IRS REQUIRES 'CONTEMPORANEOUS RECORDS' UNDER TRANSFER PRICING PENALTY REGS FOR TAX YEARS THAT STARTED WHILE NOW-WITHDRAWN REGS WERE EFFECTIVE.

Rev. Proc. 94-33

Part III

Administrative, Procedural, and Miscellaneous

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SECTION 1. PURPOSE

This revenue procedure provides guidance regarding the rules that should be followed for taxable years ending after November 5, 1990, but beginning before January 1, 1994, in determining whether there is a substantial or gross valuation misstatement under sections 6662(e) and (h) of the Internal Revenue Code.

SECTION 2. BACKGROUND

.01 Section 6662(a) of the Code imposes a penalty in the amount of 20 percent of any underpayment of tax to which the section applies. Section 6662(b) lists the types of underpayments to which section 6662(a) applies. One such underpayment is an underpayment attributable to any substantial valuation misstatement under chapter 1 of the Code. Section 6662(e) describes the circumstances under which a substantial valuation misstatement exists. In the case of a gross valuation misstatement, the amount of the penalty is increased to 40 percent of any underpayment of tax to which the section applies. Section 6662(h) describes the circumstances under which a gross valuation misstatement exists.

.02 On January 21, 1993, the IRS published a notice of proposed rulemaking in the Federal Register (58 FR 5304) that proposed amendments to the Income Tax Regulations under sections 6662(e) and (h) and section 6664(c) of the Code. Those proposed regulations were to be applicable to tax years beginning after April 21, 1993. Those proposed regulations provided, in part, that to avoid imposition of the penalty, a taxpayer must make a reasonable effort to accurately determine its proper tax liability and demonstrate that it reasonably believed that its transfer pricing methodology produced an arm's length result. See section 1.6662-5(j)(5) of the proposed regulations. Whether the taxpayer made a reasonable effort to accurately determine its proper tax liability would be evaluated with reference to contemporaneous documentation. See section 1.6662- 5(j)(5)(ii) of the proposed regulations. The proposed regulations required taxpayers to provide that documentation to the Service within 30 days of the Service's request. See section 1.6662- 5(j)(5)(ii) of the proposed regulations.

.03 Sections 6662(e) and (h) of the Code recently were amended by section 13236 of the Omnibus Budget Reconciliation Act of 1993 ("OBRA 1993") (Pub. L. 103-66, 107 Stat. 312). Accordingly, proposed regulations section 1.6662-5 (e) and (j) and section 1.6664-4(d), published on January 21, 1993, have been withdrawn. See Withdrawal of notice of proposed rulemaking, published in the Federal Register on February 2, 1994.

.04 New temporary and proposed regulations under sections 6662(e) and (h) (as amended by OBRA 1993) and section 6664(c) were published on February 2, 1994. See Notice of proposed rulemaking by cross reference to temporary regulations and temporary regulations published in the Federal Register on February 2, 1994. Those regulations are effective for taxable years beginning after December 31, 1993.

SECTION 3. PROCEDURE

For taxable years ending after November 5, 1990, but beginning prior to January 1, 1994, the Treasury Department considers the proposed regulations published on January 21, 1993, to be a reasonable interpretation of section 6662(e). Because taxpayers could not anticipate the importance of contemporaneous documentation in establishing reasonable cause and good faith under those proposed regulations, contemporaneous documentation is not mandatory for taxable years beginning prior to April 22, 1993. However, for tax years beginning after April 21, 1993 (the effective date of the proposed regulations issued on January 21, 1993), but beginning before January 1, 1994, taxpayers can establish that they acted with reasonable cause and in good faith only if they produce contemporaneous documentation. Regardless of the taxable year, the existence of contemporaneous documentation is a relevant factor in determining whether the taxpayer had reasonable cause and good faith, particularly for transactions after April 21, 1993.

DRAFTING INFORMATION

The principal author of this revenue procedure is Thomas L. Ralph of the Office of Associate Chief Counsel (International). For further information regarding this revenue procedure contact Mr. Ralph at (202) 622-3880 (not a toll free call).