International Tax Alert News from Transfer Pricing 1 April 2015 IRS issues annual APA report for 2014 Executive summary The IRS issued the 16th annual Advance Pricing Agreement (APA) report (the Report) on 30 March 2015, in Announcement 2015-11. The Report provides an updated discussion of the APA program, including its activities and structure for calendar year 2014, gives useful insights into the operation of the program and indicates some of the treatment and processes that companies applying for an APA can expect to encounter. The Report shows that taxpayers have maintained their interest in APAs by filing a similar number of requests – 111 in 2013 and 108 in 2014. The total number of APAs concluded has significantly dropped by 30% and the median amount of time to finalize an APA slightly increased from 32.7 months to 35.3 months. The Report mirrors the streamlined structure first unveiled last year, and continues to include information on program trends not discussed prior to 2012, which can be useful for taxpayers considering an APA. Highlights • During 2014, 108 APA applications were filed and 101 APAs were completed. Though lower than the number of APAs completed during the prior two years, it still represents the third single-year triple digit number of closures and is more than twice the program’s 2011 output. • At year end, 336 APA requests were pending, up from 331 pending requests at the end of 2013. • Continuing the practice begun with the 2012 Annual Report, details on the treaty partners to bilateral APAs concluded during the year are provided. APAs with Japan (47%), Canada (15%) and the UK (10%) combined comprised 72% of all US bilateral APAs executed in 2014. Interestingly, last year those same three countries comprised 80% of all US bilateral APAs executed. EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. • Copy into your web browser: http://www.ey.com/GL/en/ Services/Tax/International- Tax/Tax-alert-library#date
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International Tax AlertNews from Transfer Pricing
1 April 2015
IRS issues annual APA report for 2014Executive summary
The IRS issued the 16th annual Advance Pricing Agreement (APA) report (the Report) on 30 March 2015, in Announcement 2015-11. The Report provides an updated discussion of the APA program, including its activities and structure for calendar year 2014, gives useful insights into the operation of the program and indicates some of the treatment and processes that companies applying for an APA can expect to encounter.
The Report shows that taxpayers have maintained their interest in APAs by filing a similar number of requests – 111 in 2013 and 108 in 2014. The total number of APAs concluded has significantly dropped by 30% and the median amount of time to finalize an APA slightly increased from 32.7 months to 35.3 months. The Report mirrors the streamlined structure first unveiled last year, and continues to include information on program trends not discussed prior to 2012, which can be useful for taxpayers considering an APA.
Highlights
• During 2014, 108 APA applications were filed and 101 APAs were completed. Though lower than the number of APAs completed during the prior two years, it still represents the third single-year triple digit number of closures and is more than twice the program’s 2011 output.
• At year end, 336 APA requests were pending, up from 331 pending requests at the end of 2013.
• Continuing the practice begun with the 2012 Annual Report, details on the treaty partners to bilateral APAs concluded during the year are provided. APAs with Japan (47%), Canada (15%) and the UK (10%) combined comprised 72% of all US bilateral APAs executed in 2014. Interestingly, last year those same three countries comprised 80% of all US bilateral APAs executed.
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• The median time required to complete an APA slightly increased, from 32.7 months in 2013 to 35.3 months in 2014.
• Overall headcount kept fairly constant at 91 professionals in March 2015.1
• Unilateral APA requests increased from 20 in 2013 to 31 in 2014.
• Approximately 55% of the APAs executed in 2014 were completed with companies having a foreign parent while 31% were completed with US parent companies. The remaining 14% involved transactions that included a partnership, a branch or other form of relationship.
• The Comparable Profits Method/Transactional Net Margin method (CPM/TNMM) accounted for 78% of the tangible / intangible cases and the Operating Margin accounted for 88% of the total cases where the CPM / TNMM method was applied.
