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Transfer pricing remains crucial as IRS CAP programme opens for 2021

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Mark Martin and Thomas Bettge of KPMG in the US note the opening of applications for the IRS’ CAP programme’s 2021 year, and reflect on how the programme’s approach to transfer pricing has shifted in recent years.

On August 27 2020, the IRS announced the opening of applications for the compliance assurance process (CAP) programme’s 2021 year. CAP is a real-time audit programme developed by the IRS’s Large Business & International Division (LB&I) for large corporate taxpayers that desire increased tax certainty, and currently has approximately 150 participants. After a period in the mid-2010s when the future of the programme appeared uncertain, LB&I revamped CAP – and its approach to transfer pricing issues – beginning in 2018, and the Internal Revenue Manual was updated to reflect these changes earlier this year. The application window for the 2021 year runs from September 1 through November 13 2020.

To harmonise the resolution of complex transfer pricing issues with the CAP programme’s goal of resolving issues prior to the filing of the participant’s tax return, the IRS may now require participants to seek advance pricing agreements (APAs) for such issues, effectively removing these issues from the CAP programme. Our experience has been that the IRS is using this authority, and that taxpayers that are in CAP – as well as taxpayers considering applying for the 2021 year – should be prepared for the possibility that an APA may be required.

APAs, which are administered by the Advance Pricing and Mutual Agreement programme (APMA), offer important benefits not available in CAP, notably the prospect of bilateral tax certainty and the ability to prospectively resolve transfer pricing issues for five years or longer. At the same time, however, APAs take significantly longer to complete than CAP cycles, and taxpayers may be concerned that APMA’s need to understand COVID-19’s effects on related party arrangements may delay resolution. 

It is important to note that APAs should not be required of CAP taxpayers as a matter of course. The Internal Revenue Manual notes that taxpayers are “encouraged, and may be required, to seek an APA to cover a recurring controlled transaction,” but goes on to describe a collaborative process involving consultation between the taxpayer, APMA, and the CAP account coordinator regarding the benefits that might be derived from an APA. For taxpayers who do pursue APAs, or who already have APA applications in process, the CAP team will endeavour to ensure coordination with APMA.

Importantly, CAP gives taxpayers the opportunity to show that their transfer pricing transactions are low risk, which may lead to issues being de-selected for CAP review. Each year, CAP participants are required to submit the model inter-company transaction template (MITT), which participants are invited to supplement with additional information that may facilitate risk assessment. The MITT is then reviewed by a dedicated transfer pricing risk assessment team, which will communicate its conclusions to the LB&I CAP team. By providing a MITT that appropriately contextualises the requested information, taxpayers may be able to avoid false positives in the risk review process, thus decreasing the risk that an APA might be required. Now that we are observing the first tranche of transfer pricing issues being pulled out of CAP and moved to APMA, it is obvious that the IRS is exercising its authority to move the review of transfer pricing issues to APMA, making it critical for taxpayers that are concerned about entering into the APA process to carefully prepare their MITT disclosures. 

Of course, transfer pricing changes are not the only thing new to CAP. One feature of the revamped programme is the bridge phase, in which participants deemed to pose the lowest compliance risk receive no CAP review whatsoever for the year. Bridge phase taxpayers do not receive “no change” letters protecting against subsequent audits, but LB&I has indicated that, consistent with the bridge phase’s objective of preserving resources, any such audits would only in exceptional circumstances. In connection with August 2020 reopening announcement, LB&I stated that taxpayers will generally remain in the bridge phase for at most two years at a time.

While CAP is a valuable programme for taxpayers, it has also proven beneficial to the IRS. Since the enactment of US reform with the Tax Cuts and Jobs Act (TCJA) in December 2017, LB&I officials have acknowledged that the CAP programme has provided the IRS with experience working through the new TCJA provisions and identifying compliance issues. 

CAP is an important compliance programme, and transfer pricing is important to CAP. Current participants and those considering applying for the 2021 year should understand how the programme approaches transfer pricing issues, and should take care to adequately contextualise their presentation of transfer pricing data to aid the risk assessment process.

Mark MartinT: +1 713 319 3976E:

Thomas BettgeT: +1 713 319 2173E:

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