us-irs-announcements-a-04-26•a-04-26.pdf
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1
ANNOUNCEMENT AND REPORT
CONCERNING
A
DVANCE PRICING AGREEMENTS
March 30, 2004
This Announcement is issued pursuant to § 521(b) of Pub. L. 106-170, the Ticket to Work and
Work Incentives Improvement Act of 1999, which requires the Secretary of the Treasury to
report annually to the public concerning Advance Pricing Agreements (APAs) and the APA
Program. The first report covered calendar years 1991 through 1999. Subsequent reports
covered calendar years 2000, 2001, and 2002. This fifth report describes the experience,
structure and activities of the APA Program during calendar year 2003. It does not provide
guidance regarding the application of the arm’s length standard.
Matthew W. Frank
Director, Advance Pricing Agreement Program
Background
Internal Revenue Code (IRC) § 482 provides that the Secretary may distribute, apportion, or
allocate gross income, deductions, credits, or allowances between or among two or more
commonly controlled businesses if necessary to reflect clearly the income of such businesses.
Under the regulations, the standard to be applied in determining the true taxable income of a
controlled business is that of a business dealing at arm’s length with an unrelated business. The
arm’s length standard also has been adopted by the international community and is incorporated
into the transfer pricing guidelines issued by the Organization for Economic Cooperation and
Development (OECD). OECD,
TRANSFER PRICING GUIDELINES FOR MULTINATIONAL
ENTERPRISES AND TAX ADMINISTRATORS (1995). Transfer pricing issues by their nature are
highly factual and have traditionally been one of the largest issues identified by the IRS in its
audits of multinational corporations. The APA Program is designed to resolve actual or potential
transfer pricing disputes in a principled, cooperative manner, as an alternative to the traditional
examination process. An APA is a binding contract between the IRS and a taxpayer by which
the IRS agrees not to seek a transfer pricing adjustment under IRC § 482 for a covered
transaction if the taxpayer files its tax return for a covered year consistent with the agreed
transfer pricing method (TPM). In 2003, the IRS and taxpayers executed 58 APAs and amended
4 APAs.
Since 1991, with the issuance of Rev. Proc. 91-22, 1991-1 C.B. 526, the IRS has offered
taxpayers through the APA Program the opportunity to reach an agreement in advance of filing a
tax return on the appropriate TPM to be applied to related party transactions. In 1996, the IRS
2
issued internal procedures for processing APA requests. Chief Counsel Directives Manual
(CCDM), ¶¶ 42.10.10 – 42.10.16 (November 15, 1996). Also in 1996, the IRS updated Rev.
Proc. 91-22 with the release of Rev. Proc. 96-53, 1996-2 C.B. 375. The APA Program continues
to operate under the provisions of Rev. Proc. 96-53, which provides taxpayers with instructions
of how to apply for an APA, and what to expect in the processing of the case. In addition, in
1998, the IRS published Notice 98-65, 1998-2 C.B. 803, which set forth streamlined APA
procedures for Small Business Taxpayers (SBTs). That Notice also expanded the availability of
the lowest APA user fee in an effort to attract taxpayers who may not have the resources to do
the sophisticated economic studies normally required in APA submissions.
Advance Pricing Agreements
An APA generally combines an agreement between a taxpayer and the IRS on an appropriate
TPM for the transactions at issue (Covered Transactions) with an agreement between the U.S.
and one or more foreign tax authorities (under the authority of the mutual agreement process of
our income tax treaties) that the TPM is correct. With such a “bilateral” APA, the taxpayer
ordinarily is assured that the income associated with the Covered Transactions will not be subject
to double taxation by the IRS and the foreign tax authority. It is the policy of the United States,
as reflected in § 7 of Rev. Proc. 96-53 to encourage taxpayers that enter the APA program to
seek bilateral or multilateral APAs when competent authority procedures are available with
respect to the foreign country or countries involved. However, the IRS may execute an APA
with a taxpayer without reaching a competent authority agreement (a “unilateral” APA).
A unilateral APA is an agreement between a taxpayer and the IRS establishing an approved TPM
for U.S. tax purposes. A unilateral APA binds the taxpayer and the IRS, but obviously does not
prevent foreign tax administrations from taking different positions on the appropriate TPM for a
transaction. As stated in Rev. Proc. 96-53, should a transaction covered by a unilateral APA be
subject to double taxation as the result of an adjustment by a foreign tax administration, the
taxpayer may seek relief by requesting that the U.S. Competent Authority consider initiating a
mutual agreement proceeding, provided there is an applicable income tax treaty in force with the
other country.
When a unilateral APA involves taxpayers operating in a country that is a treaty partner,
information relevant to the APA (including a copy of the APA and APA annual reports) may be
provided to the treaty partner under normal rules and principles governing the exchange of
information under income tax treaties.
The APA Program
An IRS team headed by an APA team leader is responsible for the consideration of each APA.
As of December 31, 2003, the APA program had 18 team leaders. The team leader is
responsible for organizing the IRS APA team. The IRS APA team arranges meetings with the
taxpayer, secures whatever information is necessary from the taxpayer to analyze the taxpayer’s
related party transactions and the available facts under the arm’s length standard of IRC § 482
and the regulations thereunder (Treas. Reg.), and leads the discussions with the taxpayer.
3
The APA team generally includes an economist, an international examiner, LMSB field counsel,
and, in a bilateral case, a U.S. Competent Authority analyst who leads the discussions with the
treaty partner. The economist may be from the APA Program or the IRS field organization. As
of December 31, 2003, the APA Program had 7 economists. The APA team may also include an
LMSB International Technical Advisor, other LMSB exam personnel, and an Appeals officer.
The APA Process
The APA process is voluntary. Taxpayers submit an application for an APA, together with a
user fee as set forth in Rev. Proc. 96-53. The APA process can be broken into five phases: (1)
application; (2) due diligence; (3) analysis; (4) discussion and agreement; and (5) drafting,
review, and execution.
(1) Application
In many APA cases, the taxpayer’s application is preceded by a pre-file conference with the APA
staff in which the taxpayer can solicit the informal views of the APA Program. Pre-file
conferences can occur on an anonymous basis, although a taxpayer must disclose its identity
when it applies for an APA. Taxpayers must file the appropriate user fee on or before the due
date of the tax return for the first taxable year that the taxpayer proposes to be covered by the
APA. Many taxpayers file a user fee first and then follow up with a full application
later. The
procedures for pre-file conferences, user fees, and applications can be found in Rev. Proc. 96-53.
The APA application can be a relatively modest document for a small business taxpayer. Notice
98-65 describes the special APA procedures for small businesses. For most taxpayers, however,
the APA application
is a substantial document filling several binders. The APA Program makes
every effort to reach agreement on the basis of the information provided in the taxpayer's
application.
The application is assigned to an APA team leader who is responsible for the case. The APA
team leader’s first responsibility is to organize the APA team. This involves contacting the
appropriate LMSB International Territory Manager to secure the assignment of an international
examiner to the APA case and the LMSB Counsel’s office to secure a field counsel lawyer. In a
bilateral case, the U.S. Competent Authority will assign a U.S. Competent Authority analyst to
the team. In a large APA case, the international examiner may invite his or her manager and
other LMSB personnel familiar with the taxpayer to join the team. When the APA may affect
taxable years in Appeals, the appropriate appellate conferee will be invited to join the team. In
all cases, the team leader contacts the Manager, LMSB International Technical Advisors, to
determine whether to include a technical advisor on the team. The IRS APA team will generally
include a technical advisor if the APA request concerns cost-sharing, intangibles or services. The
APA team leader then distributes copies of the APA application to all team members and sets up
an opening conference with the taxpayer. The APA office strives to hold this opening
conference within 45 days of the assignment of the case to a team leader. At the opening
conference, the APA team leader proposes a case plan designed to complete the recommended
U.S. negotiating position for a bilateral APA within 9 months from the date the full application
was filed and to complete a unilateral APA within 12 months from the application date. In 2003,
4
the median for completing negotiating positions was 15.2 months (average 15.3), and the median
for completing unilateral APAs was 9.2 months (average 20.0).
(2) Due Diligence
The APA team must satisfy itself that the relevant facts submitted by the taxpayer are complete
and accurate. This due diligence aspect of the APA is vital to the process. It is because of this
due diligence that the IRS can reach advance agreements with taxpayers in the highly factual
setting of transfer pricing. Due diligence can proceed in a number of ways. Typically, the
taxpayer and the APA team will agree to dates for future meetings during the opening
conference. In advance of the opening conference, the APA team leader will submit a list of
questions to the taxpayer for discussion. The opening conference may result in a second set of
questions. These questions are developed by the APA team and provided to the taxpayer through
the APA team leader. It is important to note that this due diligence is not an audit and is focused
on the transfer pricing issues associated with the transactions in the taxpayer’s application, or
such other transactions that the taxpayer and the IRS may agree to add.
