[Federal Register Volume 61, Number 28 (Friday, February 9, 1996)]
[Rules and Regulations]
[Pages 4876-4885]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-2171]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[TD 8656]
RIN 1545-AS24
Section 6662--Imposition of the Accuracy-Related Penalty
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations.
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SUMMARY: These regulations 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 implements
changes to the applicable tax laws made by the Omnibus Budget
Reconciliation Act of 1993.
DATES: These regulations are effective February 9, 1996.
Applicability: At the election of the taxpayer, these regulations
may be applied to all open taxable years beginning after December 31,
1993.
FOR FURTHER INFORMATION CONTACT: Carolyn D. Fanaroff of the Office of
Associate Chief Counsel (International), IRS (202) 622-3880 (not a
toll-free number).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in these final regulations
have been reviewed and approved by the Office of Management and Budget
in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under
control number 1545-1426. Responses to this collection of information
are required by section 6662(e) of the Internal Revenue Code in order
to administer the transfer pricing penalty under that section.
An agency may not conduct or sponsor, and a person is not required
to respond to, a collection of information unless the collection of
information displays a valid control number.
The estimated average annual burden per recordkeeper varies from 5
to 15 hours, depending on individual circumstances, with an estimated
average of 10 hours per recordkeeper.
Comments concerning the accuracy of this burden estimate and
suggestions for reducing this burden should be sent to the Internal
Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington,
DC 20224, and to the Office of Management and Budget, Attn: Desk
Officer for the Department of the Treasury, Office of Information and
Regulatory Affairs, Washington, DC 20503.
Books and records relating to this collection of information must
be retained as long as their contents may become material in the
administration of any internal revenue law. Generally, tax returns and
tax return information are confidential, as required by 26 U.S.C. 6103.
Background
Sections 6662(e) and (h) of the Internal Revenue Code reflect
amendments made by Section 13236 of the Omnibus Budget Reconciliation
Act of 1993 (OBRA `93, Public Law 103-66, 107 Stat. 312). On February
2, 1994, the IRS and Treasury published temporary regulations (59 FR
4791) and a notice of proposed rulemaking (58 FR 5263) setting forth
rules for imposing a substantial valuation misstatement penalty in
connection with transactions between persons described in section
[[Page 4877]]
482 (the transactional penalty) and net section 482 transfer price
adjustments (the net adjustment penalty) and withdrawing previously
proposed regulations issued on January 21, 1993 (58 FR 5304). On July
8, 1994, the IRS and Treasury issued new temporary regulations (59 FR
35030) under section 6662(e) conforming the previously- issued
regulations to the final 482 regulations published on the same day. A
cross-referenced notice of proposed rulemaking accompanied the
temporary regulations (59 FR 35066).
The IRS and Treasury received numerous comments on the proposed and
temporary regulations from taxpayers, practitioners, tax treaty
partners, industry representatives, and professional associations. In
general, most commenters recognized the government's interest in
encouraging timely compliance with the arm's length standard at the
time that a tax return is filed. These commenters primarily addressed
particular aspects of the specified method rule in Sec. 1.6662-
6(d)(2)(ii) of the temporary regulations that they believed imposed an
unnecessary burden.
In response to these comments, the IRS and Treasury have attempted
to simplify the requirements set forth in the proposed and temporary
regulations without departing from the basic objective of section
6662(e): to improve compliance with the arm's length standard by
encouraging taxpayers to make reasonable efforts to determine and
document arm's length prices for their intercompany transactions. The
regulations are adopted as revised by this Treasury decision, and the
corresponding proposed and temporary regulations are removed. Set forth
below is a discussion of the most significant comments and the changes
made in response to them.
Discussion of Major Comments and Changes to the Regulations
The Reasonableness Standard
Commenters expressed concern that the standard for assertion of the
transactional penalty and the net adjustment penalty (together, the
penalty) under the proposed and temporary regulations effectively makes
the penalty a ``no fault'' penalty to be imposed in any case in which
the statutory thresholds for imposition are met. Commenters suggested
that, in all cases, a taxpayer could not have used the most reliable
measure of an arm's length result if it subsequently is determined that
the taxpayer's analysis was incorrect. Some of these commenters urged
the IRS to impose the penalty only where a taxpayer deliberately
attempts to shift income.
The IRS and Treasury have determined that it is not necessary to
revise the proposed and temporary regulations in response to these
comments. The proposed and temporary regulations do not adopt a ``no-
fault'' approach. Like other penalty statutes, the provisions of
section 6662(e) incorporate standards of reasonable cause and good
faith. See section 6662(e)(3)(D) and section 6664(c). Accordingly,
under both the temporary and final regulations, the penalty is excused
if the taxpayer, based upon the data that was reasonably available to
it, reasonably concluded that its analysis was the most reliable and
satisfied the documentation requirement of the regulations. In such a
case, the taxpayer may be subject to an adjustment if the IRS later
employs a different analysis or uses different data leading to a
different result, but an adjustment does not necessarily trigger the
imposition of the penalty. The regulations provide guidance on the
interpretation of the reasonableness standard. See Sec. 1.6662-6(d).
Reported Results
In response to comments, the final regulations clarify the method
of determining reported results, and what will be considered amended
returns for taxpayers electing Accelerated Issue Resolution or similar
procedures.
Evaluation of Methods Other Than the Method Actually Applied
Under Sec. 1.6662-6T(d)(2)(ii) of the temporary regulations,
taxpayers may satisfy the specified method requirement by selecting and
applying a specified method in a reasonable manner. In order to meet
this requirement, taxpayers must make 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 of Sec. 1.482-
1(c). Some commenters argued that this requirement would be overly
burdensome because it could mean that the taxpayer effectively must
disprove all other methods in order to avoid imposition of the penalty.
Others asserted that the requirement in Sec. 1.6662-6T(d)(2)(ii) that
taxpayers make a reasonable effort to evaluate other methods in a
manner consistent with the principles of the best method rule was
inconsistent with language contained in Sec. 1.482-1(c)(1).
