Td 8656

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Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations

—Persons that are engaged to influence
a HUD officer or employee in the
award of financial assistance or the
taking of a management action by the
Department must register with HUD,
and report to HUD on their lobbying
activities.
The second feature imposed
limitations on the fees that may be paid
to consultants who are engaged to
influence the award or allocation of the
Department’s financial assistance.
The requirements of Section 13 are
codified at 24 CFR part 86.
The Lobbying Disclosure Act of 1995
(Pub. L. 104–65, approved December 19,
1995) established government-wide
lobbying procedures and requirements.
Sections 11(b)(1) and 24(a) of the new
law repealed section 13, effective
January 1, 1996.
The purpose of this rule is to remove
part 86 to conform the Code of Federal
Regulations to the new statutory
authority.
Justification for Final Rule
In accordance with 24 CFR part 10, it
is the practice of the Department to offer
interested parties the opportunity to
comment on proposed regulations.
However, this regulation relates to
administrative procedures only and
conforms the Code of Federal
Regulations to existing law. The
purpose of this rule is to remove part 86
to conform the Code of Federal
Regulations to the new statutory
authority. Therefore, the Department
has determined that public comment is
unnecessary and contrary to the public
interest.

C. Executive Order 12606, the Family
The General Counsel, as the
Designated Official under Executive
Order 12606, The Family, has
determined that this final rule is
procedural only, and does not have
potential for significant impact on
family-formation, maintenance, and
general well-being, and, thus is not
subject to review under the Order.

Paperwork Reduction Act

The General Counsel, as the
Designated Official under section 6(a) of
Executive Order 12612, Federalism, has
determined that this final rule is
procedural only, and does not have
substantial, direct effects on States, on
their political subdivisions, or on their
relationship with the Federal
government, or on the distribution of
power and responsibilities among the
various levels of government.

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.

List of Subjects in 24 CFR Part 86
Administrative practice and
procedure, Lobbying (Government
agencies), Reporting and recordkeeping
requirements.
Accordingly, under the authority of
42 U.S.C. 3535(d), part 86 is removed
from title 24 of the Code of Federal
Regulations.
Dated: February 2, 1996.
Henry G. Cisneros,
Secretary.
[FR Doc. 96–2856 Filed 2–8–96; 8:45 am]
BILLING CODE 4210–32–P

DEPARTMENT OF THE TREASURY
Internal Revenue Service

A. Environmental Impact

26 CFR Parts 1 and 602

This final rule is categorically
excluded from the NEPA requirements
of HUD regulations at 24 CFR § 50.20(k),
which implement section 102(2)(C) of
the National Environmental Policy Act
of 1969. The rule involves internal
administrative procedures whose
content does not constitute a
developmental decision nor affect the
physical condition of project areas or
building sites.

[TD 8656]

The Secretary, in approving this rule
for publication, certifies in accordance
with 5 U.S.C. 605(b) (the Regulatory
Flexibility Act) that this rule would not
have a significant impact on a
substantial number of small entities.
This is a procedural rule only,
conforming the Code of Federal
Regulations to existing law.

SUPPLEMENTARY INFORMATION:

D. Executive Order 12612, Federalism

Other Matters

B. Regulatory Flexibility Act

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).

RIN 1545–AS24

Section 6662—Imposition of the
Accuracy-Related Penalty
Internal Revenue Service (IRS),
Treasury.
ACTION: Final and temporary
regulations.
AGENCY:

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.
SUMMARY:

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

Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations
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 previouslyissued 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

4877

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

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Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations

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 1.66626(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

Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations
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 muchneeded 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.

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

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.

26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.

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

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 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.

4879

§ 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

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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 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 § 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

Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations
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×$5,000,000=$3,000,000) and the
six million dollar adjustment ($6,000,000/
$15,000,000×$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×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