(3) Analysis
A significant part of the analytical work associated with an APA is done typically by the APA or
IRS field economist assigned to the case. The analysis may result in the need for additional
information. Once the IRS APA team has completed its due diligence and analysis, it begins
negotiations with the taxpayer over the various aspects of the APA including the selection of
comparable transactions, asset intensity and other adjustments, the TPM, which transactions to
cover, the appropriate critical assumptions, the APA term, and other key issues. The APA team
leader will discuss particularly difficult issues with his or her managers, but generally the APA
team leader is empowered to negotiate the APA.
(4) Discussion and Agreement
This phase differs for bilateral and unilateral cases. In a bilateral case, the discussions proceed in
two parts and involve two IRS offices -- the APA Program and the U.S. Competent Authority.
In the first part, the APA team will attempt to reach a consensus with the taxpayer regarding the
recommended position that the U.S. Competent Authority should take in negotiations with its
treaty partner. This recommended U.S. negotiating position is a paper drafted by the APA team
leader and signed by the APA Director that provides the APA Program’s view of the best TPM
for the covered transaction, taking into account IRC § 482 and the regulations thereunder, the
relevant tax treaty, and the U.S. Competent Authority’s experience with the treaty partner.
The experience of the APA office and the U.S. Competent Authority is that APA negotiations
are likely to proceed more rapidly with a foreign competent authority if the U.S. negotiating
position is fully supported by the taxpayer. Consequently, the APA Office works together with
the taxpayer in developing the recommended U.S. negotiating position. On occasion, the APA
team will agree to disagree with a taxpayer. In these cases, the APA office will send a
recommended U.S. negotiating position to the U.S. Competent Authority that includes elements
with which the taxpayer does not agree. This disagreement is noted in the paper. The APA team
5
leader also solicits the views of the field members of the APA team, and, in the vast majority of
APA cases, the international examiner, LMSB field counsel, and other IRS field team members
concur in the position prepared by the APA team leader.
Once the APA Program completes the recommended U.S. negotiating position, the APA process
shifts from the APA Program to the U.S. Competent Authority. The U.S. Competent Authority
analyst assigned to the APA takes the recommended U.S. negotiating position and prepares the
final U.S. negotiating position, which is then transmitted to the foreign competent authority. The
negotiations with the foreign competent authority are conducted by the U.S. Competent
Authority analyst, most often in face-to-face negotiating sessions conducted periodically
throughout the year. At the request of the U.S. Competent Authority analyst, the APA team
leader may continue to assist the negotiations.
In unilateral APA cases, the discussions proceed solely between the APA Program and the
taxpayer. In a unilateral case, the taxpayer and the APA Program must reach agreement to
conclude an APA. Like the bilateral cases, the APA team leader almost always will achieve a
consensus with the IRS field personnel assigned to the APA team regarding the final APA. The
APA Program has a procedure in which the IRS field personnel are solicited formally for their
concurrence in the final APA. This concurrence, or any items in disagreement, is noted in a
cover memorandum prepared by the APA team leader that accompanies the final APA sent
forward for review and execution.
(5) Drafting, Review, and Execution
Once the IRS and the taxpayer reach agreement, the drafting of the final APA generally takes
little time because the APA Program has developed standard language that is incorporated into
every APA. The current version of this language is found in Attachment A. APAs are reviewed
by the Branch Chief and the APA Director. In addition, the team leader prepares a summary
memorandum for the Associate Chief Counsel (International) (ACC(I)). On March 1, 2001, the
ACC(I) delegated to the APA Director the authority to execute APAs on behalf of the IRS. See
Chief Counsel Notice CC-2001-016. The APA is executed for the taxpayer by an appropriate
corporate officer.
Model APA at Attachment A
[§ 521(b)(2)(B)]
Attachment A contains the current version of the model APA language. As part of its continuing
effort to improve its work product, the APA Program has revised the model language to reflect
the program’s collective experience with substantive and drafting issues.
6
The Current APA Office Structure, Composition, and Operation
In 2003, the APA Office consisted of four branches with Branches 1 and 3 staffed with APA
team leaders and Branch 2 staffed with economists and a paralegal. Branch 4, the APA West
Coast branch, is headquartered in Laguna Niguel, California, with an additional office in San
Francisco, and is presently staffed with both team leaders and an economist.
Overall, the APA staff increased from 34 to 36. The APA Program hired a new APA Director
and a new team leader. In addition, one team leader transferred to the APA Office from another
Chief Counsel function, and one team leader transferred from the APA Office to another Chief
Counsel function. The number of APA team leaders increased from 17 to 18, while the number
of economists remained constant at 7.
As of December 31, 2003, the APA staff was as follows:
Director’s Office
1 Director
1 Special Counsel to the Director
1 Secretary to the Director
Branch 1
1 Branch Chief
1 Secretary
8 Team Leaders
Branch 2
1 Branch Chief
1 Paralegal
6 Economists
Branch 3
1 Branch Chief
1 Secretary
8 Team Leaders
Branch 4
1 Branch Chief
1 Secretary
2 Team Leaders
1 Economist
APA Training
In 2003, the APA Office continued to emphasize training as a high priority. Training sessions
regarded APA-related current developments, new APA office practices and procedures, and
international tax law issues. The APA New Hire Training materials were updated, as necessary,
throughout the year. The updated materials are available to the public through the APA internet
site on the IRS Digital Daily (www.irs.gov). These materials do not constitute guidance on the
application of the arm’s length standard.
7
APA Program Statistical Data
[§ 521(b)(2)(C) and (E)]
The statistical information required under § 521(b)(2)(C) is contained in Tables 1 and 9 below;
the information required under § 521(b)(2)(E) is contained in Tables 2 and 3 below:
Table 1: APA Applications, Executed APAs, and Pending APAs
1
Unilateral Bilateral Multilateral
Year
Total
Cumulative
Total
APA applications filed during
year 2003
44 46 90 766
APAs executed
• Year 2003
21 37 58 492
• 1991–2002
206 221 7 434
APA renewals executed
during year 2003
8 9 17 108
Revised or Amended APAs
executed during year 2003
3 1 4 25
Pending requests for APAs 67 162 229
• Pending requests for
new APAs
46 109 155
• Pending requests for
renewal APAs
21 53 74
APAs canceled or revoked 0 0 0 5
APAs withdrawn 2 1 3 83
1
In 2003:
• The APA Office and taxpayers agreed to amend four APAs (three unilateral and one bilateral). In one of
these, the taxpayer reorganized its business. In three, the changes reflected technical corrections or
modifications to minor aspects of the APA.
• Reasons for withdrawals included settling principal issues through other venues, jurisdictional issues,
taxpayer reorganizations, and changes in facts and circumstances.
8
TABLE 2: MONTHS TO COMPLETE APAS
2
Months to Complete Advance Pricing Agreements in Year 2003
Combined Unilateral, Bilateral, Multilateral: Average 33.7
Combined Unilateral, Bilateral, Multilateral: Median 32.0
Unilateral New Unilateral Renewal Unilateral Combined
Average 22.3 Average 16.2 Average 20.0
Median 8.5 Median 9.8 Median 9.2
Bilateral/Multilateral
New
Bilateral/Multilateral
Renewal
Bilateral/Multilateral
Combined
Average 41.2 Average 42.3 Average 41.5
Median 35.4 Median 50.2 Median 39.4
2
The average time required to conclude a bilateral APA has historically been split roughly equally between the APA
and U.S. Competent Authority Offices.
9
TABLE 3: APA COMPLETION TIME – MONTHS PER APA
Months
Number
of APAs
Months
Number
of APAs
Months
Number
of APAs
Months
Number
of APAs
1
0
26
0
51
3
76
0
2
0
27
1
52
2
77
0
3
0
28
1
53
1
78
1
4
0
29
0
54
0
79
0
5
1
30
1
55
2
80
0
6
2
31
3
56
0
81
0
7
5
32
0
57
0
82
0
8
1
33
1
58
0
83
0
9
2
34
3
59
1
84
0
10
4
35
1
60
1
85
0
11
0
36
1
61
0
86
0
12
0
37
1
62
0
87
0
13
1
38
0
63
0
88
0
14
0
39
1
64
1
89
0
15
1
40
2
65
0
90
0
16
1
41
0
66
0
91
0
17
0
42
1
67
0
92
1
18
1
43
0
68
0
93
0
19
1
44
0
69
0
94
1
20
0
45
1
70
0
95
0
21
1
46
0
71
0
96
0
22
1
47
1
72
0
97
0
23
0
48
0
73
0
98
1
24
0
49
0
74
0
99
0
25
1
50
1
75
0
100
0
TABLE 4: RECOMMENDED NEGOTIATING POSITIONS
Recommended Negotiating Positions Completed in Year 2003 19
TABLE 5: MONTHS TO COMPLETE RECOMMENDED NEGOTIATING POSITIONS
New Renewal Combined
Average 14.5 Average 15.3 Average 15.3
Median 15.2 Median 13.1 Median 15.2
10
TABLE 6: RECOMMENDED NEGOTIATING POSITIONS COMPLETION TIME –
MONTHS PER APA
Months Number Months Number Months Number Months Number
1
0
11
1
21
0
31
0
2
0
12
0
22
1
32
0
3
0
13
2
23
0
33
0
4
0
14
1
24
2
34
0
5
1
15
3
25
0
35
0
6
2
16
0
26
1
36
0
7
1
17
1
27
1
37
0
8
0
18
0
28
0
38
0
9
1
19
1
29
0
39
0
10
0
20
0
30
0
40
0
T
ABLE 7: SMALL BUSINESS TAXPAYER APAS
3
Small Business Taxpayer APAs Completed in Year 2003
12
Renewals
8
New
4
Unilateral
8
Bilateral
4
TABLE 8: MONTHS TO COMPLETE SMALL BUSINESS TAXPAYER APAS
Months to Complete Small Business Taxpayer APAs in Year 2003
New Renewal Combined
Average 12.5 Average 13.8 Average 13.0
Median 11.5 Median 11.9 Median 11.5
3
Small Business Taxpayer APAs are processed under the special procedures set forth in Notice 98-65.