The notion of a comparison of methods is inherent in the best
method rule of Sec. 1.482-1(c)(1). In order to be judged the ``best''
method, the method to some extent must be compared to other methods.
The examples set forth under Sec. 1.482-8 illustrate an appropriate
application of a comparative analysis. In introducing these examples,
Sec. 1.482-8 states that ``a method may be applied in a particular case
only if the comparability, quality of data, and reliability of
assumptions under that method make it more reliable than any other
available measure of the arm's length result.''
The comparison to be done under the best method rule will not
necessarily entail a thorough analysis under every potentially
applicable method. The nature of the available data will often indicate
either that a particular method should be the most reliable or that
certain other specified methods would be clearly unreliable. Indeed, in
some cases, it might be reasonable to conclude that a particular method
is likely to be the most reliable with virtually no consideration of
other potentially applicable methods. For example, if the comparable
uncontrolled price method can be applied based upon a closely
comparable uncontrolled transaction, it normally would be unnecessary
to give any serious consideration to the other methods. Whether more
extensive consideration could be needed in other cases will depend on
the facts and circumstances.
Accordingly, the final regulations retain the notion that
comparisons to other specified methods may have to be made and the
extent of such comparisons may vary depending upon the data available
and other factors.
Most Current Data Requirement
One of the factors taken into account in determining whether a
taxpayer reasonably selected and applied a specified method is whether
the taxpayer made a reasonable search for data. The proposed and
temporary regulations provided that this factor would not be met unless
the taxpayer used the most current data that was available prior to
filing the tax return. Section 1.6662-6T(d)(2)(iii)(B).
Commenters expressed concern that this requirement would be unduly
burdensome because it would require a taxpayer to continually update
its transfer pricing analysis until the filing of its tax return.
Commenters also argued that this rule could lead to an increased
incidence of double taxation if particular foreign jurisdictions did
not permit alterations to transactional prices either after the
transaction or after the close of a taxable year.
In response to these comments, the requirement to consider the most
[[Page 4878]]
current available data has been modified. Under the final regulations,
taxpayers are expected to use only data available before the end of the
taxable year and consequently have no obligation to continue to search
for data after the close of the taxable year to avoid the penalty.
However, when a taxpayer obtains additional relevant data between the
close of the year and the date on which the tax return is filed (for
example, in connection with transfer pricing analyses conducted with
respect to the subsequent taxable year), the final regulations require
the taxpayer to include such data in its principal documents as
provided in Sec. 1.6662-6(d)(2)(iii)(B)(9). These documents must be
provided to the IRS upon request. These changes are intended to relieve
much of the burden on taxpayers and at the same time to ensure that,
upon examination, the taxpayer provides the IRS with all relevant
information in its possession.
Reasonably Thorough Search for Data
Commenters requested additional guidance regarding the scope of the
term reasonably thorough search for data under Sec. 1.6662-
6(d)(2)(ii)(B). The proposed and temporary regulations provide that, in
determining whether a search for data was reasonably thorough, the
expense of acquiring additional data may be weighed against the dollar
amount of the transactions.
The IRS and Treasury have determined that more specific guidelines
that would be applicable to all situations cannot be provided because
the determination of whether a taxpayer engaged in a reasonable search
for data depends on the facts and circumstances of each case.
Therefore, the final regulations adhere to the general approach of the
proposed and temporary regulations.
However, the final regulations provide a more precise statement of
the rule that governs the determination of whether the taxpayer made a
reasonable search for data. Section 1.6662- 6(d)(2)(ii)(B) of the final
regulations provides that taxpayers may weigh the expense a search for
data against (i) the likelihood that they will find additional data
that will improve the reliability of the results and (ii) the amount by
which any new data would change the taxpayer's taxable income. Thus, a
taxpayer that has located reliable data leading to an analysis that is
unlikely to become more reliable if additional data were located would
not need to continue a search. In addition, as the amount of taxable
income potentially at stake declines (either because of low dollar
amounts of the controlled transactions or because of low variability in
results that are expected under the facts and circumstances), the need
to continue to search for data also decreases.
Experience and Knowledge
Section 1.6662-6(d)(2)(ii)(A) provides that one of the factors
taken into account in determining whether a taxpayer reasonably applied
a specified method is the experience and knowledge of the taxpayer,
including all members of the taxpayer's controlled group. Commenters
objected to this factor because it is not limited to consideration of
the experience and knowledge of the taxpayer. The purpose of this
factor is to consider the experience and knowledge of all the parties
that are likely to be involved in the pricing of the controlled
transactions. If the scope of this factor were limited to the taxpayer
participating in the controlled transaction, the experience and
knowledge of related persons who may have had a role in determining
intercompany prices of the taxpayer might not be taken into account.
Accordingly, this factor has not been changed in the final regulations.
Thresholds for Application
The net adjustment penalty under section 6662(e)(1)(B)(ii)
potentially applies if the net section 482 adjustment exceeds the
lesser of $5 million or 10 percent of the taxpayer's gross receipts.
Some commenters objected to the statutory $5 million threshold,
pointing out that a relatively insignificant error could easily lead to
a $5 million adjustment with respect to very large intercompany
transactions. As a result, taxpayers that made reasonable efforts to
determine an arm's length result might nonetheless be subject to
penalty.
The $5 million threshold for imposition of the penalty is fixed by
statute. However, Sec. 1.6662-6(d)(2)(ii)(G) of the final regulations
has been added to provide that the size of an adjustment in relation to
the size of the controlled transaction is relevant to determining
whether a taxpayer made a reasonable effort to apply a specified or
unspecified method. Accordingly, the fact that a proposed adjustment is
small in relation to the dollar amount of the controlled transaction to
which it relates is relevant in determining if a taxpayer made a
reasonable effort to apply a specified or unspecified method.
