may be undercut by its severity. Imposition of a penalty as can make the stakes so high that a taxpayer is more likely to settle in a proceeding not guided by principles of law becaus feels threatened. As the Service stated, "increasing severity i unrelated to this deterrence objective is inappropriate and un

Experience in litigation and administrative proceedings in tion or other issues under Section 482 and in other areas of there are no legal standards or only vague ones about what is for being very cautious in accepting facile assertions that ex new transfer pricing penalty will induce taxpayers to take positions. Experience of many suggests precisely the opposite that an IRS examining agent having a different view abo increase any tax deficiency he proposes by simply asserting a 40 percent penalty could well lead a taxpayer rationally to initially claiming a more aggressive value serves his or her in in the long run, because some court or other authority a dispute may simply "split the difference." IRS Deputy As Counsel (International) Charles S. Triplett stated:

In what may have been efforts to achieve judicial economy, m have resulted in decisions that represent a compromise of the of the parties. An unfortunate byproduct of these cases is that very well influence both the government and the taxpayer overly aggressive positions, on the assumption that the cour to scale back anything either side proposes

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5. Principle: A penalty should be fair, and should be pe fair. The new penalty is grossly unfair. It holds a taxpayer p liable by reference to a legal standard that was not in existen the taxpayer shaped and completed the business transaction later on a tax return." The taxpayer is penalized by reference established only after the behavior. If the penalty were "erin law would be unconstitutionally ex post facto. Similarly, a would be subject to constitutional challenge for undue vagu the labelling of a tax penalty as "civil" rather than "crimina a difference in its desirability or its constitutionality?

6. Principle: The amount of a penalty should be perceived reasonable and not disproportionate to the culpability of th

and good faith for intercompany transfer prices reported on their tax 5. It does so deliberately under the "net annual effect" basis, even the deviation of the price used on the tax return from the price tely held to be correct is small or clearly within the 200 percent/50 I standard set under the new law as being acceptable. This expresses that an international business should be subject to the penalty just e it happens to be large.

1989 Report on Civil Tax Penalties, the Service stated:

If penalties become too severe, they may have penal aspects, penal pects that are more appropriately dealt with in the context of criminal nctions...

If the severity of a civil penalty exceeds the severity that is appropriate a civil context, it may have an adverse impact on taxpayer attitudes out the fairness of our self-assessment system. 109

hstanding such principles, unless the "reasonable cause/good faith" on applies, the new transfer pricing penalty may be imposed at the 40 percent in cases argumentatively labelled as "gross valuation ements," even though the taxpayer was not "negligent" within aning of the accuracy-related penalty provisions of the law. If the r were actually negligent, i.c., had failed "to make a reasonable t to comply with" the law or had acted in a way that was "careless, s," or in "intentional disregard" of rules and regulations, the penalty only be at the 20-percent rate."

110

over, the statute deliberately withholds other forms of relief granted ayers for other accuracy-related penalties. The taxpayer is not autoly granted relief from the new penalty because he can show he bstantial authority" for his position, because he made "adequate re" of all the relevant facts because he believed that the transaction ted on his tax return was "more likely than not proper," or because e was "no intent or plan to avoid tax." Relief will be available in such ly to the uncertain extent the taxpayer can show it is warranted by asonable cause/good faith" exception.

new rules will almost certainly be viewed as punitive, severe, and ed to culpability. It seems highly unlikely that the authors of the alty expected the rules to be perceived as fair and proportionate to lity; it seems much more likely that the authors consciously decided rt from principles of fairness and proportionality in favor of being

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resources of the Service will not divert those resources fro tant objects. The new penalty casts a large net, swe taxpayers who have engaged in no misconduct. Its automati permit relief from the penalty only by a finding that the actions of the taxpayer challenged by the Service were take able cause" and "in good faith." Such a finding require circumstances determination to be made on a case-by-case

from the one the Service must make to challenge the tax ..ce. Each such determination requires a factual investig evaluation necessarily make significant demands on the li of the Service. Nevertheless, the resources must be expen taxpayers initially caught in the broad, tight net of the pen tions are not to be penalized, too.