11
TABLE 9: INDUSTRIES COVERED
4
Industry Involved - NAICS Codes Number
Electronic equipment, appliance and component manufacturing - 335 7-9
Wholesale trade, nondurable goods - 422 4-6
Chemical manufacturing - 325 4-6
Wholesale trade, durable goods - 421 4-6
Credit intermediation and related activities - 522 4-6
Computer and electronic product manufacturing - 334 4-6
Machinery manufacturing - 333 1-3
Broadcasting and telecommunications - 513 1-3
Information service and data processing services - 514 1-3
Securities, commodity contracts and other intermediary and related activities - 523 1-3
Oil and gas extraction - 212 1-3
Motor vehicle and parts dealers - 441 1-3
Food manufacturing - 311 1-3
Apparel manufacturing - 315 1-3
Beverage and tobacco manufacturing - 312 1-3
Fabricated metal manufacturing - 332 1-3
Transportation equipment manufacturing - 336 1-3
Miscellaneous manufacturing - 339 1-3
Sporting goods, hobby, book and music stores - 451 1-3
Air transportation - 481 1-3
Accommodation - 721 1-3
Food services and drinking places - 722 1-3
Trades or Businesses
[§ 521(b)(2)(D)(i)]
The nature of the relationships between the related organizations, trades, or businesses covered
by APAs executed in 2003 is set forth in Table 10 below:
TABLE 10: NATURE OF RELATIONSHIPS BETWEEN RELATED ENTITIES
Relationship Number of APAs
Foreign Parent - U.S. Subsidiary (-ies) 31
U.S. Parent - Foreign Subsidiary (-ies) 23
Foreign Company and U.S. branch(es) 4
4
The categories in this table are drawn from the North American Industry Classification System (NAICS), which
has replaced the U.S. Standard Industrial Classification (SIC) system. NAICS was developed jointly by the U.S.,
Canada, and Mexico to provide new comparability in statistics about business activity across North America.
12
Covered Transactions
[§ 521(b)(2)(D)(ii)]
The controlled transactions covered by APAs executed in 2003 are set forth in Table 11 and
Table 12 below:
TABLE 11: TYPES OF COVERED TRANSACTIONS
Transaction Type Number
Sale of tangible property into the U.S. 23
Performance of services by Non-U.S. entity 16
Performance of services by U.S. entity 12
Sale of tangible property from the U.S. 9
Use of intangible property by U.S. entity 7
Use of intangible property by Non-U.S. entity 6
Financial products - Non-U.S. parent 2
Financial products - U.S. branch of foreign company 2
Other 11
TABLE 12: TYPES OF SERVICES INCLUDED IN COVERED TRANSACTIONS
Intercompany Services Involved in the Covered Transactions Number
Administrative 10
Accounting 9
Marketing 9
Distribution 9
Manufacturing services 8
Management 7
Research and development 7
Legal 6
Technical support services 6
Product support 5
Logistical support 5
Headquarters costs 4
Communication service 3
Contract research & development 3
Billing services 3
Purchasing 3
License administration services 2
Assembly 2
13
Business Functions Performed and Risks Assumed
[§ 521(b)(2)(D)(ii)]
The general descriptions of the business functions performed and risks assumed by the
organizations, trades, or businesses whose results are tested in the covered transactions in the
APAs executed in 2003 are set forth in Tables 13 and 14 below:
T
ABLE 13: FUNCTIONS PERFORMED BY THE TESTED PARTY
Functions Performed Number
Manufacturing 33
Distribution functions 28
Marketing functions 23
Transportation and warehousing 12
Managerial, legal, accounting, finance, personnel, and other support services 11
Research and development 10
Product assembly and/or packaging 9
Trading and risk management of financial products 7
Purchasing and materials management 7
Product design and engineering 6
Licensing of intangibles 6
Technical training and tech support for sales staff (including sub-distributors) 5
Product testing and quality control 4
Process engineering 3
Telecom services 2
TABLE 14: RISKS ASSUMED BY THE TESTED PARTY
Risks Assumed
Number
General business risks (e.g., related to ownership of PP&E) 57
Market risks, including fluctuations in costs, demand, pricing, & inventory 52
Credit and collection risks 37
Financial risks, including interest rates & currency 31
Product liability risks 22
R&D risks 21
14
Discussion
The vast majority of APAs have covered transactions that involve numerous business functions
and risks. For instance, with respect to functions, companies that manufacture products have
typically conducted research and development, engaged in product design and engineering,
manufactured the product, marketed and distributed the product, and performed support
functions such as legal, finance, and human resources services. Regarding risks, companies have
been subject to market risks, R&D risks, financial risks, credit and collection risks, product
liability risks, and general business risks. In the APA evaluation process a significant amount of
time and effort is devoted to understanding how the functions and risks are allocated amongst the
controlled group of companies that are party to the covered transactions.
In its APA submission, the taxpayer must provide a functional analysis. The functional analysis
identifies the economic activities performed, the assets employed, the economic costs incurred,
and the risks assumed by each of the controlled parties. The importance of the functional analysis
derives from the fact that economic theory posits that there is a positive relationship between risk
and expected return and that different functions provide different value and have different
opportunity costs associated with them. It is important that the functional analysis go beyond
simply categorizing the tested party as, say, a distributor. It should provide more specific
information since, in the example of distributors, not all distributors undertake similar functions
and risks.
Thus, the functional analysis is critical in determining the TPM (including the selection of
comparables). Although functional comparability is an essential factor in evaluating the
reliability of the TPM (including the selection of comparables), the APA evaluation process also
involves consideration of economic conditions such as the economic condition of the particular
industry.
In evaluating the functional analysis, the APA program considers contractual terms between the
controlled parties and the consistency of the conduct of the parties with respect to the allocation
of risk. In accord with the section 482 regulations, the APA program also gives consideration to
the ability of controlled parties to fund losses that might be expected to occur as the result of the
assumption of risk. Another relevant factor considered in evaluating the functional analysis is the
extent to which each controlled party exercises managerial or operational control over the
business activities that directly influence the amount of income or loss realized. The section 482
regulations posit that parties at arm's length will ordinarily bear a greater share of those risks
over which they have relatively more control.
Related Organizations, Trades, or Businesses Whose Prices or Results are
Tested to Determine Compliance with APA Transfer Pricing Methods
[§ 521(b)(2)(D)(iii)]
The related organizations, trades, or businesses whose prices or results are tested to determine
compliance with TPMs prescribed in APAs executed in 2003 are set forth in Table 15 below:
15
TABLE 15: RELATED ORGANIZATIONS, TRADES, OR BUSINESSES WHOSE PRICES
OR RESULTS ARE TESTED
5
Type of Organization Number
U.S. distributor 20
Multiple tested parties 16
U.S. provider of services 11
Non-U.S. provider of services 9
Non-U.S. manufacturer 8
U.S. manufacturer 7
U.S. licensor of intangible property 4
Non-U.S. distributor 4
U.S. dealer in financial products 3
Non-U.S. dealer in financial products 2
Other 4
Transfer Pricing Methods and the Circumstances Leading to the Use of Those
Methods
[§ 521(b)(2)(D)(iv)]
The TPMs used in APAs executed in 2003 are set forth in Tables 16–20 below:
5
“Multiple tested parties” includes covered transactions that utilize profit splits, CUPs, and CUTs.
