The IRS Large Business & International (LB&I) Division has released the final version of Publication 5125 (2-2016), Large Business & International — Examination Process (the Final Publication), which revises its examination process.

Highlights

— Clear expectations are set for LB&I examiners, taxpayers and representatives.
— LB&I will generally only accept informal claims for refund that are provided to an exam team within 30 days of the opening conference.
— Changes to the examination process indicate that LB&I is moving towards centrally selecting issues for examinations, which will then be managed and audited by "issue teams" with a case manager with overall responsibility for the case.
— LB&I will be seeking ongoing acknowledgement of facts from taxpayers to ensure accurate tax determinations.
— The revisions to LB&I's examination process are effective May 1, 2016. For cases in process as of May 1, examinations will transition to the new process by adopting changes in the Execution and Resolution phases.

Background

The new examination process will replace LB&I's current Quality Examination Process (QEP Publication 04837 (Rev. 10-20-10)). The new examination process will apply to cases within LB&I's jurisdiction, including both Coordinated Industry Cases (CIC) and Industry Cases (IC). The Final Publication: (1) lists the expected roles and responsibilities of the LB&I Examination Team and the taxpayer, (2) modifies and adopts the three-phase examination process (i.e., planning, execution and resolution) in the QEP and the Transfer Pricing Audit Roadmap issued in February 2014 (see Tax Alert 2014-331), (3) incorporates the new Information Document Request (IDR) Directive (see Tax Alert 2014-502), and (4) creates new expectations related to the filing of claims for refund. Publication 5125 was initially issued in a draft form dated July 2014 (see Tax Alert 2014-2053).

The IRS has stated that it will publish corresponding updates to the Internal Revenue Manual on or before May 1, 2016. In addition, for cases in process as of May 1, the IRS has stated that it will transition the examination process by adopting changes in the Execution and Resolution phases.

New roles and responsibilities

Under the new Exam Process, LB&I expects exam teams and taxpayers to work transparently and collaboratively to develop the audit steps and timelines for the issues in the examination plan to resolve those issues at the earliest appropriate point. Taxpayers and their representatives will need to focus on: (i) identifying personnel for each issue with sufficient knowledge to actively assist in the development of the issues; (ii) following the procedures in the IDR Directive; and (iii) collaborating with each issue team to arrive at a written acknowledgement of the facts, including providing support for any additional facts, or if facts remain in dispute, documenting where the dispute lies.

LB&I examination process

There are three phases to an LB&I exam: Planning, Execution and Resolution.

Planning: communication, issue team approach, examination plan

This phase determines the scope of the audit (i.e., the issues selected for examination). LB&I will select issues with the broadest compliance impact and explain to the taxpayer why each issue was selected. The taxpayer should provide input on how each issue can be effectively examined. A communication strategy should be established to monitor the progress of the examination and technology should be leveraged to communicate and transmit data. LB&I will apply a new "issue team" approach for each issue. The size and composition of each team (number and type of technical specialists) will depend on the nature and complexity of the issue. Issue teams are expected to work in a transparent manner with identified knowledgeable taxpayer personnel to develop examination procedures tailored to the issues selected to establish the relevant facts and ensure that each party's position is fully understood.

The designated case manager will have overall responsibility for the case and each issue will have an issue team manager. Issue team managers will collaborate with the case manager. The issue manager will be a manager of one of the technical team members. The issue manager has oversight over the planning, execution and resolution of the issue, including evaluating the strengths and weaknesses of each side's tax position and seeking resolution at the earliest appropriate point.

Agreements reached between LB&I and the taxpayer in the planning phase will be jointly reviewed and incorporated into the final examination plan. This plan will be issue-focused and include timelines, audit steps and communication agreements.

Execution: issue development process, written acknowledgement of facts

Issue development means identifying and documenting all relevant facts, applying the law to those facts, and clearly presenting the legal positions. LB&I issue teams and taxpayers should actively discuss any factual differences, legal disputes and other areas of disagreement. Resolution strategies should be considered throughout the examination to resolve issues at the earliest appropriate point. With respect to IDRs, issue teams and taxpayers must follow the LB&I IDR Directive.

LB&I issue team members must document all the facts they have established. For potentially unagreed issues, the issue team members are expected to seek the taxpayer's acknowledgment on the facts, resolve any factual differences and/or document factual disputes. The issue manager should ensure that all relevant facts, including additional and/or disputed facts, are appropriately considered before a Notice of Proposed Adjustment is issued.