Reliance on Prior Analyses
Citing the preamble to the temporary regulations and the 1993
legislative history, some commenters requested that a pricing
methodology that was approved by the IRS on audit or in connection with
an Advanced Pricing Agreement (APA) be considered to satisfy the
specified method requirement of the regulations. In response to this
comment, Sec. 1.6662-6(d)(2)(ii)(F) of the final regulations has been
added to provide that whether a taxpayer relied on a methodology
developed in connection with an APA or approved by the IRS pursuant to
an audit is relevant to determining whether the taxpayer made a
reasonable effort to apply a specified or unspecified method, as long
as the taxpayer applied the agreed method reasonably and consistently
with its prior application, and adjustments have been made for any
material changes in the facts and circumstances since the original
application of that method. Pursuant to Sec. 1.6662-6(d)(3)(ii) (B) and
(C), this factor is also relevant if the taxpayer employed an
unspecified method.
Principal Documents
Section 1.6662-6(d)(2)(iii)(B) of the final regulations provides a
list of principal documents that must be provided to the IRS within 30
days of a request. The proposed and temporary regulations set forth a
contemporaneous documentation requirement pursuant to which all of
these documents must have been in existence at the time that the
taxpayer filed its tax return. In response to comments, several changes
have been made to these provisions.
Under the final regulations, the contemporaneous documentation
requirement does not apply to the summary of data acquired after the
close of the taxable year or the general index of principal and
background documents. Thus, these documents do not have to be prepared
at the time the return is filed.
Several commenters argued that the requirement that the principal
documents generally be provided within 30 days of a request is too
short, but this requirement has not been changed in the final
regulations because the statute mandates this 30-day disclosure period.
Moreover, except for the two principal documents excluded from the
contemporaneous documentation requirement, as described above, all
principal documents are required to be prepared by the time the tax
return is filed. The IRS and Treasury believe that 30 days should be
adequate to provide documents that already exist and that were prepared
with the intention of being provided to the IRS.
Other commenters suggested that the list of documents in
Sec. 1.6662-6(d)(2)(iii)(B) is too specific and that, in
[[Page 4879]]
some cases, it should not be necessary to provide all of the documents
listed. Some of these commenters suggested that the list of documents
be replaced with a more flexible approach under which the documents
required would depend on the facts and circumstances.
The final regulations have not been changed in response to this
comment. The list of principal documents is intended to provide the IRS
with the documents necessary to conduct a complete examination of a
taxpayer's transfer pricing. It is anticipated that all of the
principal documents listed would be needed in connection with all
transfer pricing audits. In addition, the suggested flexible approach
would deprive taxpayers and the IRS of much-needed certainty. In the
absence of the specific guidance provided by the regulations, most
taxpayers would face uncertainty as to the appropriate scope of the
documentation requirement.
Disclosure of Profit Split, Lump Sum, and Unspecified Methods
The proposed and temporary regulations require that the taxpayer
disclose on its tax return if the taxpayer used a profit split method,
an unspecified method, or transferred an intangible in exchange for a
lump sum payment. Commenters expressed concern about this requirement,
particularly with respect to the profit split method. They asserted
that it is inappropriate to impose a penalty on a taxpayer that used a
profit split method, solely because it failed to comply with disclosure
requirements, if the taxpayer otherwise fully complied with the
regulations under section 6662(e). In response to this comment, the
final regulations eliminate the disclosure requirement with respect to
the profit split method, lump sum payments, and unspecified methods.
The IRS and Treasury believe that these matters are more appropriately
addressed under section 6038 and section 6038A of the Internal Revenue
Code governing, in part, information returns on Forms 5471 and 5472.
The IRS intends to review these forms to determine whether they should
be revised.
Effective Date
These regulations are effective February 9, 1996. However,
taxpayers may elect to apply these regulations to all open 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 EO 12866. Therefore, a
regulatory assessment 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
the regulations and, therefore, a Regulatory Flexibility Analysis is
not required. Pursuant to section 7805(f) of the Internal Revenue Code,
the notice of proposed rulemaking and temporary regulations preceding
these regulations were sent to the Small Business Administration for
comment on their impact on small business.
Drafting Information
The principal author of these regulations is Carolyn D. Fanaroff of
the Office of the Associate Chief Counsel (International), IRS.
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 for part 1 is amended by removing the
entry ``Sections 1.6662-0 and 1.6662-6T'' and adding an entry in
numerical order to read as follows:
Authority: 26 U.S.C. 7805. * * *
Section 1.6662-6 also issued under 26 U.S.C. 6662. * * *
Par. 2. Section 1.6662-0 is amended by:
1. Revising the entry for Sec. 1.6662-5T.
2. Adding an entry for Sec. 1.6662-6.
3. Removing the entry for Sec. 1.6662-6T.
The revisions and additions read as follows:
Sec. 1.6662-0 Table of contents.
* * * * *
Sec. 1.6662-5T Substantial and gross valuation misstatements under
chapter 1 (Temporary).
(a) through (e)(3) [Reserved].
(e)(4) Tests related to section 481.
(i) Substantial valuation statement.
(ii) Gross valuation misstatement.
(iii) Property.
(f) through (i) [Reserved].
(j) Transactions between persons described in section 482 and
net section 482 transfer price adjustments.
Sec. 1.6662-6 Transactions between persons described in section 482
and net section 482 transfer price adjustments.
(a) In general.
(1) Purpose and scope.
(2) Reported results.
(3) Identical terms used in the section 482 regulations.
(b) The transactional penalty.
(1) Substantial valuation misstatement.
(2) Gross valuation misstatement.
(3) Reasonable cause and good faith.
(c) Net adjustment penalty.
(1) Net section 482 adjustment.
(2) Substantial valuation misstatement.
(3) Gross valuation misstatement.
(4) Setoff allocation rule.
(5) Gross receipts.
(6) Coordination with reasonable cause exception under section
6664(c).
(7) Examples.
(d) Amounts excluded from net section 482 adjustments.
(1) In general.
(2) Application of a specified section 482 method.
(i) In general.
(ii) Specified method requirement.
(iii) Documentation requirement.
(A) In general.
(B) Principal documents.
(C) Background documents.