16
TABLE 16: TRANSFER PRICING METHODS USED FOR TRANSFERS OF TANGIBLE
AND
INTANGIBLE PROPERTY
6
TPM Used Number
CPM: PLI is operating margin 9
CPM: PLI is markup on total costs 7
Unspecified method 6
CUT (intangibles only) 4
CPM: PLI is gross margin 3
CPM: PLI is return on assets or capital employed 3
CPM: PLI is Berry ratio 3
CPM: PLI is other PLI 3
Resale Price Method (tangibles only) 3
Other profit split 3
Residual profit split 2
CUP (tangibles only) - not based on published market data 2
Cost Plus Method (tangibles only) 2
Other 2
TABLE 17: TRANSFER PRICING METHODS USED FOR SERVICES
TPM Used Number
Cost plus a markup 12
CPM: PLI is markup on total costs 7
Cost with no markup 5
CPM: PLI is Berry ratio 3
Other 3
TABLE 18: TRANSFER PRICING METHODS USED FOR FINANCIAL PRODUCTS
TPM used Number
Interbranch allocation (using indirect evidence of CUPs) 3
Profit split 2
6
Profit Level Indicators (“PLIs”) used with the Comparable Profit Method of Treas. Reg. § 1.482-5, and as used in
these TPM tables, are as follows: (1) operating margin (ratio of operating profit to sales); (2) markup on total costs
(comparative markup on total costs); (3) gross margin (ratio of gross profit to sales); (4) rate of return on assets or
capital employed (ratio of operating profit to operating assets); and (5) Berry ratio (gross profit to operating
expenses).
17
Discussion
The TPMs used in APAs completed during 2003 were based on the section 482 regulations.
Under Treas. Reg. § 1.482-3, the arm’s length amount for controlled transfers of tangible
property may be determined using the Comparable Uncontrolled Price (CUP) method, the Resale
Price Method, the Cost Plus Method, the Comparable Profits Method (CPM), or the Profit Split
method. Under Treas. Reg. § 1.482-4, the arm’s length amount for controlled transfers of
intangible property may be determined using the Comparable Uncontrolled Transaction (CUT)
method, CPM, or the Profit Split Method. An “Unspecified Method” may be used for both
tangible and intangible property if it provides a more reliable result than the enumerated methods
under the best method rule of Treas. Reg. § 1.482-1(c). For transfers involving the provision of
services, Treas. Reg. § 1.482-2(b) provides that services performed for the benefit of another
member of a controlled group should bear an arm’s length charge, either deemed to be equal to
the cost of providing the services (when non-integral, see Treas. Reg. § 1.482-2(b)(3)) or which
should be an amount that would have been charged between independent parties.
In addition, Treas. Reg. § 1.482-2(a) provides rules concerning the proper treatment of loans or
advances, and Treas. Reg. § 1.482-7 provides rules for qualified cost sharing arrangements under
which the parties agree to share the costs of development of intangibles in proportion to their
shares of reasonably anticipated benefits. APAs involving cost sharing arrangements generally
address both the method of allocating costs among the parties as well as determining the
appropriate amount of the “buy-in” payment due for the transfer of intangibles to the controlled
participants.
In reviewing the TPMs applicable to transfers of tangible and intangible property reflected in
Table 16, the majority of the APAs followed the specified methods. However, there are several
distinguishing points that should be made. The Regulations note that for transfers of tangible
property, the Comparable Uncontrolled Price (CUP) method will generally be the most direct
and reliable measure of an arm’s length price for the controlled transaction if sufficiently reliable
comparable transactions can be identified. Treas. Reg. § 1.482-3(b)(2)(ii)(A). It was the
experience of the APA Program in 2003 that in the cases that came into the APA Program,
sufficiently reliable CUP transactions were difficult to find. In APAs executed in 2003, there
were two covered transactions that used the CUP method; both used internal data on transactions
between the taxpayer and unrelated parties.
Similar to the CUP method, for transfers of intangible property, the CUT method will generally
provide the most reliable measure of an arm’s length result if sufficiently reliable comparables
may be found. Treas. Reg. § 1.482-4(c)(2)(ii). It has generally been difficult to identify external
comparables, and APAs using the CUT method tend to rely on internal transactions between the
taxpayer and unrelated parties. In 2003, there were four covered transactions that utilized the
CUT TPM.
The Cost Plus Method (tangibles only) and Resale Price Method were applied in 2003 in two and
three APAs respectively. See Treas. Reg. § 1.482-3(c), (d).
18
The CPM is frequently applied in APAs. This is because reliable public data on comparable
business activities of independent companies may be more readily available than potential CUP
data, and comparability of resources employed, functions, risks, and other relevant
considerations is more likely to exist than comparability of product. The CPM also tends to be
less sensitive than other methods to differences in accounting practices between the tested party
and comparable companies, e.g., classification of expenses as cost of goods sold or operating
expenses. Treas. Reg. § 1.482-3(c)(3)(iii)(B), and -3(d)(3)(iii)(B). In addition, the degree of
functional comparability required to obtain a reliable result under the CPM is generally less than
required under the Resale Price or Cost Plus methods, because differences in functions
performed often are reflected in operating expenses, and thus taxpayers performing different
functions may have very different gross profit margins but earn similar levels of operating profit.
Treas. Reg. § 1.482-5(c)(2).
Table 16 reflects 28 uses of the CPM (with varying PLIs) in covered transactions involving
tangible or intangible property. The CPM was also used in some APAs concurrently with other
methods.
The CPM has proven to be versatile in part because of the various PLIs that can be used in
connection with the method. Reaching agreement on the appropriate PLI has been the subject of
much discussion in many of the cases, and it depends heavily on the facts and circumstances.
Some APAs have called for different PLIs to apply to different parts of the covered transactions
or with one PLI used as a check against the primary PLI.
The CPM also was used regularly with services as the covered transactions in APAs executed in
2003. There were a total of 10 services covered transactions using the CPM method with various
PLIs according to the specific facts of the taxpayers involved. Table 17 reflects the methods
used to determine the arm’s length results for APAs involving services transactions.
In 2003, there were two APAs involving tangible or intangible property that used the residual
profit split, Treas. Reg. § 1.482-6(c)(3). In residual profit split cases, routine contributions by
the controlled parties are allocated routine market returns, and the residual income is allocated
among the controlled taxpayers based upon the relative value of their contributions of intangible
property to the relevant business activity.
Profit splits have also been used in a number of financial product APAs in which the primary
income-producing functions are performed in more than one jurisdiction. Two APAs executed
in 2003 applied such a profit split.
There were three financial product APAs involving interbranch allocations. These involve a
single taxpayer with branches that act autonomously with respect to the covered transactions,
generally involving foreign currency exchanges. These particular APAs determine the
appropriate amount of profits attributable to each branch from the activity by reference to the
branches’ internal accounting methods. The results take into account all trades, and test the arms
length results using statistical tests to verify that controlled trades are priced the same as
uncontrolled trades.
19
Critical Assumptions
[§ 521(b)(2)(D)(v)]
Critical Assumptions used in APAs executed in 2003 are described in Table 19 below:
TABLE 19: CRITICAL ASSUMPTIONS
Critical Assumptions involving the following: Number of APAs
Material changes to the business 57
Material changes to tax and/or financial accounting practices 57
Assets will remain substantially same 16
Catastrophic events 9
No discounts or rebates 6
Use of Mark-to-Market method 4
Other financial ratio 3
Major regulatory changes 2
Changes in affiliated companies 2
Variation in budgeted v. actual expenses 2
Changes in market shares 2
Ratio of R&D to sales 2
Material sales fluctuations 2
Other 13
Discussion
APAs include critical assumptions upon which their respective TPMs depend. A critical
assumption is any fact (whether or not within the control of the taxpayer) related to the taxpayer,
a third party, an industry, or business and economic conditions, the continued existence of which
is material to the taxpayer's proposed TPM. Critical assumptions might include, for example, a
particular mode of conducting business operations, a particular corporate or business structure, or
a range of expected business volume. Rev. Proc. 96-53, § 5.07. Failure to meet a critical
assumption may render an APA inappropriate or unworkable.
A critical assumption may change (and/or fail to materialize) due to uncontrollable changes in
economic circumstances, such as a fundamental and dramatic change in the economic conditions
of a particular industry. In addition, a critical assumption may change (and/or fail to materialize)
due to a taxpayer's actions that are initiated for good faith business reasons, such as a change in
business strategy, mode of conducting operations, or the cessation or transfer of a business
segment or entity covered by the APA.
If a critical assumption has not been met, the APA may be revised by agreement of the parties.
If such agreement cannot be achieved, the APA may be canceled. If a critical assumption has
not been met, it requires taxpayer's notice to and discussion with the Service, and, in the case of a
bilateral APA, competent authority consideration. Rev. Proc. 96-53, § 11.07.
20
Sources of Comparables, Selection Criteria, and the Nature of Adjustments to
Comparables and Tested Parties
[§ 521(b)(2)(D)(v), (vi), and (vii)]
The sources of comparables, selection criteria, and rationale used in determining the selection
criteria for APAs executed in 2003 are described in Tables 20 through 22 below. Various
formulas for making adjustments to comparables are included as Attachment B.
