APA report reflects continued productivity of new program in

Tax Insights
from Transfer Pricing
Tax Controversy and Dispute Resolution
United States: APA report reflects
continued productivity of new
program in resolving double
taxation disputes
April 2, 2014
In brief
The IRS, through the Office of the Advance Pricing and Mutual Agreement (APMA) Program, on March
27 issued its 15th Annual Statutory Report (Announcement 2014-14 or the report) concerning Advance
Pricing Agreements (APAs). This is the second APA report that the IRS has issued since the February
2012 formation of the new APMA Program, which has combined responsibility for APAs and Mutual
Agreement Procedures (MAPs) pertaining to treaty issues resulting in double taxation. The new report
describes the experience, structure, and activities of the APMA Program solely with respect to APAs.
The report indicates that the IRS has remained productive in processing APA requests in comparison to
the most recent years prior to the restructuring. The APMA Program executed a record 145 APAs during
2013, compared to the prior record of 140 APAs in 2012 and a record low 42 APAs in 2011. Also of
importance, the average time to complete APAs decreased.
The continued increase in the number of APA completions, coupled with decreased processing times, is
attributable to several factors: the staffing and group structure of the APA function; a more streamlined
APA process under the APMA structure; and strong APMA leadership who emphasize efficient analysis
and negotiation of APA requests. The new record high in APA completions is particularly noteworthy
given the federal government shutdown that occurred in October 2013, which forced APMA Program
employees to stop working for more than two weeks and disrupted meeting schedules and other official
work.
The report also presents, for the second consecutive year, a breakdown of the primary countries with
which the IRS has concluded bilateral APAs. These statistics continue to reflect the significant role of
Japan in the overall APA process, with bilateral APAs with Japan again accounting for over 50 percent of
the bilateral APAs executed by the IRS. Canada, the United Kingdom, and Australia contributed the next
largest number of bilateral APAs concluded in 2013, accounting for 19, eight, and five percent,
respectively.
As in prior years, APA submissions and concluded APAs were led primarily by bilateral APAs, with most
completed APAs involving inbound transactions (foreign parent companies with US subsidiaries). In
addition, most completed APAs involved tangible goods or services transactions and companies
operating in wholesale/retail trade or manufacturing industries.
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New proposed revenue procedures governing APA applications and MAP applications were released during 2013 for
public comment. The IRS notes that these proposed revenue procedures reflect changes in APMA’s structure and contain
adjustments designed to make the APA process more efficient and effective. (For prior coverage, see WNTS Insights, “IRS
proposes significant revisions to advance pricing agreement procedures,” November 27, 2013, and “IRS proposes
significant revisions to Competent Authority procedures,” December 4, 2013.) The report further states that the model
APA agreement, which was last revised significantly in 2009, is under review for changes.
In detail
Continued productivity in the APA
Process
In 2013, the APMA Program executed
145 APAs. Consistent with the trend
from the prior year, this represents a
single-year record number of
completed APAs in the combined 20plus years of the APMA Program and
the predecessor APA Program. The
continued productivity is particularly
encouraging after the APA Program,
in its final year before reorganization
into the APMA Program, completed
only 42 APAs in 2011, a 10-year low
for the program. The continued
productivity, in conjunction with a
slight dip in new applications, also led
to the second year in a row that the
ending inventory of pending APA
requests decreased. In addition, the
median time to complete APAs
decreased from 39.8 months in 2012
to 32.7 months in 2013.
Observation: The continued trend
of reducing the average time to
complete an APA has exceeded
APMA’s previously stated goal of
reducing its average APA completion
time to approximately 36 months.
As mentioned, the decrease in APA
inventory was accompanied by a slight
decrease in the number of new APA
applications. After 126 submissions
were filed in 2012, 111 submissions
were filed in 2013. The 111 APA
submissions are relatively in line with
the number of submissions over the
past several years. While there were
only 96 APA submissions filed in
2011, there were 144 submissions in
2010, 127 submissions in 2009, and
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123 submissions in 2008. In addition,
the number of APAs withdrawn
increased by 50 percent, from six in
2012 to nine in 2013.
negotiation, are expected to continue
to drive productivity in the APA
process in 2014 and continue to yield
reductions in processing time.