4881

(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 × 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
× 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 ×
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.
Total section 482 adjust(2) Application of a specified section
ments .............................
4,500,000 482 method—(i) In general. An amount
is excluded from the calculation of a net
(ii) Members A, B, and C have gross
section 482 adjustment if the taxpayer
receipts of 20 million dollars, 12 million
establishes that both the specified
dollars, and 11 million dollars, respectively.
Thus, the total gross receipts are 43 million
method and documentation
dollars. None of the adjustments are
requirements of this paragraph (d)(2) are
excluded under paragraph (d) of this section. met with respect to that amount. For
The net section 482 adjustment ($4.5 million) purposes of this paragraph (d), a method
is greater than the lesser of five million
will be considered a specified method if
dollars or ten percent of gross receipts ($43
it is described in the regulations under
million × 10% = $4.3 million). Therefore,
section 482 and the method applies to
there is a substantial valuation misstatement.
transactions of the type under review. A
Example 4. (i) The Internal Revenue
qualified cost sharing arrangement is
Service makes the following section 482
considered a specified method. See
adjustments to the income of an affiliated
§ 1.482–7. An unspecified method is not
group that files a consolidated return for the
considered a specified method. See
taxable year:
§§ 1.482–3(e) and 1.482–4(d).
(1) Attributable to Member A .
$1,500,000
(ii) Specified method requirement.
(2) Attributable to Member B ..
3,000,000
The specified method requirement is
met if the taxpayer selects and applies

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Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations

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 accurate 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;

Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations
(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 accurate 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

4883

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

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Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations

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
× 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 × 10%

Federal Register / Vol. 61, No. 28 / Friday, February 9, 1996 / Rules and Regulations
= $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.
§ 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.
[FR Doc. 96–2171 Filed 2–8–96; 8:45 am]
BILLING CODE 4830–01–U

DEPARTMENT OF DEFENSE
Office of the Secretary
32 CFR Part 290
[DCAA Regulation 5410.8]

Defense Contract Audit Agency
(DCAA), Freedom of Information Act
Program
Office of the Secretary, DoD.
Final rule.

AGENCY:
ACTION:

This amendment changes the
area code listed for the DCAA Eastern
Regional Office from (404) to (770) due
to area code changes made by AT&T for
the Smyrna, Georgia area.
EFFECTIVE DATE: February 9, 1996.
FOR FURTHER INFORMATION CONTACT:
Mr. Dave Henshall, DCAA Information
and Privacy Advisor, ATTN: CMR,
Defense Contract Audit Agency, 8725
John J. Kingman Road, Suite 2135, Fort
Belvoir, VA 22060–6219, Telephone:
(703) 767–1244.
SUMMARY:

List of Subjects in 32 CFR Part 290
Freedom of Information.
Accordingly 32 CFR Part 290 is
amended as follows:
PART 290—[AMENDED]
1. The authority citation for Part 290
continues to read as follows:

4885

Authority: 5 U.S.C. 552.

Appendix B to Part 290—[Amended]
2. In Appendix B to Part 290, under
the heading for Georgia, DCAA Eastern
Regional Office, remove, ‘‘(404)’’ and
add ‘‘(770).’’
Dated: February 1, 1996.
L.M. Bynum,
Alternate OSD Federal Register Liaison
Officer, Department of Defense.
[FR Doc. 96–2756 Filed 2–8–96; 8:45 am]
BILLING CODE 5000–04–M

DEPARTMENT OF TRANSPORTATION
Coast Guard
33 CFR Part 100
[CGD11–96–001]
RIN 2115–AE46

Special Local Regulations: Newport to
Ensenada Race
Coast Guard, DOT.
Notice of implementation.

AGENCY:
ACTION:

This notice implements 33
CFR 100.1101, ‘‘Southern California
marine events,’’ for the Newport to
Ensenada Race. This event consists of a
sailboat race with 400–500 participants.
These regulations will be effective in the
portion of the Pacific Ocean off
Newport, California. Implementation of
section 33 CFR 100.1101 is necessary to
control vessel traffic in the regulated
area for the start of the race only to
ensure the safety of participants and
spectators.
EFFECTIVE DATE: 33 CFR 100.1101 is
effective from 12 noon on 26 April 1996,
and terminates at 3 PM 26 April 1996,
unless cancelled earlier by the Patrol
Commander.
FOR FURTHER INFORMATION CONTACT:
QMC D.K. Larson, U.S. Coast Guard
Marine Safety Office/Group Los
Angeles/Long Beach, California; Tel:
(310) 980–4442.
SUMMARY:

SUPPLEMENTARY INFORMATION:

Drafting Information
The drafters of this notice are QMC
D.K. Larson, Coast Guard Marine Safety
Office/Group Los Angeles/Long Beach,
Project Officer, and LT A.K. Abbott,
Eleventh Coast Guard District Legal
Office, Project Attorney.
Discussion of Notice
The Newport to Ensenada Race is
scheduled to occur on 26 April 1996.
These Special Local Regulations permit
Coast Guard control of vessel traffic in