T
ABLE 20: SOURCES OF COMPARABLES
Comparable Sources
Number of Times This
Source Used
Compustat 44
Disclosure 14
Moody's 5
Japan Company Handbook 4
Worldscope 4
Dun & Bradstreet 3
Other 8
TABLE 21: COMPARABLE SELECTION CRITERIA
Selection Criteria Considered
Number of Times This
Criterion Used
Comparable functions 57
Comparable risks 43
Comparable industry 38
Comparable products 25
Comparable intangibles 21
Comparable terms 4
21
TABLE 22: ADJUSTMENTS TO COMPARABLES OR TESTED PARTIES
Adjustment Number of Times Used
Balance sheet adjustments
Inventory 35
Payables 33
Receivables 33
Property, plant, equipment 10
Accounting adjustments
LIFO to FIFO inventory accounting 11
Accounting reclassifications (e.g., from COGS to operating
expenses)
9
Other 1
Profit level indicator adjustments (used to "back into" one
PLI from another)
Operating expense 2
Other 5
Miscellaneous adjustments
Foreign exchange 3
Goodwill value or amortization 2
Other 4
Discussion
At the core of most APAs are comparables. The APA program works closely with taxpayers to
find the best and most reliable comparables for each covered transaction. In some cases, CUPs
or CUTs can be identified. In other cases, comparable business activities of independent
companies are utilized in applying the CPM or residual profit split methods. Generally, in the
APA Program's experience since 1991, CUPs and CUTs have been most often derived from the
internal transactions of the taxpayer.
For profit-based methods in which comparable business activities or functions of independent
companies are sought, the APA Program typically has applied a three-part process. First, a pool
of potential comparables has been identified through broad searches. From this pool, companies
having transactions that are clearly not comparable to those of the tested party have been
eliminated through the use of quantitative and qualitative analyses, i.e., quantitative screens and
business descriptions. Then, based on a review of available descriptive and financial data, a set
of comparable transactions or business activities of independent companies has been finalized.
The comparability of the finalized set has then been enhanced through the application of
adjustments.
22
Sources of Comparables
Comparables used in APAs can be U.S. or foreign. This depends on the relevant market, the
type of transaction being evaluated, and the results of the functional and risk analyses. In
general, comparables have been located by searching a variety of databases that provide data on
U.S. publicly traded companies and on a combination of public and private non-U.S. companies.
Table 20 shows the various databases and other sources used in selecting comparables for the
APAs executed in 2003.
Although comparables were most often identified from the databases cited in Table 20, in some
cases comparables were found from other sources, such as comparables derived internally from
taxpayer transactions with third parties.
Selecting Comparables
Initial pools of potential comparables generally are derived from the databases using a
combination of industry and keyword identifiers. Then, the pool is refined using a variety of
selection criteria specific to the transaction or business activity being tested and the TPM being
used.
The listed databases allow for searches by industrial classification, by keywords, or by both.
These searches can yield a number of companies whose business activities may or may not be
comparable to those of the entity being tested. Therefore, comparables based solely on industry
classification or keyword searches are rarely used in APAs. Instead, the pool of comparables is
examined closely, and companies are selected based on a combination of screens, business
descriptions, and other information found in the companies’ Annual Reports to shareholders and
filings with the U.S. Securities and Exchange Commission (SEC).
Business activities are required to meet certain basic comparability criteria to be considered
comparables. Functions, risks, economic conditions, and the property (product or intangible) and
services associated with the transaction must be comparable. Determining comparability can be
difficult – the goal has been to use comparability criteria restrictive enough to eliminate business
activities that are not comparable, but yet not so restrictive as to have no comparables remaining.
The APA Program normally has begun with relatively strict comparability criteria and then has
relaxed them slightly if necessary to derive a pool of reliable comparables. A determination on
the appropriate size of the comparables set, as well as the business activities that comprise the
set, is highly fact specific and depends on the reliability of the results.
In addition, the APA Program, consistent with the section 482 regulations, generally has looked
at the results of comparables over a multi-year period. Sometimes this has been a three-year
period, but it has been more or less, depending on the circumstances of the controlled
transaction. Using a shorter period might result in the inclusion of comparables in different
stages of economic development or use of atypical years of a comparable due to cyclical
fluctuations in business conditions.
23
Many covered transactions have been tested with comparables that have been chosen using
additional criteria and/or screens. These include sales level criteria and tests for financial distress
and product comparability. These common selection criteria and screens have been used to
increase the overall comparability of a group of companies and as a basis for further research.
The sales level screen, for example, has been used to remove companies that, due to their size,
might face fundamentally different economic conditions from those of the transaction or business
activities being tested. In addition, APA analyses have incorporated selection criteria related to
removing companies experiencing "financial distress" due to concerns that companies in
financial distress often have experienced unusual circumstances that render them not comparable
to the business activity being tested. These criteria include: an unfavorable auditor's opinion,
bankruptcy, and, in certain circumstances, operating losses in a given number of years.
An additional important class of selection criteria is the development and ownership of
intangible property. In some cases in which the business activity being tested is a manufacturer,
several criteria have been used to ensure, for example, that if the controlled entity does not own
significant manufacturing intangibles or conduct research and development (R&D), then neither
will the comparables. These selection criteria have included determining the importance of
patents to a company or screening for R&D expenditures as a percentage of sales. Again,
quantitative screens related to identifying comparables with significant intangible property
generally have been used in conjunction with an understanding of the comparable derived from
publicly available business information.
Selection criteria relating to asset comparability and operating expense comparability have also
been used at times. A screen of property, plant, and equipment (PP&E) as a percentage of sales
or assets, combined with a reading of a company's SEC filings, has been used to help ensure that
distributors (generally lower PP&E) were not compared with manufacturers (generally higher
PP&E), regardless of their industry classification. Similarly, a test involving the ratio of
operating expenses to sales has helped to determine whether a company undertakes a significant
marketing and distribution function.
Table 23 shows the number of times various screens were used in APAs executed in 2003:
24
TABLE 23: COMPARABILITY SCREENS
Comparability/Financial Distress Screen Times Used
Comparability screens used
Sales 15
R&D/ sales 11
Foreign sales/ total sales 5
Operating expenses/ sales 2
SG&A/ sales 4
Non-startup or start-up 2
Financial distress
Bankruptcy 16
Unfavorable auditor's opinion 13
Losses in one or more years 9
Adjusting Comparables
After the comparables have been selected, the regulations require that "[i]f there are material
differences between the controlled and uncontrolled transactions, adjustments must be made if
the effect of such differences on prices or profits can be ascertained with sufficient accuracy to
improve the reliability of the results." Treas. Reg. § 1.482-1(d)(2). In almost all cases involving
income-statement-based PLIs, certain "asset intensity" or "balance sheet" adjustments for factors
that have generally agreed-upon effects on profits are calculated. In addition, in specific cases,
additional adjustments are performed to improve reliability.
The most common balance sheet adjustments used in APAs are adjustments for differences in
accounts receivable, inventories, and accounts payable. The APA Program generally has
required adjustments for receivables, inventory, and payables based on the principle that there is
an opportunity cost for holding assets. For these assets it is generally assumed that the cost is a
short-term debt interest rate.
To compare the profits of two business activities with different relative levels of receivables,
inventory, or payables, the APA Program estimates the carrying costs of each item and adjusts
profits accordingly. Although different formulas have been used in specific APA cases,
Attachment B presents one set of formulas used in many APAs. Underlying these formulas are
the notions that (1) balance sheet items should be expressed as mid-year averages, (2) formulas
should try to avoid using data items that are being tested by the TPM (for example, if sales are
controlled, then the denominator of the balance sheet ratio should not be sales), (3) a short-term
interest rate should be used, and (4) an interest factor should recognize the average holding
period of the relevant asset.
The APA Program also requires that data be compared on a consistent accounting basis. For
example, although financial statements may be prepared on a first-in first-out (FIFO) basis,
cross-company comparisons are less meaningful if one or more of the comparables use LIFO
25
inventory accounting methods. This adjustment directly affects costs of goods sold and
inventories, and therefore affects both profitability measures and inventory adjustments.
Still important in some cases is the adjustment for differences in relative levels of PP&E between
a tested business activity and the comparables. Ideally, comparables and the business activity
being tested will have fairly similar relative levels of PP&E, since major differences can be a
sign of fundamentally different functions and risks. Typically, the PP&E adjustment is made
using a medium term interest rate.
Additional adjustments used less frequently include those for differences in other balance sheet
items, operating expenses, R&D, or currency risk. Accounting adjustments, such as
reclassifying items from cost of goods sold to operating expenses, for example, are also made
when warranted to increase reliability. Often, data is not available for both the controlled and
uncontrolled transactions in sufficient detail to allow for these types of adjustments.
The adjustments made to comparables or tested parties in APAs executed in 2003 are reflected in
Table 22 above.
Nature of Ranges and Adjustment Mechanisms
[§ 521(b)(2)(D)(viii)–(ix)]
The types of ranges and adjustment mechanisms used in APAs executed in 2003 are described in
Table 24 and 25 below.
