Global Tax Alert | 19 February 2014

US IRS releases transfer pricing audit roadmap

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Executive summary

On 14 February 2014, the Internal Revenue Service (IRS) issued the Transfer Pricing Audit Roadmap (Roadmap), which provides best practices and helpful reference materials for LB&I employees regarding the administration of transfer pricing audits. The Roadmap, organized around a basic 24-month audit timeline, breaks down a transfer pricing audit into three phases: planning, execution and resolution, under the rubric of the IRS's Quality Examination Process (QEP). From an institutional perspective, the Roadmap represents an effort to formalize the continuous involvement of transfer pricing specialists in transfer pricing audits, from inception to completion. Overall, the Roadmap emphasizes coordination within LB&I, including the exam team and transfer pricing specialists, and the taxpayer, and encourages constant communication among all three groups of stakeholders. Further, opening with the statement that “Transfer pricing cases are usually won and lost on the facts,” the Roadmap seems to emphasize fact gathering as a means of building a case not only for exam, but for successful litigation. Accordingly, taxpayers are well-advised to ensure that their transfer pricing documentation is robust and presents a factual picture consistent with its tax returns and financial statements.

Detailed discussion

(a) Involving TP specialists in TP audits

As part of the 1 October 2010 reorganization that created the Large Business & International (LB&I) division, the Transfer Pricing Operations (TPO) group was created.1 The TPO is headed by an executive, and encompasses both the Advance Pricing and Mutual Agreement (APMA) Program and the Transfer Pricing Practice (TPP). The TPP is a group of transfer pricing specialists – including economists, lawyers, international examiners, and other experts – assembled to assist the field team with transfer pricing enforcement. In the past, transfer pricing cases were handled primarily by international examiners, who were trained in more general international tax issues and typically did not have in-depth knowledge of US transfer pricing rules. In September 2012, the TPP began actively participating in field audits.

(b) Planning phase: pre-examination analysis
1. Preliminary assessment

The initial planning phase of the Roadmap can last up to six months, and starts before the 24-month audit cycle begins. During this phase, examiners are instructed to review the taxpayer's returns, with particular emphasis being placed on Forms 5471, 5472, 8833, 8858, 8865, and 926, as well as schedules UTP and M-3. Examiners are also encouraged to familiarize themselves with the taxpayer's business operations (e.g., review of 10-K information) and to perform preliminary economic analyses (e.g., conduct key financial ratio analysis, etc.). Essentially, this phase of the exam involves reviewing the information already at the IRS's disposal, including prior audit cycle results, reports and Appeals Case Memoranda, as well as internal IRS tools to conduct industry analyses. Also during this phase, the examiner prepares the mandatory information document request (IDR) and initial examination contact letter, both of which are issued simultaneously.2 Finally, the Roadmap makes the first of many references to TPP involvement throughout the document, noting that a member of the TPP and/or an economist will participate in the preliminary assessments, and the level of involvement of a TPP member can range from advisor to lead examiner.

2. Internal Revenue Code Section 6662(e)3 documentation review

In this step of the planning phase, examiners review and analyze the Section 6662(e) documentation and note areas that require further development, confirmation or inquiry. Examiners will determine whether the documentation provided meets the requirements established in the Regulations, and are instructed to coordinate with the economist and the TPP on the initial assessment and hypothesis.

3. Planning meetings

Along with discussing general items such as timeframes and key milestones, the preliminary planning meeting should be used as an opportunity for examiners to identify the key taxpayer personnel who will be responsible for assisting the exam team with the transfer pricing audit and to request data and records relevant for the transfer pricing audit. The Roadmap also instructs TPP members to discuss the IDR process (e.g., response times, taxpayer input) with the taxpayer during this meeting and specifically mandates APMA notification with regard to challenged transactions involving treaty partners.

4. Opening conference

The opening conference, which kicks off the 24-month audit cycle, provides a forum for the audit team to discuss the general aspects of the audit process (e.g., review of the Roadmap as applied to the case, IDR response time and delays, Notice of Proposed Adjustment (NOPA) issues and resolution processes) with the taxpayer.

5. Taxpayer orientations

Within 30 days of the opening conference, there will be a financial statement/books and records orientation meeting. The goal is to address all topics financial, and can include, inter alia, a reconciliation from geographical trial balance to the consolidated financial statement in the 10-K; reviewing segmented financial statements and roll ups to the consolidated financial statement; mapping from the tax return to trial balance to general ledgers; reviewing work papers for book/tax differences; and gaining an overview of the taxpayer's accounting practices and policies. Soon after the financial statement/books and records orientation meeting is held, there should also be a transfer pricing orientation meeting. In that meeting, the examiner's goal is to, inter alia, gain more insight into the taxpayer's intercompany transactions; determine the functions performed, assets employed and risks assumed amongst controlled parties; identify who is responsible for tax planning; understand the value chain(s) associated with the intangible, services, or tangible goods; and gain an understanding of the taxpayer's transfer pricing methodology.

6. Preparation of initial risk analysis and audit plan

The last step of the planning phase includes the preparation of the risk analysis and audit plan, both of which are approved internally and then provided to the taxpayer. This period also serves as an opportunity to request additional information from the taxpayer.

(c) Execution phase: fact finding

The execution phase typically spans across a 14-month period. This phase is comprised of two main steps: fact finding and issue development.