Observation: Based on PwC’s
experience with the current APMA
program, we anticipate that
productivity in the APA process will
continue in 2014.
Role of bilateral APAs
As stated within the report, the
continued productivity is attributable
both to increased staffing and
efficiency in the APA process. After
increasing staff in 2011, the APMA
Program now employs over 90
professionals, including more than 25
economists. The organization of the
APMA Program also continues to
increase operating efficiencies because
bilateral APA requests no longer need
to be “handed off” from APA team
leaders to US Competent Authority
analysts, and then back again once
agreement with treaty partners has
been reached. Instead, since the
merger of the APA Program into the
Office of Competent Authority, a
single team is responsible for
developing the IRS position, reaching
agreement with treaty partners, and
finalizing the APA.
Observation: Another important
factor, not mentioned in the report, is
the strong emphasis of APMA
management on faster processing of
APA requests by APMA staff, with
more focus on identifying and
resolving significant issues and less
time spent on marginal issues. The
better staffing and more streamlined
processes, as well as management’s
emphasis on efficient analysis and
Of the 111 APA submissions filed in
2013, 89 submissions (approximately
80 percent) requested bilateral APAs,
20 submissions requested unilateral
APAs, and two submissions requested
multilateral APAs. The demand for
bilateral APAs is consistent with 2012,
when approximately 80 percent of
submissions requested bilateral APAs.
In addition, of the 145 APAs that were
executed in 2013, 105 involved
bilateral APAs (approximately 72
percent). The percentage of executed
bilateral APAs in 2013 remains
consistent with 2012, during which
approximately 74 percent of executed
APAs were bilateral.
As in prior years, executed inbound
APAs (those involving foreign parent
companies and US subsidiaries)
outnumbered executed outbound
APAs (those involving US parents
companies and foreign subsidiaries).
There was, however, less emphasis on
inbound APAs in 2013, which
accounted for approximately 55
percent of executed APAs, as
compared to 75 percent in 2012. The
percentage of renewal APAs also
decreased slightly among completed
bilateral APAs. In 2013, renewal
APAs accounted for 49 of the 105
completed bilateral APAs
(approximately 47 percent); in 2012,
renewal APAs accounted for 55 of the
103 completed bilateral APAs
(approximately 53 percent).
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For the second time, the IRS has
provided a country-by-country
breakdown of executed APAs of a
material number with treaty partners.
Consistent with 2012, 53 percent of
bilateral APAs were executed with
Japan. Canada accounted for 19
percent of the completed APAs, the
United Kingdom for eight percent,
and Australia for five percent. All
other countries combined accounted
for 15 percent. The large percentage
of executed APAs with Japan and
Canada remains consistent with prior
comments made by Michael Danilack,
the US Competent Authority and
Deputy Commissioner (International)
of the IRS Large Business and
International Division, and other IRS
executives, who have publicly noted
the high level of cooperation with
Japan’s National Tax Agency as well
as an improved record of success in
resolving transfer pricing issues with
the Canada Revenue Agency.
APA inventory and processing
time
As noted above, for the second time
since the inception of the APMA
Program or its predecessor, both the
inventory of pending APA
submissions and the time in inventory
decreased in 2013. At the end of 2013,
there were 331 pending APAs
consisting of 277 bilateral APAs, 51
unilateral APAs, and three
multilateral APAs. The APA
inventory has continued to trend
downward. As of 2012, there were 391
pending requests for APAs, and as of
2011, there were 445 pending
requests.
The current caseload is dominated by
bilateral APAs, which represented
approximately 84 percent of the total
inventory at the end of 2013. This is a
slight increase in the percentage of
bilateral APAs in the inventory as
compared to the end of 2012.