TABLE 24: TYPES OF RANGES
7
Type of Range Number
Interquartile range 31
Specific point (royalty) 8
Floor (i.e., result must be no less than x) 6
Specific point within CPM range (not floor or ceiling) 3
Financial products - statistical confidence interval to test against internal CUPs 2
Ceiling (i.e., result must be no more than x) 2
Other 7
7
Numbers do not include TPMs with cost or cost-plus methodologies.
26
TABLE 25: ADJUSTMENTS WHEN OUTSIDE OF THE RANGE
Adjustment mechanism Number
Taxpayer makes an adjustment: to closest edge of single year 15
Taxpayer makes an adjustment: to specified point 11
Taxpayer makes an adjustment: to closest edge of multi-year average 9
Taxpayer makes an adjustment: to median of current year 7
Taxpayer makes an adjustment: to other 6
Taxpayer makes an adjustment: to median of multi-year average 3
Other 3
Discussion
Treas. Reg. § 1.482-1(e)(1) states that sometimes a pricing method will yield "a single result that
is the most reliable measure of an arm's length result." Sometimes, however, a method may yield
"a range of reliable results," called the "arm's length range." A taxpayer whose results fall within
the arm's length range will not be subject to adjustment.
Under Treas. Reg. § 1.482-1(e)(2)(i), such a range is normally derived by considering a set of
more than one comparable uncontrolled transaction of similar comparability and reliability. If
these comparables are of very high quality, as defined in the Regulations, then under Treas. Reg.
§ 1.482-1(e)(2)(iii)(A), the arm's length range includes the results of all of the comparables (from
the least to the greatest). However, the APA Program has only rarely identified cases meeting
the requirements for the full range. If the comparables are of lesser quality, then under Treas.
Reg. § 1.482-1(e)(2)(iii)(B), "the reliability of the analysis must be increased, when it is possible
to do so, by adjusting the range through application of a valid statistical method to the results of
all of the uncontrolled comparables." One such method, the "interquartile range," is ordinarily
acceptable, although a different statistical method "may be applied if it provides a more reliable
measure." The "interquartile range" is defined as, roughly, the range from the 25th to the 75th
percentile of the comparables' results. See Treas. Reg. § 1.482-1(e)(2)(iii)(C). The interquartile
range was used 31 times in 2003.
Nineteen covered transactions reflected on Table 24 specified a single, specific result, or "point."
Three of these covered transactions involved a CPM in which the taxpayer agreed to a specific
result. Some APAs specify not a point or a range, but a "floor" or a "ceiling". When a floor is
used, the tested party's result must be greater than or equal to some particular value. When a
ceiling is used, the tested party's result must be less than or equal to some particular value. Six
APAs executed in 2003 used a floor and two used a ceiling.
Some APAs look to a tested party’s results over a period of years (multi-year averaging) to
determine whether a taxpayer has complied with the APA. In 2003, rolling multi-year averaging
was used for 10 covered transactions. Seven of those used three-year averages, one used a four-
year average, and the other two used five-year averages. Cumulative multi-year averages were
used for three covered transactions. Additionally, six covered transactions used term averages,
and one covered transaction used a partial term average.
27
Adjustments
Under Treas. Reg. § 1.482-1(e)(3), if a taxpayer's results fall outside the arm's length range, the
Service may adjust the result "to any point within the arm's length range." Accordingly, an APA
may permit or require a taxpayer and its related parties to make an adjustment after the year's end
to put the year's results within the range, or at the point specified by the APA. Similarly, to
enforce the terms of an APA, the Service may make such an adjustment. When the APA
specifies a range, the adjustment is sometimes to the closest edge of the range, and sometimes to
another point such as the median of the interquartile range. Depending on the facts of each case,
such automatic adjustments are not always permitted. APAs may specify that in such a case
there will be a negotiation between the competent authorities involved to determine whether and
to what extent an adjustment should be made. APAs may permit automatic adjustments unless
the result is far outside the range specified in the APA. Thus APAs provide flexibility and
efficiency, permitting adjustments when normal business fluctuations and uncertainties push the
result somewhat outside the range.
In order to conform the taxpayer's books to these tax adjustments, the APA usually permits a
"compensating adjustment" as long as certain requirements are met. Such compensating
adjustments may be paid between the related parties with no interest, and the amount transferred
will not be considered for purposes of penalties for failure to pay estimated tax. See § 11.02
Rev. Proc. 96-53.
APA Term and Rollback Lengths
[§ 521(b)(2)(D)(x)]
The various term lengths for APAs executed in 2003 are set forth in Table 26 below:
28
TABLE 26: TERMS OF APAS
APA Term in Years Number of APAs
1 1
2 0
3 3
4 11
5 29
6 5
7 5
8 3
9 0
10 0
11 1
Number of rollback years to which an APA TPM was applied in 2003 is set forth in Table 27
below:
TABLE 27: NUMBER OF YEARS COVERED BY ROLLBACK OF APA TPM
Number of Rollback Years Number of APAs
1 3
2 1
3 3
4 2
5 or more 4
Nature of Documentation Required
[§ 521(b)(2)(D)(xi)]
APAs executed in 2003 required that taxpayers provide various documents with their annual
reports. These documents are described in Table 28 below:
29
TABLE 28: NATURE OF DOCUMENTATION REQUIRED
8
Documentation
Number of
Times
Required
Statement identifying all material differences between Taxpayer's business
operations during APA Year and description of Taxpayer's business operations
contained in Taxpayer's request for APA, or if there have been no such
material differences, a statement to that effect
57
Description of any failure to meet Critical Assumptions or, if there have been
none, a statement to that effect
57
Statement identifying all material changes in Taxpayer's accounting methods
and classifications, and methods of estimation, from those described or used in
Taxpayer's request for APA, or if there have been none, statement to that effect
57
Financial analysis demonstrating Taxpayer's compliance with TPM 57
Description of, reason for, and financial analysis of, any Compensating
Adjustments with respect to APA Year, including means by which any
Compensating Adjustment has been or will be satisfied
57
Organizational chart 51
Financial statements as prepared in accordance with US GAAP 50
Certified public accountant's opinion that financial statements present fairly
financial position of Taxpayer and the results of its operations, in accordance
with US GAAP
49
Financial statements as prepared in accordance with a foreign GAAP 15
Certified public accountant's opinion that financial statements present fairly
financial position of Taxpayer and the results of its operations, in accordance
with a foreign GAAP
14
Various work papers 10
Book to tax reconciliations 10
Profit & Loss statement 6
Schedule of costs and expenses (e.g., intercompany allocations) 6
Certified public accountant's review of financial statements 3
Description of any matters economically or substantively related to the covered
transactions, but that are not subject to the APA
2
Other 16
Approaches for Sharing of Currency or Other Risks
[§ 521(b)(2)(D)(xii)]
During 2003, there were 31 tested parties that faced financial risks, including interest rate and
currency risks. Three APAs provide specific approaches for dealing with currency risk,
including adjustment mechanisms and critical assumptions.
8
The first eight categories of documentation listed in this table were drawn from the standard APA language used in
2003. The facts and circumstances of some APAs may eliminate the need for some standard documentation
requirements.
30
Efforts to Ensure Compliance with APAs
[§ 521(b)(2)(F)]
As described in Rev. Proc. 96-53, section 11, APA taxpayers are required to file annual reports
to demonstrate compliance with the terms and conditions of the APA. The filing and review of
annual reports is a critical part of the APA process. Through annual report review, the APA
program monitors taxpayer compliance with the APA on a contemporaneous basis. Annual
report review provides current information on the success or problems associated with the
various TPMs adopted in the APA process.
All reports received by the APA Office are tracked by one designated APA team leader who also
has the primary responsibility for annual report review. One of the economists also spends a
significant amount of time reviewing annual reports. Other APA team leaders also assist in this
review, especially when the team leader who negotiated the case is available, since that person
will already be familiar with the relevant facts and terms of the agreement. Once received by the
APA Office, the annual report is sent out to the district personnel with exam jurisdiction over the
taxpayer.
The statistics for the review of APA annual reports are reflected in Table 29 below. As of
December 31, 2003, there were 222 pending annual reports. In 2003, there were 303 reports
closed.
TABLE 29: STATISTICS OF ANNUAL REPORTS
Number of APA annual reports pending as of December 31, 2003 222
Number of APA annual reports closed in Year 2003 303
9
Number of APA annual reports requiring adjustment in Year 2003 11
Number of taxpayers involved in adjustments 5
Number of APA annual reports required to be filed in Year 2003 235
Number of APA annual reports actually filed in Year 2003 235
Number of APA annual report cases over one year old 66
9
This number differs from previously published figures because of annual reports closed but not yet entered on the
system used to compile those statistics.