(3) Application of an unspecified method.
(i) In general.
(ii) Unspecified method requirement.
(A) In general.
(B) Specified method potentially applicable.
(C) No specified method applicable.
(iii) Documentation requirement.
(A) In general.
(B) Principal and background documents.
(4) Certain foreign to foreign transactions.
(5) Special rule.
(6) Examples.
(e) Special rules in the case of carrybacks and carryovers.
(f) Rules for coordinating between the transactional penalty and
the net adjustment penalty.
(1) Coordination of a net section 482 adjustment subject to the
net adjustment penalty and a gross valuation misstatement subject to
the transactional penalty.
(2) Coordination of net section 482 adjustment subject to the
net adjustment penalty and substantial valuation misstatements
subject to the transactional penalty.
(3) Examples.
(g) Effective date.
* * * * *
Par. 3. Section 1.6662-5T is revised to read as follows:
Sec. 1.6662-5T Substantial and gross valuation misstatements under
chapter 1 (Temporary).
(a) through (e)(3) [Reserved]. For further information, see
Sec. 1.6662-5(a) through (e)(3).
(e)(4) Tests related to section 482--(i) Substantial valuation
misstatement. There is a substantial valuation
[[Page 4880]]
misstatement if there is a misstatement described in Sec. 1.6662-6
(b)(1) or (c)(1) (concerning substantial valuation misstatements
pertaining to transactions between related persons).
(ii) Gross valuation misstatement. There is a gross valuation
misstatement if there is a misstatement described in Sec. 1.6662-6
(b)(2) or (c)(2) (concerning gross valuation misstatements pertaining
to transactions between related persons).
(iii) Property. For purposes of this section, the term property
refers to both tangible and intangible property. Tangible property
includes property such as land, buildings, fixtures and inventory.
Intangible property includes property such as goodwill. Covenants not
to compete, leaseholds, patents, contract rights, debts and choses in
action, and any other item of intangible property described in
Sec. 1.482-4(b).
(f) through (h) [Reserved] For further information, see
Sec. 1.6662-5 (f) through (h).
(i) [Reserved].
(j) Transactions between persons described in section 482 and net
section 482 transfer price adjustments. For rules relating to the
penalty imposed with respect to a substantial or gross valuation
misstatement arising from a section 482 allocation, see Sec. 1.6662-6.
Par. 4. Section 1.6662-6 is added to read as follows:
Sec. 1.6662-6 Transactions between persons described in section 482
and net section 482 transfer price adjustments.
(a) In general--(1) Purpose and scope. Pursuant to section 6662(e)
a penalty is imposed on any underpayment attributable to a substantial
valuation misstatement pertaining to either a transaction between
persons described in section 482 (the transactional penalty) or a net
section 482 transfer price adjustment (the net adjustment penalty). The
penalty is equal to 20 percent of the underpayment of tax attributable
to that substantial valuation misstatement. Pursuant to section 6662(h)
the penalty is increased to 40 percent of the underpayment in the case
of a gross valuation misstatement with respect to either penalty.
Paragraph (b) of this section provides specific rules related to the
transactional penalty. Paragraph (c) of this section provides specific
rules related to the net adjustment penalty, and paragraph (d) of this
section describes amounts that will be excluded for purposes of
calculating the net adjustment penalty. Paragraph (e) of this section
sets forth special rules in the case of carrybacks and carryovers.
Paragraph (f) of this section provides coordination rules between
penalties. Paragraph (g) of this section provides the effective date of
this section.
(2) Reported results. Whether an underpayment is attributable to a
substantial or gross valuation misstatement must be determined from the
results of controlled transactions that are reported on an income tax
return, regardless of whether the amount reported differs from the
transaction price initially reflected in the taxpayer's books and
records. The results of controlled transactions that are reported on an
amended return will be used only if the amended return is filed before
the Internal Revenue Service has contacted the taxpayer regarding the
corresponding original return. A written statement furnished by a
taxpayer subject to the Coordinated Examination Program or a written
statement furnished by the taxpayer when electing Accelerated Issue
Resolution or similar procedures will be considered an amended return
for purposes of this section if it satisfies either the requirements of
a qualified amended return for purposes of Sec. 1.6664-2(c)(3) or such
requirements as the Commissioner may prescribe by revenue procedure. In
the case of a taxpayer that is a member of a consolidated group, the
rules of this paragraph (a)(2) apply to the consolidated income tax
return of the group.
(3) Identical terms used in the section 482 regulations. For
purposes of this section, the terms used in this section shall have the
same meaning as identical terms used in regulations under section 482.
(b) The transactional penalty--(1) Substantial valuation
misstatement. In the case of any transaction between related persons,
there is a substantial valuation misstatement if the price for any
property or services (or for the use of property) claimed on any return
is 200 percent or more (or 50 percent or less) of the amount determined
under section 482 to be the correct price.
(2) Gross valuation misstatement. In the case of any transaction
between related persons, there is a gross valuation misstatement if the
price for any property or services (or for the use of property) claimed
on any return is 400 percent or more (or 25 percent or less) of the
amount determined under section 482 to be the correct price.
(3) Reasonable cause and good faith. Pursuant to section 6664(c),
the transactional penalty will not be imposed on any portion of an
underpayment with respect to which the requirements of Sec. 1.6664-4
are met. In applying the provisions of Sec. 1.6664-4 in a case in which
the taxpayer has relied on professional analysis in determining its
transfer pricing, whether the professional is an employee of, or
related to, the taxpayer is not determinative in evaluating whether the
taxpayer reasonably relied in good faith on advice. A taxpayer that
meets the requirements of paragraph (d) of this section with respect to
an allocation under section 482 will be treated as having established
that there was reasonable cause and good faith with respect to that
item for purposes of Sec. 1.6664-4. If a substantial or gross valuation
misstatement under the transactional penalty also constitutes (or is
part of) a substantial or gross valuation misstatement under the net
adjustment penalty, then the rules of paragraph (d) of this section
(and not the rules of Sec. 1.6664-4) will be applied to determine
whether the adjustment is excluded from calculation of the net section
482 adjustment.