Resolution: issue resolution, exit strategy

The goal of each examination is to reach agreement, if possible, on each issue. LB&I encourages the use of all available issue resolution tools to save resources and lessen the burden on both parties, but now requires the consideration of Fast Track Settlement with Appeals for all unagreed issues. Consistent with the Appeals Judicial Approach and Culture (AJAC) Project, if a taxpayer provides new facts in a case closed to Appeals, the case will be returned to exam's jurisdiction for consideration. If the taxpayer presents a relevant new theory or legal argument during the Appeals process, Appeals will engage Exam for their review and comment, but will retain jurisdiction of the case. Cases closed to Appeals now require that a minimum of 365 days remain on the statute of limitations when the case is received by the IRS Appeals Office.

The new exam process anticipates that, in many instances, LB&I and the taxpayer will perform a joint critique of their examination and recommend improvements, which should include the future tax treatment of issues to eliminate carryover and recurring issues.

Expectations with respect to claims

Under the new Exam Process, LB&I will generally only accept informal claims for refund that are provided to an exam team within 30 days of the opening conference. After this period, taxpayers must submit formal claims using Form 1120X, Amended U.S. Corporate Income Tax Return, Form 1040X, Amended U.S. Individual Income Tax Return, or Form 843, Claim for Refund and Request for Abatement, with supporting documentation.

LB&I will not require a formal claim if an issue has been identified for examination, unless IRS published guidance specifically requires formal claims to be filed for an issue (e.g., Notice 2008-39 for research credit claims). In limited circumstances, exceptions to the formal claims process may be granted by LB&I senior management. Netting of claims does not preclude the requirement for filing a formal claim for refund.

The new Exam Process reiterates the requirements for valid refund claims (formal and informal) that are found in Treasury Regulation Section 301.6402-2. Valid refund claims must: (1) set forth in detail each ground upon which a credit or refund is claimed, (2) present facts sufficient to apprise the IRS of the exact basis for the claim and (3) contain a written declaration that it is made under penalties of perjury. While claims failing to meet these regulatory standards will be disallowed, LB&I will discuss deficiencies not meeting the Treasury Regulations and provide the taxpayer an opportunity to correct the deficiencies. LB&I will not, however, act on an incomplete or otherwise invalid claim for refund.

When taxpayers file a formal claim, they should concurrently provide a copy of the claim to the LB&I exam team. If the claim is fully documented and factually supported, LB&I may be able to accept the claim without the use of IDRs. Claims will be risk assessed in the same manner as any other audit issue. If an issue on a claim needs to be examined, LB&I and the taxpayer will discuss the potential need for additional resources and extend the statute and examination timeline as necessary.

Implications

Restricting the filing of informal claims to within 30 days of the opening conference will limit the ability of taxpayers to raise affirmative adjustments during an examination and will require the filing of formal claims that may or may not be examined during the current examination. This, in turn, could result in a subsequent examination of claims after the completion of the audit. Taxpayers should be prepared to submit fully developed affirmative informal claims within the 30-day period.

The May 1, 2016 effective date applies to both in-process and new audits. It is unclear if LB&I will accept informal claims from taxpayers with in-process audits after May 1, because they will generally be more than 30 days past the opening conference. Therefore, taxpayers with in-process audits should consider now whether or not they want to file any informal claims before the May 1 effective date.

Taxpayers should ensure that they have an overall IRS audit strategy that allows them to manage the technical support and other resource commitments necessary to effectively and efficiently deal with the new examination process. For example, are taxpayers prepared to identify personnel to work with particular issue teams? Manage the new IDR procedures? Reply to requests for documents like global tax organization charts?

The new examination process reinforces an issue-based examination approach in which LB&I issue teams will be responsible for conducting the examination of predetermined issues. Taxpayers need to understand the new roles and responsibilities of the LB&I examination team, especially the new positions of case manager and issue team manager.

With the incorporation of the Information Document Request Directive and AJAC, LB&I has an expectation that taxpayers will work transparently and collaboratively with it to provide all facts and legal arguments in a more prescribed manner during the examination. Taxpayers will need to be particularly focused on managing these expectations while ensuring that all necessary facts, legal arguments and disagreements are effectively presented.

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