31
ATTACHMENT A
ADVANCE PRICING AGREEMENT
between
[Insert Taxpayer
=s Name]
and
THE INTERNAL REVENUE SERVICE
32
ADVANCE PRICING AGREEMENT
between
[Insert Taxpayer
=s Name]
and
THE INTERNAL REVENUE SERVICE
PARTIES
The Parties to this Advance Pricing Agreement (APA) are the Internal Revenue
Service (IRS) and [Insert Taxpayer
=s Name], EIN ________ (Taxpayer).
RECITALS
Taxpayer=s principal place of business is [City, State]. [Insert general description
of taxpayer and other relevant parties] .
This APA contains the Parties= agreement on the best method for determining
arm=s-length prices of the Covered Transactions under I.R.C. section 482, any
applicable tax treaties, and the Treasury Regulations.
Unless otherwise specified, terms in the plural include the singular and vice
versa. Appendix D contains definitions for capitalized terms not elsewhere defined in
this APA.
{If renewal, add} [Taxpayer and IRS previously entered into an APA covering
taxable years ending _____ to ______, executed on ________.]
AGREEMENT
The Parties agree as follows:
1. Covered Transactions. This APA applies to the Covered Transactions, as
defined in Appendix A.
2. Transfer Pricing Method. Appendix A sets forth the Transfer Pricing Method
(TPM) for the Covered Transactions.
33
3. Term. This APA applies to Taxpayer=s taxable years ending __________
through ________ (APA Term).
4. Operation.
a. Revenue Procedure 96-53 governs the interpretation, legal effect, and
administration of this APA.
b. Nonfactual oral and written representations, within the meaning of
sections 10.04 and 10.05 of Revenue Procedure 96-53 (including any proposals to use
particular TPMs), made in conjunction with the APA Request constitute statements
made in compromise negotiations within the meaning of Rule 408 of the Federal Rules
of Evidence.
5. Compliance.
a. For each taxable year covered by this APA (APA Year), if Taxpayer
complies with the terms and conditions of this APA, then the IRS will not make or
propose any allocation or adjustment under I.R.C. section 482 to the Covered
Transactions.
b. If Taxpayer does not comply, then the IRS may:
i. enforce the terms and conditions of this APA and make or propose
allocations or adjustments under I.R.C. section 482 consistent with
this APA;
ii. cancel or revoke this APA under section 11.05 or 11.06 of Revenue
Procedure 96-53; or
iii. revise this APA, if the Parties agree.
c. Taxpayer must timely file an Annual Report for each APA Year in
accordance with Appendix C and section 11.01 of Revenue Procedure 96-53. Taxpayer
must file an original and four copies of the Annual Report by the later of (a) 90 days
after the time prescribed by law (including extensions) for filing its federal income tax
return for the APA Year covered by the report, or (b) 90 days after the effective date of
this APA. [The Service and the Taxpayer may agree to alternative filing dates.] The IRS
may request additional information reasonably necessary to clarify or complete the
Annual Report. Taxpayer will provide all requested information within 30 days.
Additional time may be allowed for good cause.
d. The IRS will determine whether Taxpayer has complied with this APA
based on Taxpayer=s U.S. Returns, Financial Statements, and other APA Records, for
the APA Term and any other year necessary to verify compliance. For Taxpayer to
34
comply with this APA, an independent certified public accountant must {use the
following or an alternative} render an opinion that the Taxpayer=s Financial Statements
present fairly, in all material respects, Taxpayer=s financial position under U.S. GAAP.
e. In accordance with section 11.04 of Revenue Procedure 96-53, Taxpayer
will (1) maintain its APA Records, and (2) make them available to IRS in connection with
an examination under section 11.03. Compliance with this subparagraph constitutes
compliance with the record-maintenance provisions of I.R.C. sections 6038A and 6038C
for the Covered Transactions for any taxable year during the APA Term.
f. If Taxpayer=s actual transactions do not result in compliance with the TPM,
Taxpayer:
i. Must report its taxable income in an amount that is consistent with
the TPM and all other requirements of this APA on its timely filed
U.S. Return. However, for any APA Year, if Taxpayer=s timely filed
U.S. Return is filed no later than 60 days after the effective date of
this APA, then Taxpayer may instead report its taxable income in
an amount that is consistent with the TPM and all other
requirements of this APA on an amended U.S. Return filed no later
than 120 days after the effective date of this APA.
ii. May make compensating adjustments under Revenue Procedure
96-53, section 11.02, subject to any modifications or restrictions in
Appendix A or elsewhere in this APA.
g. {Insert when U.S. Group or Foreign Group contains more than one
member.} [This APA addresses the arm=s-length nature of prices charged or received in
the aggregate between Taxpayer[s] and Foreign Participants. Except as explicitly
provided, this APA does not address and does not bind the IRS with respect to prices
charged or received, or the relative amounts of income or loss realized, by particular
legal entities that are members of U.S. Group or that are members of Foreign Group.]
h. The True Taxable Income within the meaning of Treasury Regulations
section 1.482-1(a)(1) of a member of an affiliated group filing a U.S. consolidated return
will be determined under the I.R.C. section 1502 Treasury Regulations.
i. {Optional for US Parent Signatories} To the extent that Taxpayer=s
compliance with this APA depends on certain acts of Foreign Group members,
Taxpayer will ensure that each Foreign Group member will perform such acts.
6. Critical Assumptions. This APA=s critical assumptions, within the meaning of
Revenue Procedure 96-53, section 5.07, appear in Appendix B. Revenue Procedure
96-53, section 11.07, governs if any critical assumption has not been met.
35
7. Disclosure. This APA, and any background information related to this APA or the
APA Request, are: (1) considered Areturn information@ under I.R.C. section
6103(b)(2)(C); and (2) not subject to public inspection as a Awritten determination@ under
I.R.C. section 6110(b)(1). Section 521(b) of Pub. L. 106-170 provides that the
Secretary of the Treasury must prepare a report for public disclosure that includes
certain specifically designated information concerning all APAs, including this APA, in a
form that does not reveal taxpayers= identities, trade secrets, and proprietary or
confidential business or financial information.
8. Disputes. If a dispute arises concerning the interpretation of this APA, the
Parties will seek a resolution by the IRS Associate Chief Counsel (International), to the
extent reasonably practicable, before seeking alternative remedies. If any dispute
arises that is not related to interpreting this APA, the Parties will seek to resolve the
dispute in a manner consistent with Revenue Procedure 96-53, section 11.03(4).
9. Materiality. In this APA the terms Amaterial@ and Amaterially@ will be interpreted
consistently with the definition of Amaterial facts@ in Revenue Procedure 96-53, section
11.05(1).
10. Section Captions. This APA=s section captions, which appear in italics, are for
convenience and reference only. The captions do not affect in any way the
interpretation or application of this APA.
11. Entire Agreement and Severability. This APA is the complete statement of the
Parties= agreement. The Parties will sever, delete, or reform any invalid or
unenforceable provision in this APA to approximate the Parties= intent as nearly as
possible.
12. Successor in Interest. This contract binds, and inures to the benefit of, any
successor in interest to Taxpayer.
13. Notice. Any notices required by this APA or Revenue Procedure 96-53 must be
in writing. Taxpayer will send notices to the IRS at the address and in the manner set
forth in Revenue Procedure 96-53, section 5.13(2). The IRS will send notices to:
Taxpayer Corporation
Attn: Jane Doe, Sr. Vice President (Taxes)
1000 Any Road
Any City, USA 10000
(phone: _________)
36
14. Effective date and Counterparts. This APA is effective starting on the date, or
later date of the dates, upon which all Parties execute this APA. The Parties may
execute this APA in counterparts, with each counterpart constituting an original.
WITNESS,
The Parties have executed this APA on the dates below.
[Taxpayer Name in all caps]
By: ___________________________ Date:_______, 20___
Jane Doe
Sr. Vice President (Taxes)
IRS
By: ___________________________ Date:_______, 20___
Matthew W. Frank
Director, Advance Pricing Agreement Program
37
APPENDIX A
COVERED TRANSACTIONS AND TRANSFER PRICING METHOD (TPM)
_____________________________________________________________________
_____________________________________________________________________
1. Covered Transactions.
[Define the Covered Transactions.]
2. TPM.
{Note: If appropriate, adapt language from the following examples.}
$ CUP Method
The TPM is the comparable uncontrolled price (CUP) method. The
price charged for _________ must equal between _______ and
___________ (the Arm=s Length Range). Taxpayer must realize,
recognize, and report results on its U.S. Returns that clearly reflect such
pricing.
$ Resale Price Method (RPM)
The TPM is the resale price method (RPM). Taxpayer must realize,
recognize, and report results on its U.S. Returns that clearly reflect a
gross margin (defined as gross profit divided by sales revenue as those
terms are defined in Treasury Regulations sections 1.482-5(d)(1) and (2))
of between ____% and ___ % (the Arm=s Length Range) for the Covered
Transactions.
