[4830-01-u]
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.
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 [INSERT DATE OF PUBLICATION OF THIS
DOCUMENT IN THE FEDERAL REGISTER].
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 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 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 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 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 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 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 1.482-1(c)(1).
The notion of a comparison of methods is inherent in the best method
rule of 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 1.482-8 illustrate an appropriate application of a comparative
analysis. In introducing these examples, 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
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 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 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, 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, 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 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 1.6662-
6(d)(2)(iii)(B) is too specific and that, in 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 [INSERT DATE OF PUBLICATION OF THIS
DOCUMENT IN THE FEDERAL REGISTER]. 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 1.6662-5T.
2. Adding an entry for 1.6662-6.
3. Removing the entry for 1.6662-6T.
The revisions and additions read as follows:
1.6662-0 Table of contents.
* * * * *
1.6662-5T Substantial and gross valuation misstatements under chapter 1
(Temporary).
(a) through (e)(3) [Reserved].
(e)(4) Tests related to section 482.
(i) Substantial valuation misstatement.
(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.
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:
1.6662-5T Substantial and gross valuation misstatements under chapter 1
(Temporary).
(a) through (e)(3) [Reserved]. For further information, see 1.6662-
5(a) through (e)(3).
(e)(4) Tests related to section 482--(i) Substantial valuation
misstatement. There is a substantial valuation misstatement if there is a
misstatement described in 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 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 money, land, buildings, fixtures and inventory. Intangible property
includes property such as goodwill, covenants not to compete, leaseholds,
patents, contract rights, debts, choses in action, and any other item of
intangible property described in 1.482-4(b).
(f) through (h) [Reserved] For further information, see 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 1.6662-6.
Par. 4. Section 1.6662-6 is added to read as follows:
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 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 1.6664-4 are met. In applying the
provisions of 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 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 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
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 1.482-1(g)(4),
must be 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 $9,000,000
(2) Attributable to an increase in sales proceeds
due to a decrease in the profit margin of a
related buyer 6,000,000
(3) Because of a setoff under 1.482-1(g)(4) (5,000,000)
___________
Total section 482 adjustments 10,000,000
(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 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 $11,000,000
(2) Attributable to an increase in sales proceeds
due to a decrease in the profit margin of a
related buyer 2,000,000
(3) Because of a setoff under
1.482-1(g)(4) (9,000,000)
__________
Total section 482 adjustments 4,000,000
(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 1.482-7. An unspecified
method is not considered a specified method. See 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 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 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 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
1.482-1(e)(2)(ii)(B), one reasonable method of selecting a point in the range
would be that provided in 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 reliable measure of an
arm's length result under the principles of the best method rule in
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;
(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 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 reliable measure of an arm's length result
under the principles of the best method rule in 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
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 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 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 $2,000,000
percent or more of the correct section 482
arm's length result
(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% = $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 $6,000,000
percent or more of the correct section 482
arm's length result
(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 [INSERT DATE OF
PUBLICATION OF THIS DOCUMENT IN THE FEDERAL REGISTER]. However, taxpayers may
elect to apply this section to all open taxable years beginning after December
31, 1993.
1.6662-6T [Removed]
Par. 5. Section 1.6662-6T is removed.
Par. 6a. In 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:
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 1.6662-6(d) apply. A taxpayer that does not
satisfy the rules of 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 1.6662-6(b). If the standards of the net section 482 penalty
exclusion provisions under 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 602.101, paragraph (c) is amended by removing the entry for
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