IRC Section 482 authorizes the IRS to adjust the income, deductions, credits, or allowances of commonly controlled taxpayers to prevent evasion of taxes or to clearly reflect their income. The regulations under Section 482 generally provide that intercompany prices in controlled transactions (whether for goods, services, money, or intangibles) produce results that are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances. This standard is known as the arm’s length standard. To discourage taxpayers from shifting income through transfer prices, penalty provisions for transfer pricing misstatements were introduced under IRC Section 6662 in late 1993.
Taxpayers with significant intercompany transactions may be exposed to substantial or gross valuation misstatement penalties under IRC Section 6662 and associated regulations. These penalties could be 20% or 40% of the additional tax owed as the result of an IRS transfer pricing adjustment(s). Taxpayers can protect themselves from transfer pricing misstatement penalties through reliance on appropriate transfer pricing documentation in accordance with the Regulations that exists when the tax return is filed (“contemporaneous documentation”).
The IRS recently (Feb. 2014) issue a publication providing more information on the IRS’ transfer pricing examination process, titled, Transfer Pricing Audit Roadmap.