Imposition of Accuracy-Related Penalty

DEPARTMENT OF THE TREASURY

26 CFR Parts 1 and 602

[TD 8551]

RIN 1545-AS25

Imposition of Accuracy-Related Penalty

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary Regulations.

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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 Sec. 1.482-1(c) and the arm's length range rule contained

in Sec. 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 Sec. 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 Sec. 1.482-1(e)(2)(iii)(B), one

reasonable method of selecting a point in the range would be that

provided in Sec. 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 Sec. 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 Sec. 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 Sec. 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 Sec. 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.

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 Sec. 1.6662-6T(d)(2)(iii)(D) and Sec. 1.6662-

6T(d)(3)(iii)(C) to read as follows:

Sec. 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 Sec. 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

Sec. 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 Sec. 1.482-1(e)(2)(ii)(B), one

reasonable method of selecting a point in the range would be that

provided in Sec. 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 Sec. 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 Sec. 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 Sec. 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

Sec. 1.482-4(f)(5), and must be titled ``Disclosure of lump sum payment

required by Sec. 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 Sec. 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 Sec. 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.

Dated: June 27, 1994.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved:

Leslie Samuels,

Assistant Secretary of the Treasury (Tax Policy).

[FR Doc. 94-16357 Filed 7-5-94; 12:26 pm]

BILLING CODE 4830-01-P