Document Preservation for Transfer Pricing Litigation: What You Need to Know
Assume the Internal Revenue Service (“IRS”) is auditing your company’s transfer pricing. The administrative process is starting to break down, and it looks as if the IRS might assert a sizeable income adjustment. What is your duty to save documents for a potential upcoming court case?
Basic Duty. When you “reasonably anticipate” litigation with the IRS, you must start preserving the documents that are “potentially relevant” to the dispute. This duty is as old as our legal system: The premise is that no litigant should be allowed to destroy evidence needed by the court or the opposing party to advance the case. Destroying relevant documents may lead to severe consequences, such as sanctions or a presumption that the evidence would have undercut your position.
When do you “reasonably anticipate” transfer pricing litigation such that you must begin preserving documents? Case law on this timing question is surprisingly complex, with outcomes varying from jurisdiction to jurisdiction. It might be when the revenue agent tells you that the IRS is planning to issue a notice of deficiency or when you decide that you will not sign an extension of the statute of limitations. Or it might be earlier in the administrative process: perhaps when you receive a revenue agent’s report or even a notice of proposed adjustment. Deciding when in the administrative process to start preserving documents should also take into account whether you have claimed “work product” protection for legal documents, such as opinion letters from outside counsel. Because work product is created “in anticipation of litigation,” a court might look askance at a party that has claimed work-product protection while simultaneously claiming that it didn’t have a duty to preserve documents. There are no straightforward rules though on answering the “when” question.
It is also not always clear which documents are “potentially relevant” to litigation that has not even begun yet. Transfer pricing cases require a functional analysis to decide which subsidiaries created value that must be compensated. That analysis could implicate almost all of the company’s operations and may not be limited to the tax years before the court. A staggering amount of non-tax business documents—including emails, presentations, spreadsheets, Word files, and databases—may be relevant. And while some of these documents will be kept by the tax department, many more will likely be kept by businesspeople scattered throughout the company’s operating divisions.
The Right Perspective. Keep in mind that the goal often isn’t merely to do the bare minimum. In most non-tax cases, your company is probably the defendant, so it’s usually seeking to poke holes in the other side’s position. In a transfer pricing dispute, though, the taxpayer has the double burden of proving that the IRS’s position is arbitrary, capricious, and unreasonable and that its position is correct. Contemporaneous documents are critical to a taxpayer’s ability to build its case. It would be wrong to think of document preservation as a nuisance to be handled at the lowest possible cost. Burdensome (and expensive) though it is, consider it an opportunity to save the evidence you will need to tell your story to the IRS or the court.
The silver lining is that you probably have done some of the work already. When the company filed its tax return, the tax department was required to preserve records “sufficient to establish” tax due, such as the return itself and supporting workpapers. To protect against tax penalties, it was also required to preserve basic documentation about the company’s transfer pricing method. And tax departments frequently work diligently to preserve documents that the IRS might request in audit. So some—but likely not all—relevant documents might already have been preserved for the upcoming case.
Don’t Go It Alone! If there is one key takeaway, it is this: Whenever you face a question in this area, you should reach out to your in-house legal department or outside counsel for advice. Document-preservation questions are notoriously tricky, and the stakes are often high. In-house counsel and outside counsel are well-situated to advise on when you should begin preserving documents and how to determine what categories of information should be preserved. Your company likely has a document-preservation policy that describes how the company will go about issuing a “legal hold,” a notification sent to employees informing them of their duty to preserve documents. And your company might even use specialized software that can issue the legal holds, track them, and periodically follow up with employees. Simply put, there is no reason to go it alone.
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