As stated above, the median time to
complete APAs also decreased from
39.8 months in 2012 to 32.7 months
in 2013. The figure below shows the
months to complete new and renewal
APAs, broken down by type.
Months to Complete APAs Executed in 2013
Unilateral
Average
Bilateral
Median
Average
Unilateral and Bilateral
Median
Average
Median
New
34.9
34.5
41.8
38.8
40.5
37.8
Renewal
25.4
23.7
36.2
31.9
32.4
31.4
New and Renewal
28.4
27.9
39.2
37.2
36.2
32.7
Types of transactions covered in
APAs
A variety of transactions were covered
in the 145 APAs executed in 2013.
Consistent with prior years, more than
40 percent of the transactions
involved the transfer of tangible
goods. Sales of tangible goods by non-
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US entities accounted for 27 percent
of executed APAs, while sales by US
entities covered 14 percent. More
than 35 percent of transactions
involved the provision of services.
The provision of services by US
entities accounted for 25 percent of
executed APAs, while the provision of
services by non-US entities accounted
for 11 percent. The majority of all
other transactions (18 percent)
involved the payment for the use of
intangible property. The figure below
shows the breakdown of transactions
covered by executed APAs in 2013.
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Types of Transactions Covered by APAs Executed in 2013
Transaction Type
Percentage
Sale of Tangible Property by Non-US Entity
27%
Performance of Services by US Entity
25%
Sale of Tangible Property by US Entity
14%
Performance of Service by Non-US Entity
11%
Use of Intangible Property by Non-US Entity
9%
Use of Intangible Property by US Entity
9%
All Other Types of Transactions
5%
Observation: The report notes that
while “complex transactions involving
intangibles may be more challenging
than other types of transactions and
represent a smaller percentage of the
APA inventory than other
transactions,” the IRS remains
focused on dealing with and executing
upon such APAs appropriately. This
statement demonstrates a continued
commitment by the IRS to address
more complex transactions involving
intangibles through APAs, as opposed
to a more adversarial audit process.
Industries covered in APAs
In 2013, completed APAs involved five
general industry segments and an “all
other industries” category. The
wholesale/retail trade industry
comprised the largest industry
segment of executed APAs (41
percent), and the manufacturing
industry comprised 35 percent.
Conversely, in 2012, manufacturing
comprised the largest industry
segment of executed APAs (42
percent), and wholesale/retail trade
followed with 35 percent.
Methods used in APAs
Within the wholesale/retail trade
industry, the wholesale distribution of
durable goods accounted for 33 APAs
(23 percent of all 2013 executed
APAs). Within the manufacturing
industry, the manufacturing of
transportation equipment accounted
for 15 APAs (10 percent of all 2013
executed APAs), and chemical
manufacturing accounted for 10 APAs
(seven percent of all 2013 executed
APAs).
Consistent with all prior 22 years of
the APA process, the comparable
profits method (CPM), with varying
profit level indicators (PLIs), was the
method most used for applying the
arm’s-length standard with regard to
transfers of tangible and intangible
property. The CPM was used in 77
percent of these APAs. While the
CPM and Residual Profit Split
Methods were used relatively
consistently between 2013 and 2012,
use of the Comparable Uncontrolled
Price Method decreased, as the
method is no longer separately listed
in the report as an applied specified
method. The figure below shows the
breakdown of methods used in APAs
regarding transactions involving
tangible or intangible property
executed in 2013.
Transfer Pricing Methods for Transactions involving Tangible or Intangible Property
Method
Percentage
Comparable Profits Method
77%
Residual Profit Split Method
6%
Other Methods
17%
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Of the 77 percent of cases utilizing the
CPM, the Return on Sales (the ratio of
operating profits to sales) was used as
the PLI in 78 percent of those APAs.
