The transfer pricing dispute between the IRS and the taxpayer generally begins with the IRS examination process. Let’s understand the key steps that may lead to a transfer pricing dispute with the IRS.
The IRS starts by reviewing the U.S. company’s transfer pricing. The IRS may ask for the following:
The IRS generally communicates with the U.S. taxpayer being examined, rather than automatically sending a separate notice to the foreign parent or affiliate. However, the foreign company may need to provide information or become involved because the examination concerns transactions between the U.S. company and its foreign related party.
If the examiner concludes the pricing between related parties doesn’t reflect an arm’s-length standard, the IRS issues a Notice of Proposed Adjustment (NOPA), often referred to as Form 5701, explaining the basis for the proposed change. This is typically accompanied by a 30-day letter. The letter formally notifies the taxpayer of the proposed adjustment and gives them 30 days to file a protest before the case is closed at the examination level or referred for further action.
A proposed adjustment usually means the IRS is reallocating income into the U.S. entity by increasing U.S. taxable income. This raises the risk of the same income being taxed twice, once by the IRS and once by the foreign country where the related foreign entity is taxed. The 30-day letter starts a clock, so foreign companies need to coordinate quickly with U.S. and foreign advisors to decide whether to protest and how it may affect potential MAP relief down the line.
The U.S. taxpayer may respond to the IRS by providing additional documents, explaining its position, or presenting a different economic analysis.
The foreign parent or affiliate may need to provide information and support the U.S. company’s position. Resolving the issue at this stage can help avoid the additional time and cost of a formal appeal or court proceeding.
If the issue cannot be resolved with the IRS examination team, the taxpayer may generally request consideration by the IRS Independent Office of Appeals.
Appeals is separate from the examination team and independently considers the taxpayer’s position and the IRS’s position.
An appeal process with the IRS provides another opportunity to resolve the dispute without going to court and may help reduce the risk and cost of prolonged litigation.
The Appeals officer considers the arguments and evidence presented by both the taxpayer and the IRS. Appeals generally considers the strengths and weaknesses of each position, including the potential risks and costs if the case goes to court.
Depending on the circumstances, certain alternative dispute resolution (ADR) options may also be available.