(c) Net adjustment penalty--(1) Net section 482 adjustment. For
purposes of this section, the term net section 482 adjustment means the
sum of all increases in the taxable income of a taxpayer for a taxable
year resulting from allocations under section 482 (determined without
regard to any amount carried to such taxable year from another taxable
year) less any decreases in taxable income attributable to collateral
adjustments as described in Sec. 1.482-1(g). For purposes of this
section, amounts that meet the requirements of paragraph (d) of this
section will be excluded from the calculation of the net section 482
adjustment. Substantial and gross valuation misstatements that are
subject to the transactional penalty under paragraph (b) (1) or (2) of
this section are included in determining the amount of the net section
482 adjustment. See paragraph (f) of this section for coordination
rules between penalties.
(2) Substantial valuation misstatement. There is a substantial
valuation misstatement if a net section 482 adjustment is greater than
the lesser of 5 million dollars or ten percent of gross receipts.
(3) Gross valuation misstatement. There is a gross valuation
misstatement if a net section 482 adjustment is greater than the lesser
of 20 million dollars or twenty percent of gross receipts.
(4) Setoff allocation rule. If a taxpayer meets the requirements of
paragraph (d) of this section with respect to some, but not all of the
allocations made under section 482, then for purposes of determining
the net section 482 adjustment, setoffs, as taken into account under
Sec. 1.482-1(g)(4), must be
[[Page 4881]]
applied ratably against all such allocations. The following example
illustrates the principle of this paragraph (c)(4):
Example. (i) The Internal Revenue Service makes the following
section 482 adjustments for the taxable year:
(1) Attributable to an increase in gross income because of an
increase in royalty payments........................................ $
9
,
0
0
0
,
0
0
0
(2) Attributable to an increase in sales proceeds due to a decrease
in the profit margin of a related buyer............................. 6
,
0
0
0
,
0
0
0
(3) Because of a setoff under Sec. 1.482-1(g)(4).................... (
5
,
0
0
0
,
0
0
0
)
--
Total section 482 adjustments.................................... 1
0
,
0
0
0
,
0
0
0
(ii) The taxpayer meets the requirements of paragraph (d) with
respect to adjustment number one, but not with respect to adjustment
number two. The five million dollar setoff will be allocated ratably
against the nine million dollar adjustment ($9,000,000/
$15,000,000 x $5,000,000=$3,000,000) and the six million dollar
adjustment ($6,000,000/$15,000,000 x $5,000,000=$2,000,000).
Accordingly, in determining the net section 482 adjustment, the nine
million dollar adjustment is reduced to six million dollars
($9,000,000-$3,000,000) and the six million dollar adjustment is
reduced to four million dollars ($6,000,000-$2,000,000). Therefore,
the net section 482 adjustment equals four million dollars.
(5) Gross receipts. For purposes of this section, gross receipts
must be computed pursuant to the rules contained in Sec. 1.448-
1T(f)(2)(iv), as adjusted to reflect allocations under section 482.
(6) Coordination with reasonable cause exception under section
6664(c). Pursuant to section 6662(e)(3)(D), a taxpayer will be treated
as having reasonable cause under section 6664(c) for any portion of an
underpayment attributable to a net section 482 adjustment only if the
taxpayer meets the requirements of paragraph (d) of this section with
respect to that portion.
(7) Examples. The principles of this paragraph (c) are illustrated
by the following examples:
Example 1. (i) The Internal Revenue Service makes the following
section 482 adjustments for the taxable year:
(1) Attributable to an increase in gross income because of
an increase in royalty payments........................... $2,000,000
(2) Attributable to an increase in sales proceeds due to a
decrease in the profit margin of a related buyer.......... 2,500,000
(3) Attributable to a decrease in the cost of goods sold
because of a decrease in the cost plus mark-up of a
related seller............................................ 2,000,000
------------
Total section 482 adjustments.......................... 6,500,000
(ii) None of the adjustments are excluded under paragraph (d) of
this section. The net section 482 adjustment ($6.5 million) is
greater than five million dollars. Therefore, there is a substantial
valuation misstatement.
Example 2. (i) The Internal Revenue Service makes the following
section 482 adjustments for the taxable year:
(1) Attributable to an increase in gross income because of an
increase in royalty payments........................................ $
1
1
,
0
0
0
,
0
0
0
(2) Attributable to an increase in sales proceeds due to a decrease
in the profit margin of a related buyer............................. 2
,
0
0
0
,
0
0
0
(3) Because of a setoff under Sec. 1.482-1(g)(4).................... (
9
,
0
0
0
,
0
0
0
)
--
Total section 482 adjustments.................................... 4
,
0
0
0
,
0
0
0
(ii) The taxpayer has gross receipts of sixty million dollars
after taking into account all section 482 adjustments. None of the
adjustments are excluded under paragraph (d) of this section. The
net section 482 adjustment ($4 million) is less than the lesser of
five million dollars or ten percent of gross receipts ($60
million x 10%=$6 million). Therefore, there is no substantial
valuation misstatement.
Example 3. (i) The Internal Revenue Service makes the following
section 482 adjustments to the income of an affiliated group that
files a consolidated return for the taxable year:
(1) Attributable to Member A............................... $1,500,000
(2) Attributable to Member B............................... 1,000,000
(3) Attributable to Member C............................... 2,000,000
------------
Total section 482 adjustments.......................... 4,500,000
(ii) Members A, B, and C have gross receipts of 20 million
dollars, 12 million dollars, and 11 million dollars, respectively.
Thus, the total gross receipts are 43 million dollars. None of the
adjustments are excluded under paragraph (d) of this section. The
net section 482 adjustment ($4.5 million) is greater than the lesser
of five million dollars or ten percent of gross receipts ($43
million x 10% = $4.3 million). Therefore, there is a substantial
valuation misstatement.