The new transactional-specific transfer pricing penalty do with the principle stated in the Service's Report on Penalt

...The design of penalties should follow a course that rec limited resources for administration of penalties. Specifical penalties aimed at marginal noncompliance, elegantly stru difficult-to-administer penalties, and legislative or regulator for scarce resources in particular areas that prevent the broade ation of competing resource needs should be avoided.113 The new penalty aggravates the costly habit of diverting and private resources and energies into directions that d developing substantive rules for principled disposition of the core of the problems presented. This is a drawback that t shares with the multitude of recent initiatives for stepped-u for information reporting, and for dispute resolution, which with problems in this area on an ad hoc, case-by-case basis such initiatives are promising, they cannot substitute for s more generally applicable rules that resolve the issues on a n and predictable basis.

Comparison of the New Penalty to the Negligence Penalty

The key respects in which the new penalty fails to c principles that guided the 1989 reform of the civil tax penal

tion meets the statutorily stated standard of (a) being intentional, ss, or careless, and (b) not being under the circumstances a reasonable od faith effort to ascertain and to comply with the rule; and if it , the amount of the penalty is computed by reference only to that any understatement of tax that is attributable to the taxpayer's ent behavior.

structure of the negligence penalty-unlike that of the new transfer valuation penalty-reinforces the duty of governmental tax authorimake substantive rules that define in advance and in understandable ge the behavior expected of taxpayers; and if they fail to discharge ty, there is no penalty. The structure of the negligence penalty also ces the reciprocal duty of all taxpayers to make reasonable and good fforts to find out and comply with what is expected of them under ules; and if they fail to discharge that duty by disregarding those hey will be subject to a penalty at a substantial 20 percent rate on rt of a tax understatement due to their negligent conduct. negligence penalty, unlike the new transfer pricing valuation penores well under the major criteria for a tax penalty described above: ts the cardinal criterion of being designed primarily to reinforce a tive tax rule or "normative standard" for taxpayer behavior rather raise revenue or achieve some other purpose. It can be effective in s imposed at the substantial but not unduly severe rate of 20 percent targeted to that part of an understatement of tax due to a taxpayer's duct. It is fair in the sense that it treats similarly situated taxpayers ly; it does this both in reference to the substantive rule of tax law ed and in reference to the procedural standard of care as to whether nable and good faith effort has been made by a taxpayer to comply he substantive rule. It also is fair in the sense that the rules by ce to which it operates, both substantive and procedural, must have romulgated in advance of the conduct subject to the penalty.

New Penalty an Appropriate Exercise of Governmental ity?

decision to add the new transfer pricing valuation penalty to the vast of penalties and other loosely constrained powers already accorded vice for interpreting and enforcing the vague standards of the statute

Was it appropriate for the Treasury and the Service to Congress to enact, or for the administration to approve its the White Paper the Treasury and the Service pointed substantive rules of law needed to determine the correct due in major categories of international transactions. Co administration officials who agreed to enactment were av knew that the administration was at work developing n guidelines for regulations and international agreements. officials also knew that an ultimate issue in this area for and taxing authorities concerns the portion of a taxpayer income from international transactions that is to be subje each country claiming jurisdiction, and that there were internal U.S. law or in treaty tax law all the rules needed items of income, expense, profit, or loss to each countr

source.

Now that the penalty has been enacted, was it appropria and IRS officials to publicly announce their intention to s without waiting for development of regulations? General rul tion are needed by IRS field agents to assure uniform and nor application of the penalty to various taxpayers, some of w business competitors. Is it appropriate for Treasury official speculating about the benefits of an in terrorem approac withhold publication of rules providing needed guidance to taxpayers about the standard of taxpayer compliance expec penalty? Taxpayers are not the only persons to whom the re good faith standard applies; the Service is not supposed to in where a taxpayer's standard for compliance with the tax la to its requirements. Is it appropriate for Treasury and Ser be advising international business taxpayers that they can from the financial threat of imposition of the new penalty invitations by Service tax enforcement officials to enter into tions for advance pricing agreements about the basis to taxing future international transactions under conditions wh tive rules of generally applicable law needed for determinatio transfer prices are still not in force, and (2) the terms of a reached by direct business competitors with the Service or