the scope of a reasonably thorough search for data.

(C) The extent to which the taxpayer followed the relevant requirements set forth in regulations under section 482 with respect to the application of the method.

(D) The extent to which the taxpayer reasonably relied on the analysis of, or a study done by, a professional qualified to conduct such an analysis or study, including an attorney, accountant, or economist. Whether the professional is an employee of, or related to, the taxpayer is not determinative in evaluating the reliability of that analysis or study, as long as the analysis or study is objective, thorough, and well reasoned. Such reliance is reasonable only if the taxpayer disclosed to the professional all relevant information regarding the controlled transactions at issue. A transfer pricing study or analysis that was reasonably relied upon in a prior year may reasonably be relied upon in the current year if the relevant facts and circumstances have not changed or if the study or analysis has been appropriately modified to reflect any change in facts and circumstances.

(E) If the taxpayer attempted to determine an arm's length result by using more than one uncontrolled comparable, whether the taxpayer arbitrarily selected a result that corresponds to an extreme point in the range of results derived from the uncontrolled comparables. Such a result generally would not likely be closest to an arm's length result. If the uncontrolled comparables that the taxpayer uses to determine an arm's length result are described in section 1.482-1(e)(2)(ii)(B), one reasonable method of selecting a point in the range would be that provided in section 1.482-1(e)(3).

(iii) * * * (A) IN GENERAL. The documentation requirement of this paragraph (d)(2)(iii) is met if the taxpayer maintains sufficient documentation to establish that the taxpayer reasonably concluded that, given the available data and the applicable pricing methods, the method (and its application of that method) provided the most accurate measure of an arm's length result under the principles of the best method rule in section 1.482-1(c), and provides that documentation to the Internal Revenue Service within 30 days of a request for it. That documentation must be in existence when the return is filed. The district director may, in his discretion, excuse a minor or inadvertent failure to provide required documents, but only if the taxpayer has made a good faith effort to comply, and the taxpayer promptly remedies the failure when it becomes known. The required documentation is divided into three categories, principal documents, background documents, and tax return documentation, as described in paragraphs (d)(2)(iii)(B), (C), and (D) of this section.

(B) PRINCIPAL DOCUMENTS. The principal documents should accurately and completely describe the basic transfer pricing analysis conducted by the taxpayer. The documentation must include the following --

(1) An overview of the taxpayer's business, including an analysis of the economic and legal factors that affect the pricing of its property or services;

(2) A description of the taxpayer's organizational structure (including an organization chart) covering all related parties engaged in transactions potentially relevant under section 482, including foreign affiliates whose transactions directly or indirectly affect the pricing of property or services in the United States;

(3) Any documentation explicitly required by the regulations under section 482;

(4) A description of the method selected and an explanation of why that method was selected;

(5) A description of the alternative methods that were considered and an explanation of why they were not selected;

(6) A description of the controlled transactions (including the terms of sale) and any internal data used to analyze those transactions. For example, if a profit split method is applied, the documentation must include a schedule providing the total income, costs, and assets (with adjustments for different accounting practices and currencies) for each controlled taxpayer participating in the relevant business activity and detailing the allocations of such items to that activity;

(7) A description of the comparables that were used, how comparability was evaluated, and what (if any) adjustments were made;

(8) An explanation of the economic analysis and projections relied upon in developing the method. For example, if a profit split method is applied, the taxpayer must provide an explanation of the analysis undertaken to determine how the profits would be split; and

(9) A general index of the principal and background documents and a description of the recordkeeping system used for cataloging and accessing those documents.

* * * * * *

(D) TAX RETURN DOCUMENTATION -- (1) USE OF PROFIT SPLIT METHOD. If the taxpayer applies a profit split method, as described in section 1.482-6, the taxpayer must attach a statement to a timely filed U.S. income tax return (with extensions) disclosing the kind of profit split method employed, the combined operating profit from the relevant business activity, and the split of that profit among the controlled participants in that activity. Such statement must be titled "Disclosure of profit split methodology required by section 1.6662-6T."

(2) LUMP SUM PAYMENTS. If the consideration for the controlled transfer of an intangible is in the form of a lump sum payment, the taxpayer must attach a statement to a timely filed U.S. income tax return (with extensions) for each taxable year throughout the useful life of the intangible. The statement must disclose the calculation of the arm's length consideration for the transfer under the provisions of section 1.482-4(f)(5), and must be titled "Disclosure of lump sum payment required by section 1.6662-6T."

(3) * * *

(ii) * * *

(B) SPECIFIED METHOD POTENTIALLY APPLICABLE. If the transaction is of a type for which methods are specified in the regulations under section 482, then a taxpayer will be considered to have met the unspecified method requirement if the taxpayer reasonably concludes, given the available data, that none of the specified methods was likely to provide a reliable measure of an arm's length result, and that it selected and applied an unspecified method in a way that would likely provide a reliable measure of an arm's length result. A taxpayer can reasonably conclude that no specified method was likely to provide a reliable measure of an arm's length result only if it has made a reasonable effort to evaluate the potential applicability of the specified methods in a manner consistent with the principles of the best method rule. However, it is not necessary for a taxpayer to conclude that the selected method provides a more reliable measure of an arm's length result than any other unspecified method. Whether the taxpayer's conclusion was reasonable must be determined from all the facts and circumstances. The factors relevant to this conclusion include those set forth in paragraph (d)(2)(ii) of this section.

(C) NO SPECIFIED METHOD APPLICABLE. If the transaction is of a type for which no methods are specified in the regulations under section 482, then a taxpayer will be considered to have met the unspecified method requirement if it selected and applied an unspecified method in a reasonable manner. For purposes of this paragraph (d)(3)(ii)(C), a taxpayer's selection and application is reasonable if the taxpayer reasonably concludes that the method (and its application of that method) provided the most reliable measure of an arm's length result under the principles of the best method rule in section 1.482-1(c). However, it is not necessary for a taxpayer to conclude that the selected method provides a more reliable measure of an arm's length result than any other unspecified method. Whether the taxpayer's conclusion was reasonable must be determined from all the facts and circumstances. The factors relevant to this conclusion include those set forth in paragraph (d)(2)(ii) of this section.

(iii) * * *

(C) TAX RETURN DOCUMENTATION. If the taxpayer applies an unspecified method, the taxpayer must attach a statement to a timely filed U.S. income tax return (with extensions) disclosing the use of such method for the taxable year in which the method is applied. Such statement must be titled "Disclosure of use of unspecified method required by section 1.6662-6T.

* * * * *

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 9. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805.

Par. 10. Section 602.101(c) is amended by removing the entry for "1.6662-6T. . . .1545-1365" from the table and adding the entry "1.6662-6T. . . .1545-1426" in numerical order to the table.