Welcome to In Dispute, the latest news and developments in the tax disputes landscape from KPMG’s Tax Dispute Resolution network. This podcast series provides timely insights into a variety of tax controversy topics.
My name is Mike Zima. I am a senior manager in KPMG’s Jacksonville, Florida office and a member of KPMG’s Tax Dispute Resolution network.
In September 2019, the Internal Revenue Service opened the application period for the 2020 Compliance Assurance Process, known as the CAP program. For the first time since 2015, new corporate applicants meeting eligibility requirements could apply for CAP, and may be able to do so for 2021, as well. In 2018, the IRS made certain changes to the program and announced that further changes were planned for subsequent years. These changes are the topic of this podcast.
First, I should tell you what the CAP program is. Launched in 2005, the program employs real-time issue resolution through transparent and cooperative interaction between taxpayers and the IRS to improve federal tax compliance.
By “real time,” I mean that the IRS and the taxpayer review transactions during the tax year with the intent to reach an agreement on how the transactions should be treated before they are reported on a tax return. CAP requires the taxpayer to openly and contemporaneously exchange information related to major transactions that affect its federal tax liability, as well as to discuss its proposed treatment of such transactions on its return.
The benefits of being in the CAP program include, for the taxpayer, certainty surrounding its tax return positions and the elimination of lengthy and expensive post-filing examinations. For the IRS, the benefits include an acceptable level of assurance regarding the accuracy of the taxpayer’s filed tax return and the conservation of resources that would be required of a typical post-filing examination.
Now, here are the changes: First, taxpayers must provide a preliminary list of material issues as part of their application. This list will be the starting point for finalizing an agreed issues list -- the issues that will be reviewed during the tax year.
Second, if the taxpayer has transfer pricing or is claiming a research credit in the CAP year applied for, it must provide specified information concerning those topics as part of its application. For the research credit, the taxpayer must complete and submit the CAP Research Credit Questionnaire; for transfer pricing, the taxpayer must submit the Material Intercompany Transactions Template, also known as the MITT.
The MITT requires taxpayers to report information on related-party transactions from Forms 5471, 5472, 8865, and 8858, as well as section 6662 documentation, based on the taxpayer’s last filed tax return before the CAP year begins. For purposes of the MITT, the CAP Frequently Asked Questions state that “a ‘material’ intercompany transaction is any new or recurring intercompany transaction for which the amount reported on the MITT is greater than the last agreed upon permanent materiality threshold.”1
Third, and perhaps one of the most important changes to the CAP program, is that certain transfer pricing issues may be required to be resolved via the Advance Pricing Agreement program. The MITT, along with a Worldwide Tax Organization Chart that is also required as part of the CAP application, is to be used by an IRS Transfer Pricing Risk Team to help determine the most appropriate treatment of Transfer Pricing issues.2
A refusal to comply with a request to apply for an APA may affect the taxpayer’s suitability for remaining in the CAP program and could also lead to termination from CAP during the year.3
The fourth change is that the model CAP Memorandum of Understanding now memorializes the process of determining the scope of the CAP review, including materiality thresholds, which will be jointly negotiated between the taxpayer and the IRS. Materiality thresholds are transactional dollar amounts above which a completed transaction will be disclosed by the taxpayer and reviewed as part of the CAP process. The parties will openly discuss situations where exceptions to the materiality threshold may be warranted.
A fifth change to the program is that the IRS set a 90-day target to develop and resolve issues. The taxpayer must disclose an issue within ninety (90) days of the transaction being completed or the issue having an impact on the federal income tax liability. Once an issue has been fully disclosed by the Taxpayer, the IRS will ordinarily have 90 days to complete the review and determine agreement or disagreement with the tax treatment. If the tax treatment of an issue is unagreed between the parties after 90 days from the date of full disclosure, an application to Fast Track Settlement (FTS) may be made. If the IRS offers Fast Track, the Taxpayer must agree to Fast Track and both Parties must make a good faith attempt to resolve the disagreement. Taxpayers retain access to Appeals in the normal course if Fast Track does not result in an agreement.
Sixth, taxpayers will be required to provide a post-filing representation letter within 30 days of filing their return. The representation letter will, among other things, specify that all the material issues were disclosed and resolved as of the date the return was filed, or provide a description of the material issues that were not disclosed or resolved as of that date.
Another change is the introduction of the concept of a new compliance maintenance phase -- the “bridge phase” -- that will include some taxpayers determined to be lowest risk who may be invited to continue in the CAP program without any required disclosures and without any reviews or assurance by the IRS. Under the “bridge” phase, if the taxpayer has a specific issue for which it wants certainty, it may request a pre-filing agreement (PFA). Among the changes that are expected to apply for future years— 2021 and beyond— is a requirement that a CAP applicant provide certification of its tax control framework. This involves providing information about the company’s internal control systems, its tax risk management processes and a variety of other tax control aspects.
Further information concerning the CAP program may be found on the Internal Revenue Service’s Compliance Assurance Process web page, which may be found here.
For more information, feel free to contact me, Mike Zima, at 904 350 1201. Thank you.