• The CPM/TNMM was applied in 77% of the APAs with intercompany service transactions. The Services Cost Method (SCM), which was the most commonly used method in 2013, was applied in 17% of the APAs with intercompany service transactions. The most commonly selected PLI (47%) with the CPM/TNMM was the OM.
1 Staff levels are reported as of the date of each year’s Announcement.
Background
An APA is an agreement between the IRS and a taxpayer under which the IRS agrees not to seek a transfer pricing adjustment under IRC Section 482 for one or more specific covered transaction(s) if the taxpayer files its tax return for a covered year based on the agreed TPM(s). The APA process is a voluntary program designed to resolve actual or potential transfer pricing disputes in a principled, cooperative manner, as an alternative to the traditional examination process.
The Revenue Procedure (Rev. Proc.) covering APAs has seen many updates and revisions since 1991 when Rev. Proc. 91-22 was issued. The current Rev. Proc. 2006-09 was released in December of 2005 and was amended by Rev. Proc. 2008-31 in May of 2008. In November 2013, proposed revenue procedures governing APA and MAP applications were released for public comment in Notice 2013-79, 2013-50 I.R.B. 653 and Notice 2013-78, 2013-50 I.R.B. 633, respectively. These proposed changes triggered vigorous public discourse and voluminous commentary, and the APMA Program has indicated the proposed revenue procedures will likely be revised and released later this year in final form.
The benefits of an APA include:
• Reduction or elimination of the risk of transfer pricing adjustments, penalties, and interest as well as the risk of double taxation.
• Reduction of financial statement reserves and administrative costs associated with transfer pricing compliance.
• Certainty of prospective tax treatment for APA covered transactions and a consequent increase in tax and management flexibility.
• Flexibility in adopting transfer-pricing methods to deal with unique transactions, or a lack of good comparables.
• Cost effective management of multiple past and prospective years compared to the traditional examination process.
The APMA Program favors agreements with terms of at least five years, which can be extended through renewal procedures. In 2014, 41% of the completed agreements were for terms of five years. Approximately 93% of all cases had terms of nine years or less, with the average term being six years.
When competent authority procedures are available in the other countries involved (under an effective tax treaty), the IRS encourages bilateral or even multilateral APAs. These agreements are also binding on the foreign tax authority for the same period of time and help avoid instances of double taxation.
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Detailed discussion
In 1999, Congress mandated that the APA Program publish an annual report summarizing key information regarding the various APAs filed, pending, and executed during the previous calendar year. This requirement is framed so as to achieve a compromise between providing the public information as to how the IRS resolves transfer pricing issues in the APA process, and protecting the confidential tax information of taxpayers participating in the APA Program.
APA applications, executed APAs, and pending APAsSince the APA program’s inception in 1991 through 31 December 2014, the IRS has received a total of 1,964 APA applications, and executed 1,401 APAs. The table below reports summary statistics about 2014 APA applications, executed APAs, and pending APAs. Data are reported separately for unilateral and bilateral APAs, and completion times for 2014, 2013, and 2012 are compared.
* In some cases, the totals include additional multilateral cases
Staffing changes and operating efficienciesIn 2012, there was a concerted hiring effort that focused on adding economist resources. This more than doubled the number of economists available to develop APA positions and therefore enabled the IRS to deploy the appropriate resources to each case while reducing case processing times.
Interestingly, though the overall number of employees remains the same from last year, the mix has slightly changed. While the number of economists slightly decreased in 2014 (22) with respect to 2013 (26), the number of team leaders (mostly lawyers), increased from 55 to 59. The number of senior managers who manage a group, usually very experienced professionals, has remained constant at 10.
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Months to complete APAsThe data reported below indicate that the average time to completion for new bilateral APAs has slightly increased from 41.8 months in 2013 to 44.2 in 2014. The average time to completion for new unilateral APAs has significantly decreased from 34.9 months in 2013 to 26.7 months in 2014.