Example 4. (i) The Internal Revenue Service makes the following
section 482 adjustments to the income of an affiliated group that
files a consolidated return for the taxable year:
(1) Attributable to Member A............................... $1,500,000
(2) Attributable to Member B............................... 3,000,000
(3) Attributable to Member C............................... 2,500,000
------------
Total section 482 adjustments.......................... 7,000,000
(ii) Members A, B, and C have gross receipts of 20 million
dollars, 35 million dollars, and 40 million dollars, respectively.
Thus, the total gross receipts are 95 million dollars. None of the
adjustments are excluded under paragraph (d) of this section. The
net section 482 adjustment (7 million dollars) is greater than the
lesser of five million dollars or ten percent of gross receipts ($95
million x 10% = $9.5 million). Therefore, there is a substantial
valuation misstatement.
Example 5. (i) The Internal Revenue Service makes the following
section 482 adjustments to the income of an affiliated group that
files a consolidated return for the taxable year:
(1) Attributable to Member A............................... $2,000,000
(2) Attributable to Member B............................... 1,000,000
(3) Attributable to Member C............................... 1,500,000
------------
Total section 482 adjustments.......................... 4,500,000
(ii) Members A, B, and C have gross receipts of 10 million
dollars, 35 million dollars, and 40 million dollars, respectively.
Thus, the total gross receipts are 85 million dollars. None of the
adjustments are excluded under paragraph (d) of this section. The
net section 482 adjustment ($4.5 million) is less than the lesser of
five million dollars or ten percent of gross receipts ($85 million
x 10%=$8.5 million). Therefore, there is no substantial valuation
misstatement even though individual member A's adjustment ($2
million) is greater than ten percent of its individual gross
receipts ($10 million x 10%=$1 million).
(d) Amounts excluded from net section 482 adjustments--(1) In
general. An amount is excluded from the calculation of a net section
482 adjustment if the requirements of paragraph (d) (2), (3), or (4) of
this section are met with respect to that amount.
(2) Application of a specified section 482 method--(i) In general.
An amount is excluded from the calculation of a net section 482
adjustment if the taxpayer establishes that both the specified method
and documentation requirements of this paragraph (d)(2) are met with
respect to that amount. For purposes of this paragraph (d), a method
will be considered a specified method if it is described in the
regulations under section 482 and the method applies to transactions of
the type under review. A qualified cost sharing arrangement is
considered a specified method. See Sec. 1.482-7. An unspecified method
is not considered a specified method. See Secs. 1.482-3(e) and 1.482-
4(d).
(ii) Specified method requirement. The specified method requirement
is met if the taxpayer selects and applies
[[Page 4882]]
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. The extent of this evaluation generally will depend
on the nature of the available data, and it may vary from case to case
and from method to method. This evaluation may not entail an exhaustive
analysis or detailed application of each method. Rather, after a
reasonably thorough search for relevant data, the taxpayer should
consider which method would provide the most reliable measure of an
arm's length result given that data. The nature of the available data
may enable the taxpayer to conclude reasonably that a particular
specified method provides a more reliable measure of an arm's length
result than one or more of the other specified methods, and accordingly
no further consideration of such other specified methods is needed.
Further, 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 reliable 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. In determining
the scope of a reasonably thorough search for data, the expense of
additional efforts to locate new data may be weighed against the
likelihood of finding additional data that would improve the
reliability of the results and the amount by which any new data would
change the taxpayer's taxable income. Furthermore, a taxpayer must use
the most current reliable data that is available before the end of the
taxable year in question. Although the taxpayer is not required to
search for relevant data after the end of the taxable year, the
taxpayer must maintain as a principal document described in paragraph
(d)(2)(iii)(B)(9) of this section any relevant data it obtains after
the end of the taxable year but before the return is filed, if that
data would help determine whether the taxpayer has reported its true
taxable income.
(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 a study
or other analysis performed by a professional qualified to conduct such
a study or analysis, 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 study or
analysis, as long as the study or analysis 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 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).
(F) The extent to which the taxpayer relied on a transfer pricing
methodology developed and applied pursuant to an Advance Pricing
Agreement for a prior taxable year, or specifically approved by the
Internal Revenue Service pursuant to a transfer pricing audit of the
transactions at issue for a prior taxable year, provided that the
taxpayer applied the approved method reasonably and consistently with
its prior application, and the facts and circumstances surrounding the
use of the method have not materially changed since the time of the
IRS's action, or if the facts and circumstances have changed in a way
that materially affects the reliability of the results, the taxpayer
makes appropriate adjustments to reflect such changes.
(G) The size of a net transfer pricing adjustment in relation to
the size of the controlled transaction out of which the adjustment
arose.
(iii) Documentation requirement--(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 in connection with an examination of the taxable year to
which the documentation relates. With the exception of the
documentation described in paragraphs (d)(2)(iii)(B) (9) and (10) of
this section, 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 two categories, principal documents and
background documents as described in paragraphs (d)(2)(iii) (B) and (C)
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;
[[Page 4883]]
(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;
(9) A description or summary of any relevant data that the taxpayer
obtains after the end of the tax year and before filing a tax return,
which would help determine if a taxpayer selected and applied a
specified method in a reasonable manner; and
(10) A general index of the principal and background documents and
a description of the recordkeeping system used for cataloging and
accessing those documents.
(C) Background documents. The assumptions, conclusions, and
positions contained in principal documents ordinarily will be based on,
and supported by, additional background documents. Documents that
support the principal documentation may include the documents listed in
Sec. 1.6038A-3(c) that are not otherwise described in paragraph
(d)(2)(iii)(B) of this section. Every document listed in those
regulations may not be relevant to pricing determinations under the
taxpayer's specific facts and circumstances and, therefore, each of
those documents need not be maintained in all circumstances. Moreover,
other documents not listed in those regulations may be necessary to
establish that the taxpayer's method was selected and applied in the
way that 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).