1. Fact finding

Fact finding involves the issuance of any necessary additional IDRs; interviews of relevant taxpayer employees; and plant tours and site visits. The purpose of this step is to give the audit team the ability to perform in-depth functional analysis, identifying all significant economic activities connected to the transactions under review. The examiner should also perform a comparability analysis.

The Roadmap instructs the audit team to meet with taxpayer in order to confirm the material facts developed during the examination. Particularly, a written statement summarizing the material facts from the exam team's perspective should be provided to the taxpayer and the taxpayer should be requested to provide a written confirmation or explanation of differences between its position and the IRS's. This interactive process is anticipated to have a significant impact on case resolution.

As an important side note, the Roadmap also directs audit teams to coordinate any discrete legal issues found with Field Counsel, Associate Chief Counsel International, the TPP, and the International Practice Network.4

2. Issue development

Here, the economist on the case is tasked with performing an economic analysis consistent with the working hypothesis, in consultation with various team members, including the examiner, the TPP member, and field counsel. In addition to a strong and coherent economic analysis, an effective presentation of the position is required, which will include an explanation of the background and facts used in developing hypothesis. This write-up, along with the preliminary economist's report, will form the basis of the draft NOPA, which will be submitted to the taxpayer for discussion of inaccuracies and points of disagreement. The ultimate goal being to have an agreed set of facts presented in the final NOPA, the Roadmap notes that the process can be an iterative one, based on repeated rounds of receiving the taxpayer's input and then redrafting. During this phase, the audit team should also consider the applicability of Section 6662 penalties, as well as prepare a mutual agreement procedure report if applicable.

(d) Resolution phase

The resolution phase usually occurs during the last seven months of the audit cycle. This phase is composed of three main steps, issue presentation, issue resolution, and case closing /revenue agent's report (RAR).

1. Issue presentation

Prior to finalizing the NOPA, the audit team will meet with the taxpayer to discuss the government's findings on all transactions at issue. The audit team should work to understand the taxpayer's position, determine whether the taxpayer agrees with the facts as stipulated by the IRS, and establish whether the taxpayer would agree to any issues.

2. Issue resolution

The audit team and the taxpayer will meet to determine whether a resolution of the issues raised is possible. The Roadmap suggests discussing pre-Appeals resolution opportunities on issues left unresolved at the examination level. Once all issues are fully developed and resolution efforts have been concluded, a final NOPA will be issued. For all agreed issues, a discussion of Rev. Proc. 99-32 election and its ramifications is appropriate.5

3. Case closing/RAR

In the last step, the audit team will prepare a RAR/30 day letter for all unresolved issues, hold the Appeals pre-conference meeting, and attend the post-Appeals meeting.


The Roadmap is a toolkit for conducting transfer pricing audits, from the identification of issues, to the formulation of a working hypothesis, to the resolution of the issues. The process relies heavily on open and active communication between the taxpayer and the exam team.

With an emphasis on the involvement of TPP members in every step of the audit, taxpayers should be prepared for scrutiny by professionals with sophisticated transfer pricing knowledge. Further, the importance of having robust documentation of transfer pricing methodologies is tantamount, as the Roadmap itself approaches the audit with the maxim that cases are “won or lost on the facts.” With this in mind, it is reasonable to expect that the meticulously detailed steps set forth in the Roadmap could be designed to generate reports, notes and stipulated facts that could potentially form the basis of case development for litigation, in the event that issues are unable to be resolved at the Exam or Appeals levels.

The Roadmap points out that transfer pricing audits can take a much as two to three years. As such, the Roadmap is constructed on a two-year framework. While the two-year framework is not mandatory, the Roadmap seems to emphasize issue development over currency.

Taxpayers would be well-advised to take advantage of the Roadmap, which emphasizes cooperation not only among various groups within LB&I, but also with the taxpayer. Coupled with LB&I's new IDR Directive, taxpayers should have the opportunity to frame their transfer pricing methodology in a compelling manner, clearly addressing the basis for their business decisions and the resulting financial outcomes and effective tax impact.


1. The TPO is national in scope and is divided into three territories – East, Central and West.

2. Taxpayers are required to respond within 30 days from receipt of the initial examination contact letter.

3. All “Section” references are to the US Internal Revenue Code of 1986, as amended, unless otherwise stated. The Regulations promulgated thereunder are referred to as “regulations” and cited as “Treas. Reg. Section.”

4. To assist in the development of in-house transfer pricing experts, the IRS has established internal knowledge management tools, including internal communication networks where examiners and other personnel can exchange their experiences and observations. One of these networks is the International Practice Network, a knowledge development network for international issues (including transfer pricing).

5. Rev. Proc. 99-32 discusses the Service's position regarding adjustments that may be made to conform the accounts of taxpayers to reflect allocations made under Section 482, and avoid the tax consequences that might otherwise result from those conforming adjustments.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, Transfer Pricing, Washington, DC
  • Dave Canale
    +1 202 327 7653
  • Loren Ponds
    +1 202 327 8758
Ernst & Young LLP, TCRMS, San Francisco
  • Pat Chaback
    +1 415 894 8231
Ernst & Young LLP, TCRMS, Washington, DC
  • Matthew Cooper
    +1 202 327 7177
  • John DiIorio
    +1 202 327 6847

EYG no. CM4183