Treaty partners in bilateral APAsAs shown in the chart below, APAs with Japan represent slightly less than half of all bilateral APAs executed in 2014. This is attributable to the maturity of the APA programs in the United States and Japan and the negotiating experience of the APMA team and the competent authority team representing the National Tax Administration of Japan.
Canada is the second most frequently involved treaty partner, owing to its role as the United States’ largest trading partner.
Bilateral APAs by Country
Japan47%
Canada15%
United Kingdom,
10%
Korea8%
All Other Countries, 20%
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Industries coveredAs shown in the chart below, manufacturing and wholesale/retail trade continue to comprise the largest share of APA cases, representing more than two of every three APAs completed in 2014.
Industry Representation
Wholesale/Retail Trade, 22%
Manufacturing, 47%
Services, 11%
Management, 9%
Finance, Insurance and Real Estate,
5%
All Other Industries, 6%
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More than half of all manufacturing cases involved computer and electronic products, machinery or electrical equipment, appliances, and components, while the wholesale/retail trade cases were dominated by wholesalers of durable goods.
Manufacturing
Electrical Equipment,
Applicance and Components, 17%
Chemicals, 12%
Computer and Electronic
Products, 27%
Miscellaneous Manufacturing,
17%
Machinery, 17%
Other Manufacturing,
10%
Wholesale/Retail Trade
Merchant Wholesalers,
Durable Goods 64%
Merchant Wholesalers,
Nondurable Goods 32%
Other Types of Wholesale/Retail
Trade4%
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Covered transactions and tested partiesThe Report describes, in overall terms, the covered transactions and sets out the functions performed by the related entities, as well as the tested party in each transaction. Note that one APA may cover more than one transaction.
Covered Transactions
Tested Parties
Sale of Tangible Property from the
US, 13%
Use of Intangible Property by a US
entity, 12%
Use of Intangible Property by a non-
US entity, 12%
Performance of Services by a US
entity, 22%
Performance of Services by a non-
US entity, 18%
Sale of Tangible property into the
US, 23%
Distribution, 25%
Manufacturing, 13%
Administrative Services, 15%
Product Support, 17%
R&D, 8%
Marketing, 22%
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Transfer pricing methods appliedThe CPM/TNMM continues to be the most commonly applied method in cases involving transfers of tangible and intangible property.
Tangible and Intangible Property TPM
Services TPM
CPM/TNMM, 78%
Residual Profit Split Method, 8%
CUT Method, 13%
All other TPMs, 4%
CPM/TNMM, 77%
Services Cost Method, 17%
Other Methods, 6%
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Critical assumptionsA critical assumption is a fact on which the taxpayer’s TPM is dependent. APAs typically list critical assumptions that involve a particular mode of conducting business operations, a particular corporate or business structure, or a range of expected business volume.
The model APA used by the IRS includes a standard critical assumption that there will be no material changes to the taxpayer’s business or to its tax or financial accounting practices during the APA term, and all the APAs executed in 2014 included that standard critical assumption.
A few bilateral cases have included critical assumptions tied to either the taxpayer’s profitability in a certain
year or over the term of the APA, or to the amount of non-covered transactions as a percentage of the taxpayer’s revenue.
If a critical assumption has not been met, and the parties cannot agree on how to revise the APA, the APA can be canceled. The IRS did not cancel any APAs in 2014 due to the failure of a critical assumption (or any other reason).
Implications
Taxpayers should view APMA’s continued trend of a triple digit closure rate as an indication that the IRS is serious about improving the APA process. The APMA Program recognizes that taxpayers are
voluntarily approaching the IRS for prospective resolution, and that optimizing the program provides for a more efficient deployment of resources for both the IRS and the taxpayer. APMA’s continued focus on resolving cases is expected to lead more taxpayers to consider pursuing APAs as a way to proactively resolve their transfer pricing issues. This may be especially true within the context of the OECD base erosion and profit shifting (BEPS) environment of increased focus on transparency and impending country by country reporting.
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