[Federal Register Volume 59, Number 130 (Friday, July 8, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-16357]


[[Page Unknown]]

[Federal Register: July 8, 1994]


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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