Background documents need not be provided to the Internal Revenue
Service in response to a request for principal documents. If the
Internal Revenue Service subsequently requests background documents, a
taxpayer must provide that documentation to the Internal Revenue
Service within 30 days of the request. However, the district director
may, in his discretion, extend the period for producing the background
documentation.
(3) Application of an unspecified method--(i) In general. An
adjustment is excluded from the calculation of a net section 482
adjustment if the taxpayer establishes that both the unspecified method
and documentation requirements of this paragraph (d)(3) are met with
respect to that amount.
(ii) Unspecified method requirement--(A) In general. If a method
other than a specified method was applied, the unspecified method
requirement is met if the requirements of paragraph (d)(3)(ii) (B) or
(C) of this section, as appropriate, are met.
(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) Documentation requirement--(A) In general. The documentation
requirement of this paragraph (d)(3) is met if the taxpayer maintains
sufficient documentation to establish that the unspecified method
requirement of paragraph (d)(3)(ii) of this section is met 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.
(B) Principal and background documents. See paragraphs (d)(2)(iii)
(B) and (C) of this section for rules regarding these two categories of
required documentation.
(4) Certain foreign to foreign transactions. For purposes of
calculating a net section 482 adjustment, any increase in taxable
income resulting from an allocation under section 482 that is
attributable to any controlled transaction solely between foreign
corporations will be excluded unless the treatment of that transaction
affects the determination of either corporation's income from sources
within the United States or taxable income effectively connected with
the conduct of a trade or business within the United States.
(5) Special rule. If the regular tax (as defined in section 55(c))
imposed on the taxpayer is determined by reference to an amount other
than taxable income, that amount shall be treated as the taxable income
of the taxpayer for purposes of section 6662(e)(3). Accordingly, for
taxpayers whose regular tax is determined by reference to an amount
other than taxable income, the increase in that amount resulting
[[Page 4884]]
from section 482 allocations is the taxpayer's net section 482
adjustment.
(6) Examples. The principles of this paragraph (d) are illustrated
by the following examples:
Example 1. (i) The Internal Revenue Service makes the following
section 482 adjustments for the taxable year:
(1) Attributable to an increase in gross income because of
an increase in royalty payments........................... $9,000,000
(2) Not a 200 percent or 400 percent adjustment............ 2,000,000
(3) Attributable to a decrease in the cost of goods sold
because of a decrease in the cost plus mark-up of a
related seller............................................ 9,000,000
------------
Total section 482 adjustments.......................... 20,000,000
(ii) The taxpayer has gross receipts of 75 million dollars after
all section 482 adjustments. The taxpayer establishes that for
adjustments number one and three, it applied a transfer pricing
method specified in section 482, the selection and application of
the method was reasonable, it documented the pricing analysis, and
turned that documentation over to the IRS within 30 days of a
request. Accordingly, eighteen million dollars is excluded from the
calculation of the net section 482 adjustment. Because the net
section 482 adjustment is two million dollars, there is no
substantial valuation misstatement.
Example 2. (i) The Internal Revenue Service makes the following
section 482 adjustments for the taxable year:
(1) Attributable to an increase in gross income because of
an increase in royalty payments........................... $9,000,000
(2) Attributable to an adjustment that is 200 percent or
more of the correct section 482 price..................... 2,000,000
(3) Attributable to a decrease in the cost of goods sold
because of a decrease in the cost plus mark-up of a
related seller............................................ 9,000,000
------------
Total section 482 adjustments.......................... 20,000,000
(ii) The taxpayer has gross receipts of 75 million dollars after
all section 482 adjustments. The taxpayer establishes that for
adjustments number one and three, it applied a transfer pricing
method specified in section 482, the selection and application of
the method was reasonable, it documented that analysis, and turned
the documentation over to the IRS within 30 days. Accordingly,
eighteen million dollars is excluded from the calculation of the
section 482 transfer pricing adjustments for purposes of applying
the five million dollar or 10% of gross receipts test. Because the
net section 482 adjustment is only two million dollars, the taxpayer
is not subject to the net adjustment penalty. However, the taxpayer
may be subject to the transactional penalty on the underpayment of
tax attributable to the two million dollar adjustment.
Example 3. CFC1 and CFC2 are controlled foreign corporations
within the meaning of section 957. Applying section 482, the IRS
disallows a deduction for 25 million dollars of the interest that
CFC1 paid to CFC2, which results in CFC1's U.S. shareholder having a
subpart F inclusion in excess of five million dollars. No other
adjustments under section 482 are made with respect to the
controlled taxpayers. However, the increase has no effect upon the
determination of CFC1's or CFC2's income from sources within the
United States or taxable income effectively connected with the
conduct of a trade or business within the United States.
Accordingly, there is no substantial valuation misstatement.
(e) Special rules in the case of carrybacks and carryovers. If
there is a substantial or gross valuation misstatement for a taxable
year that gives rise to a loss, deduction or credit that is carried to
another taxable year, the transactional penalty and the net adjustment
penalty will be imposed on any resulting underpayment of tax in that
other taxable year. In determining whether there is a substantial or
gross valuation misstatement for a taxable year, no amount carried from
another taxable year shall be included. The following example
illustrates the principle of this paragraph (e):
Example. The Internal Revenue Service makes a section 482
adjustment of six million dollars in taxable year 1, no portion of
which is excluded under paragraph (d) of this section. The
taxpayer's income tax return for year 1 reported a loss of three
million dollars, which was carried to taxpayer's year 2 year income
tax return and used to reduce income taxes otherwise due with
respect to year 2. A determination is made that the six million
dollar allocation constitutes a substantial valuation misstatement,
and a penalty is imposed on the underpayment of tax in year 1
attributable to the substantial valuation misstatement and on the
underpayment of tax in year 2 attributable to the disallowance of
the net operating loss in year 2. For purposes of determining
whether there is a substantial or gross valuation misstatement for
year 2, the three million dollar reduction of the net operating loss
will not be added to any section 482 adjustments made with respect
to year 2.
