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BY BARBARA MANTEGANI
Internal Revenue Service’s Douglas O’Donnell in January issued five transfer pricing memoranda of instructions to the Service’s Large Business and International Division employees (Control No. LB&I-04-0118- 001 through 005).
O’Donnell, the commissioner for LB&I at the IRS, issued instructions to Field auditors on how to conduct transfer pricing examinations and handle advance pricing agreement applications, including an instruction regarding an issue that has been the subject of repeated regulatory changes and litigation.
The memoranda update the Internal Revenue Manual (IRM) and will be incorporated into the manual to provide ongoing instruction to LB&I personnel, primarily but not exclusively International Examiners (IEs).
The timing of the memoranda’s release, when the attention of most taxpayers was on the potential impact of the tax reform bill, likely reduced the attention paid to them. That said, a closer look reveals some important guidance for taxpayers involved in either transfer pricing audits or APAs.
Transfer Pricing Information Document Requests (IDRs)
All the memoranda include identical introductory language acknowledging both that transfer pricing issues make up a substantial portion of the LB&I audit inventory, and that LB&I needs to manage transfer pricing issues and related resources ‘‘in the most efficient and effective manner possible.’’
To that end, the first memorandum, which is described as an ‘‘interim instruction,’’ makes the Mandatory Transfer Pricing IDR (the IDR requesting the taxpayer’s transfer pricing documentation for the year at issue) no longer mandatory for all cases. The memorandum, while acknowledging that the Mandatory IDR is a critical starting point for any transfer pricing examination, limits its use to examinations that arise under an approved LB&I transfer pricing campaign, or examinations where personnel from either the Transfer Pricing Practice (TPP) or Cross Border Activities (CBA) Practice Area have been assigned.
While the memo does not explicitly connect these dots, it is clear going forward that it will be LB&I policy that all transfer pricing exams will either be part of a campaign or will have National Office involvement through either TPP or CBA personnel being assigned. This should be seen as a positive development for taxpayers, in that it should lead to more consistency in both case selection and case process.
In somewhat of a surprise move, the IRS announced on March 30th that certain companies with significant contracts with the Department of Defense (designated as “specified national security contractors”) will be exempted from most of the detailed reporting required on Form 8975, the Country-by-Country report. For purposes of this notice, a U.S. MNE group is a “specified national security contractor” if more than 50 percent of the U.S. MNE group’s annual revenue, as determined in accordance with U.S. generally accepted accounting principles, in the preceding reporting period is attributable to contracts with the Department of Defense or other U.S. government intelligence or security agencies.
The potential for an exemption from reporting based on national security concerns was mentioned in the preamble to the proposed regulations issued in December of 2015, and reiterated in the preamble to the final regulations issued in June of 2016, so the move is not entirely unexpected, but certainly such an exemption is very unusual, and it is not clear how the U.S. treaty partners will respond to the exemption. Essentially, the notice allows U.S. MNE groups that meet the definition to report only their U.S. operations at the group level with no constituent level information and does not require such groups to identify any of the other countries where the group has operations.
In addition, in order for taxpayers to avoid the automatic exchange of Forms 8975 that were filed with complete information, the notice provides specific instructions to companies that might have already filed complete Forms 8975, regarding their ability to file an amended return and an amended Form 8975 for that year. The notice provides that in order to ensure originally-filed CbC reports are not automatically exchanged, specified national security contractors that are filing amended Form 8975 and Schedules A (Form 8975) to supersede an already-filed Form 8975 and Schedules A (Form 8975) should do so by April 20, 2018, if filing an amended Federal income tax return on paper, or by May 25, 2018, if filing electronically.
These deadlines no doubt are driven by the deadline for automatic exchange of information returns filed for tax years beginning on or after January 1, 2016, which under the model bilateral exchange agreement is 18 months from the last date of the 2016 tax year, or June 30, 2018. Clearly the IRS wants to give taxpayers affected by the notice the opportunity to amend their forms to take advantage of the notice before the first exchange.
It remains to be seen if any of the U.S. treaty partners will respond to this reduced reporting, or whether other countries will in turn grant their MNEs with sensitive defense contracts a similar reduced reporting requirement. Stay tuned.