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April 1, 2019 US IRS issues annual APA report for 2018 Executive summaryThe United States (US) Internal Revenue Service (IRS) Advance Pricing and Mutual Agreement (APMA) program issued the 19th annual Advance Pricing Agreement (APA) report (the Report) on 22 March 2019, in Announcement 2019-03. The Report provides an updated discussion of the APA program, including its activities and structure for calendar year 2018, gives useful insights into the operation of the program and provides some indications of what companies applying for an APA can expect to encounter. The Report shows that interest in APAs remains strong, with taxpayers filing 203 APA requests in 2018 compared to 101 in 2017. The total number of APAs concluded decreased from 116 to 107 and the median amount of time to finalize an APA slightly increased from 33.8 months to 40.2 months. Highlights
Detailed discussionBackgroundAn APA is an agreement between the IRS and a taxpayer under which the IRS agrees not to seek a transfer pricing adjustment under Internal Revenue Code 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 covering APAs has seen many updates and revisions since 1991, when Revenue Procedure 91-22 was issued. The current Revenue Procedure 2015-41, released in August of 2015, supersedes the prior APA Revenue Procedure 2006-09, and became effective for requests filed after 29 December 2015. The benefits of an APA include:
Revenue Procedure 2015-41 instructs taxpayers to request a term of at least five prospective years, which can be extended through renewal procedures. Similar to Revenue Procedure 2006-09, the new revenue procedure allows taxpayers to request “roll-back” years to be covered by an APA. In 2018, 20% of the completed agreements included roll-back years. Though 36 of the agreements were for terms of five years, the majority of the rest of the cases were for six or more years (including roll-back 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 and help avoid instances of double taxation. 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 2018, the IRS has received a total of 2,549 APA applications, and executed 1,820 APAs. The following table reports summary statistics about 2018 APA applications, executed APAs and pending APAs. Data are reported separately for unilateral and bilateral APAs,* and completion times for 2018, 2017 and 2016 are compared.
* In some cases, the totals include additional multilateral cases. IRS staffing changes and operating efficienciesIn 2012, the IRS made a concerted hiring effort to add more economists. Consequently, the number of economists available to develop APA positions more than doubled, allowing the IRS to deploy the appropriate resources to each case while reducing case-processing times. However, since 2012, the total number of APMA employees has decreased. The number of economists decreased in 2018 (12) compared to 2017 (17) and 2016 (20), the number of team leaders (a mix of lawyers and accountants) increased from 55 in 2017 to 56 in 2018. There were six managers and three assistant directors in 2018. Each assistant director supervised two managers who lead teams comprised of both team leaders and economists. Months to complete APAsThe following data indicate that the average time to completion for new bilateral APAs increased to 47.8 months in 2018 from 46.9 months in 2017. The average time to completion for new unilateral APAs decreased from 40.4 months in 2017 to 35.4 months in 2018.
Treaty partners in bilateral APAsAs shown in the following chart, APAs with Japan represent more than any other one country at 39% of bilateral APAs executed in 2018. 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 in executed APAs in 2018, as a result of its role as the second largest trading partner with the US (following China, which was the largest US trading partner for 2018) and the fact that it has been a US tax treaty partner for over 35 years. In addition, while India did not represent a significant proportion of agreements executed in 2018, a substantial number of India cases was filed as a result of the progress made in the relation between the IRS and India’s tax authorities during the last few years. In 2018, India represented 21% of bilateral APAs filed (more than any other country except for Japan) and 20% of pending bilateral APAs (the second most after Japan). This constitutes an extremely positive outcome given the uncertainty and severe risk of double taxation faced by multinationals investing in India. Bilateral APAs filed by countrySee PDF file for illustration. Bilateral APAs executed by country3See PDF file for illustration. Industries coveredAs shown in the following chart, manufacturing and wholesale/retail trade continue to comprise the largest share of APA cases, representing 83% of all APAs completed in 2017. Industry RepresentationSee PDF file for illustration. Approximately 42% of manufacturing cases involved computer and electronic products, chemicals, and transportation equipment, while the wholesale/retail trade cases were dominated by wholesalers of durable goods. ManufacturingSee PDF file for illustration. Wholesale/retail tradeSee PDF file for illustration. Covered transactions and tested partiesThe Report describes, in overall terms, the covered transactions and sets out the types of tested parties in each transaction. Note that one APA may cover more than one transaction. Covered transactionsSee PDF file for illustration. Types of tested partiesSee PDF file for illustration. Transfer pricing methods appliedThe CPM/TNMM continues to be the most commonly applied method in cases involving transfers of tangible and intangible property, as well as for services transactions. Critical assumptionsA critical assumption is a fact on which the taxpayer’s TPM depends. 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 2018 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 2018 relating to the failure of a critical assumption (or any other reason). ImplicationsDuring 2018, APMA substantially increased APA user fees in stages. The last of those increases took effect for APAs filed after 31 December 2018. Thus, it is not surprising that the number of new APAs filed before the end of 2018 increased significantly as companies tried to beat the increase in the user fees. The increased number of new APA requests, along with the decrease in economist resources, suggests that processing times may increase. The new provisions introduced as part of US tax reform have some implications for most multinationals — whether US or foreign-based. In many cases multinationals are rethinking their supply chains. As a result, multinationals are likely to continue seeking the benefits of an APA to avoid the risk of double taxation and the commitment of resources involved in audits and litigation. The highlight of the 2018 Report (continuing the trend) is the large number of pending bilateral APAs with India. The tax authority in India has been particularly focused on transfer pricing in the past years, forcing many multinationals to pursue administrative appeals or litigation. However, neither of these procedural options completely guarantee avoidance of double taxation. Consequently, the fact that multinationals now have the alternative to apply for a bilateral APA with India is a very welcome outcome. Endnotes 1. EY is handling approximately 35% of total number of bilateral APAs with India and completed the first US – India bilateral APA in January of 2018. 2. The rest consists of sister companies (24%) and all other relationships (2%). 3. Where any table in Announcement 2019-03 differs from the figures in the pie graph, the figures in the pie graph were used. For additional information with respect to this Alert, please contact the following: Ernst & Young LLP, Washington DC
Ernst & Young LLP, Dallas
Ernst & Young LLP, Atlanta
Ernst & Young LLP, San Jose
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