(f) Rules for coordinating between the transactional penalty and
the net adjustment penalty--(1) Coordination of a net section 482
adjustment subject to the net adjustment penalty and a gross valuation
misstatement subject to the transactional penalty. In determining
whether a net section 482 adjustment exceeds five million dollars or 10
percent of gross receipts, an adjustment attributable to a substantial
or gross valuation misstatement that is subject to the transactional
penalty will be taken into account. If the net section 482 adjustment
exceeds five million dollars or ten percent of gross receipts, any
portion of such amount that is attributable to a gross valuation
misstatement will be subject to the transactional penalty at the forty
percent rate, but will not also be subject to net adjustment penalty at
a twenty percent rate. The remaining amount is subject to the net
adjustment penalty at the twenty percent rate, even if such amount is
less than the lesser of five million dollars or ten percent of gross
receipts.
(2) Coordination of net section 482 adjustment subject to the net
adjustment penalty and substantial valuation misstatements subject to
the transactional penalty. If the net section 482 adjustment exceeds
twenty million dollars or 20 percent of gross receipts, the entire
amount of the adjustment is subject to the net adjustment penalty at a
forty percent rate. No portion of the adjustment is subject to the
transactional penalty at a twenty percent rate.
(3) Examples. The following examples illustrate the principles of
this paragraph (f):
Example 1. (i) Applying section 482, the Internal Revenue
Service makes the following adjustments for the taxable year:
(1) Attributable to an adjustment that is 400 percent or
more of the correct section 482 arm's length result....... $2,000,000
(2) Not a 200 or 400 percent adjustment.................... 2,500,000
------------
Total.................................................. 4,500,000
(ii) The taxpayer has gross receipts of 75 million dollars after
all section 482 adjustments. None of the adjustments is excluded
under paragraph (d) (Amounts excluded from net section 482
adjustments) of this section, in determining the five million dollar
or 10% of gross receipts test under section 6662(e)(1)(B)(ii). The
net section 482 adjustment (4.5 million dollars) is less than the
lesser of five million dollars or ten percent of gross receipts ($75
million x 10% = $7.5 million). Thus, there is no substantial
valuation misstatement. However, the two million dollar adjustment
is attributable to a gross valuation misstatement. Accordingly, the
taxpayer may be subject to a penalty, under section 6662(h), equal
to 40 percent of the underpayment of tax attributable to the gross
valuation misstatement of two million dollars. The 2.5 million
dollar adjustment is not subject to a penalty under section
6662(b)(3).
Example 2. The facts are the same as in Example 1, except the
taxpayer has gross receipts of 40 million dollars. The net section
482 adjustment ($4.5 million) is greater than the lesser of five
million dollars or ten percent of gross receipts ($40 million x
10%
[[Page 4885]]
= $4 million). Thus, the five million dollar or 10% of gross receipts
test has been met. The two million dollar adjustment is attributable
to a gross valuation misstatement. Accordingly, the taxpayer is
subject to a penalty, under section 6662(h), equal to 40 percent of
the underpayment of tax attributable to the gross valuation
misstatement of two million dollars. The 2.5 million dollar
adjustment is subject to a penalty under sections 6662(a) and
6662(b)(3), equal to 20 percent of the underpayment of tax
attributable to the substantial valuation misstatement.
Example 3. (i) Applying section 482, the Internal Revenue
Service makes the following transfer pricing adjustments for the
taxable year:
(1) Attributable to an adjustment that is 400 percent or
more of the correct section 482 arm's length result....... $6,000,000
(2) Not a 200 or 400 percent adjustment.................... 15,000,000
------------
Total.................................................. 21,000,000
(ii) None of the adjustments are excluded under paragraph (d)
(Amounts excluded from net section 482 adjustments) in determining
the twenty million dollar or 20% of gross receipts test under
section 6662(h). The net section 482 adjustment (21 million dollars)
is greater than twenty million dollars and thus constitutes a gross
valuation misstatement. Accordingly, the total adjustment is subject
to the net adjustment penalty equal to 40 percent of the
underpayment of tax attributable to the 21 million dollar gross
valuation misstatement. The six million dollar adjustment will not
be separately included for purposes of any additional penalty under
section 6662.
(g) Effective date. This section is effective February 9, 1996.
However, taxpayers may elect to apply this section to all open taxable
years beginning after December 31, 1993.
Sec. 1.6662-6T [Removed]
Par. 5. Section 1.6662-6T is removed.
Par. 6a. In Sec. 1.6664-0, the introductory text is amended by
removing the reference ``1.6664-4'' and adding ``1.6664-4T'' in its
place.
Par. 6b. Section 1.6664-4T is revised to read as follows:
Sec. 1.6664-4T Reasonable cause and good faith exception to section
6662 penalties.
(a) through (e) [Reserved].
(f) Transactions between persons described in section 482 and net
section 482 transfer price adjustments. For purposes of applying the
reasonable cause and good faith exception of section 6664(c) to net
section 482 adjustments, the rules of Sec. 1.6662-6(d) apply. A
taxpayer that does not satisfy the rules of Sec. 1.6662-6(d) for a net
section 482 adjustment cannot satisfy the reasonable cause and good
faith exception under section 6664(c). The rules of this section apply
to underpayments subject to the transactional penalty in Sec. 1.6662-
6(b). If the standards of the net section 482 penalty exclusion
provisions under Sec. 1.6662-6(d) are met with respect to such
underpayments, then the taxpayer will be considered to have acted with
reasonable cause and good faith for purposes of this section.
PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT
Par. 7. The authority citation for part 602 continues to read as
follows:
Authority: 26 U.S.C. 7805.
Par. 8. In Sec. 602.101, paragraph (c) is amended by removing the
entry for Sec. 1.6662-6T from the table and adding an entry in
numerical order to the table to read ``1.6662-6....1545-1426''.
Margaret Milner Richardson,
Commissioner of Internal Revenue.
Approved: January 19, 1996.
Leslie Samuels,
Assistant Secretary of the Treasury.
[FR Doc. 96-2171 Filed 2-8-96; 8:45 am]
BILLING CODE 4830-01-U