Such usage represents an increase
from 2012, in which Return on Sales
was used as the PLI in 61 percent of
APAs. The Berry Ratio (the ratio of
gross profits to operating expenses)
was used as the PLI in eight percent of
APAs. The figure below shows the
breakdown of PLIs used in executed
APAs regarding tangible and
intangible property.
Profit Level Indicator for Transactions involving Tangible or Intangible Property
Profit Level Indicator
Percentage
Return on Sales
78%
Berry Ratio
8%
Return on Assets or Capital Employed
6%
Other Profit Level Indicators
8%
For APAs regarding services
transactions, the Services Cost
Method was utilized in 39 percent of
APAs (an increase of 15 percentage
points from 2012). The CPM was
utilized in 36 percent of executed
APAs (a decrease of 19 percentage
points from 2012), and the
Comparable Profit Split Method was
utilized in 14 percent of APAs. Other
PLIs were utilized in the remaining 11
percent of executed APAs involving
the provision of services.
Of the services APAs utilizing the
CPM, 39 percent used the Berry Ratio
as the PLI (a decrease of 33
percentage points from 2012). The
Operating Profit to Total Services Cost
Ratio was utilized in 38 percent of
these APAs, while Return on Sales
accounted for the remaining 23
percent.
APA terms
Although the appropriate length of an
APA term is determined on a case-bycase basis, most APA submissions
propose an APA term of at least five
years. In 2013, 60 executed APAs had
a five-year term (approximately 41
percent), 23 APAs had a six-year term
(approximately 16 percent), and 23
APAs had a seven-year term
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(approximately 16 percent). Including
roll-back years, the average term
length for APAs executed in 2013 was
seven years. Approximately 83
percent of executed APAs had terms of
between five and eight years, while 10
percent of APAs had terms exceeding
nine years. Overall, executed APA
terms remain relatively consistent
with 2012.
Proposed changes to APA revenue
procedure and model APA
The report notes that new proposed
revenue procedures governing APA
applications and MAP applications
were released during 2013 for public
comment in Notices 2013-79 and
2013-78, 2013-50, respectively. The
IRS notes that these Notices reflect
changes in APMA’s structure and
contain adjustments to make the APA
process more efficient and effective.
APMA Program is paying dividends.
The IRS appears to have continuing
capacity to handle, on a sustained
basis, an increasing APA case load in
an effective and efficient manner. It
appears that APAs will continue to
provide an effective mechanism for
resolving double taxation disputes and
gaining certainty with respect to
transfer pricing issues (especially for
intercompany transactions involving
Japan, Canada, and the United
Kingdom). Further, proposed
changes with respect to APA
applications, MAP applications, and
the model APA agreement appear to
demonstrate the IRS’s continued
focus on streamlining the processing
of APAs.
The report further states that the
model APA agreement, which was last
revised significantly in 2009, is under
review for changes.
The takeaway
Overall, for the second consecutive
year, the statistics evidence that the
reorganization of the IRS APA
function into a new, more robust
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Let’s talk
For more information, contact your PwC team or the members of PwC’s APMA & TP Controversy Practice listed below:
APMA & Transfer Pricing Controversy
Richard F. Barrett, Washington, DC
+1 202 414 1480
[email protected]
Sean M. O’Connor, Washington, DC
+1 202 414 1518
sean.m.oconnor@ us.pwc.com
Gregory J. Ossi, Washington, DC
+1 202 414 1409
[email protected]
J. Bradford Anwyll, Washington, DC
+1 202 414 4336
[email protected]
David Ernick, Washington, DC
+1 202 414 1491
[email protected]
Kathryn O’Brien, Washington, DC
+1 202 414 4402
[email protected]
Barry Shott, New York
+1 646 471 1288
[email protected]
Lili Kazemi, Washington, DC
+1 202 346 5252
[email protected]
Noel de Santos, Washington, DC
+1 202 312 7943
[email protected]
Dan Homan, Washington, D.C.
+1 202 312 7648
[email protected]
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