$ Cost Plus Method
The TPM is the cost plus method. Taxpayer must realize,
recognize, and report results on its U.S. Returns that clearly reflect a ratio
of gross profit to production costs (within the meaning of Treasury
Regulations sections 1.482-3(d)(1) and (2)) of between ___% and ___%
(the Arm=s Length Range) for the Covered Transactions.
$ CPM with Berry Ratio PLI
The TPM is the comparable profits method (CPM). Taxpayer must
realize, recognize, and report results on its U.S. Returns that clearly reflect
38
a gross profit to operating expenses ratio (as those terms are defined in
Treasury Regulations sections 1.482-5(d)(2) and (3)) of between ____ and
___ (the Arm=s Length Range) for the Covered Transactions.
$ CPM using an Operating Margin PLI
The TPM is the comparable profits method (CPM). The profit level
indicator is an operating margin. Taxpayer=s reported operating profit
(within the meaning of Treasury Regulations sections 1.482-5(d)(5)) must
clearly reflect an operating margin (defined as the ratio of operating profit
to sales revenue as those terms are defined in Treasury Regulations
section 1.482-5(d)(1) and (4)) of between ____% and ___ % (the Arm=s
Length Range) for the Covered Transactions.
$ CPM using a Three-year Rolling Average Operating
Margin PLI
The TPM is the comparable profits method (CPM). The profit level
indicator is an operating margin. Taxpayer=s Three-Year Rolling Average
operating margin is defined as follows for any APA Year: the sum of
Taxpayer=s reported operating profit (within the meaning of Treasury
Regulations section 1.482-5(d)(5)) for that APA Year and the two
preceding years, divided by the sum of Taxpayer=s sales revenue (within
the meaning of Treasury Regulations section 1.482-5(d)(1)) for that APA
Year and the two preceding years. Taxpayer=s Three-Year Rolling
Average operating margin must be between ____% and ____% (the Arm=s
Length Range.)
$ Residual Profit Split Method
The TPM is the residual profit split method. Taxpayer must realize,
recognize, and report results on its U.S. Returns that clearly reflect the
following: [insert description of profit-split mechanism].
[Insert additional provisions as needed.]
3. Adjustments.
{For use with a CPM}
For each APA Year, if Taxpayer=s year-end [Three-Year Rolling Average]
{specify PLI used} for the Covered Transactions is not in compliance with the TPM,
Taxpayer will make an adjustment that brings its [Three-Year Rolling Average] {specify
PLI used} to {if the TPM specifies a point value, use that; if the TPM specifies an Arm
=s
39
Length Range, use the nearest edge of the Arm
=s Length Range or a point such as the
median within the Arm=s Length Range}.
[Insert additional provisions as needed.]
40
APPENDIX B
CRITICAL ASSUMPTIONS
_____________________________________________________________________
_____________________________________________________________________
This APA=s critical assumptions are:
1. The business activities, functions performed, risks assumed, assets
employed, and financial and tax accounting methods and classifications [and methods
of estimation] of Taxpayer in relation to the Covered Transactions will remain materially
the same as described or used in Taxpayer=s APA Request. A mere change in
business results will not be a material change.
[Insert additional provisions as needed.]
41
APPENDIX C
APA RECORDS AND ANNUAL REPORT
_____________________________________________________________________
_____________________________________________________________________
APA RECORDS
The APA Records will consist of:
1. All documents listed below for inclusion in the Annual Report, as well as all
documents, notes, work papers, records, or other writings that support the
information provided in such documents.
2. [Insert here other records as required.]
_____________________________________________________________________
_____________________________________________________________________
ANNUAL REPORT
The Annual Report will include a cover sheet and a table of contents. The cover sheet
will specify:
i. the Parties to the APA;
ii. the APA Term (defined in section 3 of this APA);
iii. the APA=s effective date (defined in section 14 of this APA);
iv. whether the APA is a renewal, and if so the term of the prior APA;
v. whether the APA has been amended, and if so the amendment=s effective
date;
vi. any information needed to distinguish the APA at issue from any other
APAs involving the same parties;
vii. any changes to the Taxpayer notice information in section 13 of this APA.
The table of contents and the Annual Report will be organized as listed below.
Taxpayer must include the following items in its Annual Report for each APA Year.
1. Statements that fully identify, describe, analyze, and explain:
a. All material differences between any of Taxpayer=s business operations
(including functions, risks, markets, contractual terms, economic conditions, property or
services, and assets employed) during the APA Year and the description of the
business operations contained in the APA Request. If there have been no material
differences, the Annual Report will include a statement to that effect.
42
b. All material changes in Taxpayer=s accounting methods and
classifications, and methods of estimation, from those described or used in Taxpayer=s
request for this APA. If there have been no such material changes, the Annual Report
will include a statement to that effect.
c. Any failure to meet any critical assumption. If there have been no failures,
the Annual Report will include a statement to that effect.
d. Any change to any entity classification for federal income tax purposes
(including any change that causes an entity to be disregarded for federal income tax
purposes) of any Worldwide Group member that is a party to the Covered Transactions
or is otherwise relevant to the TPM.
e. Any changes to Taxpayer=s financial accounting methods that were made
to conform to U.S. GAAP changes and that affect the Covered Transactions.
f. The amount, reason for, and financial analysis of any compensating
adjustments under paragraph 5(f)(ii) of this APA for the APA Year, including but not
limited to:
i. the amounts paid or received by each affected entity;
ii. the character (such as capital, ordinary, income, expense) and
country source of the funds transferred, and the specific affected
line item(s) of any affected U.S. Return; and
iii. the date(s) and means by which the payments are or will be made.
g. The amounts, description, reason for, and financial analysis of any book-
tax differences relevant to the TPM for the APA Year, as reflected on Schedule M-1 of
the U.S. Return for the APA Year.
2. The Financial Statements, and any necessary account detail to show compliance
with the TPM, with a copy of the independent certified public accountant's opinion
required by paragraph 5(d) of this APA.
3. A financial analysis that reflects Taxpayer=s TPM calculations for the APA Year.
The calculations must reconcile with and reference the Financial Statements in
sufficient account detail to allow the IRS to determine whether Taxpayer has complied
with the TPM.
4. An organizational chart for the Worldwide Group, revised annually to reflect all
ownership or structural changes of entities that are parties to the Covered Transactions
or are otherwise relevant to the TPM.
43
APPENDIX D
DEFINITIONS
_____________________________________________________________________
____________________________________________________________________
The following definitions control for all purposes of this APA. The definitions
appear alphabetically below:
Term
Definition
Annual Report
A report within the meaning of Revenue Procedure 96-53,
section 11.
APA
This Advance Pricing Agreement, which is an Aadvance pricing
agreement@ within the meaning of Revenue Procedure 96-53,
section 1.
APA Records
The records specified in Appendix C.
APA Request
Taxpayer=s request for this APA dated _________, including
any amendments or supplemental or additional information
thereto.
Covered
Transaction
This term is defined in Appendix A.
Financial
Statements
The financial statements prepared in accordance with U.S.
GAAP and stated in U.S. dollars.
Foreign Group
Worldwide Group members that are not U.S. persons.
Foreign
Participants
[name the foreign entities involved in Covered Transactions].
I.R.C.
The Internal Revenue Code of 1986, 26 U.S.C., as amended.
Pub. L. 106-170
The Ticket to Work and Work Incentives Improvement Act of
1999.
Revenue
Procedure 96-53
Rev. Proc. 96-53, 1996-2 C.B. 375.
Transfer Pricing
Method (TPM)
A transfer pricing method within the meaning of Treasury
Regulations section 1.482-1(b) and Revenue Procedure 96-53,
section 3.02.
U.S. GAAP
U.S. generally-accepted accounting principles.
44
Term
Definition
U.S. Group Worldwide Group members that are U.S. persons.
U.S. Return
For each taxable year, the Areturns with respect to income
taxes under subtitle A@ that Taxpayer must Amake@ in
accordance with I.R.C. section 6012. {Or substitute for
partnership: For each taxable year, the Areturn@ that Taxpayer
must Amake@ in accordance with I.R.C. section 6031.}
Worldwide Group
Taxpayer and all organizations, trades, businesses, entities, or
branches (whether or not incorporated, organized in the United
States, or affiliated) owned or controlled directly or indirectly by
the same interests.
45
ATTACHMENT B
FORMULAS FOR BALANCE SHEET ADJUSTMENTS
Definitions of Variables:
AP = average accounts payable
AR = average trade accounts receivable, net of allowance for bad debt
cogs = cost of goods sold
INV = average inventory, stated on FIFO basis
opex = operating expenses (general, sales, administrative, and depreciation expenses)
PPE = property, plant, and equipment, net of accumulated depreciation
sales = net sales
tc = total cost (cogs + opex, as defined above)
h = average accounts payable or trade accounts receivable holding period,
stated as a fraction of a year
i = interest rate
t
= entity being tested
c
= comparable
Equations
:
If Cost of Goods Sold is controlled (generally, sales in denominator of PLI):
Receivables Adjustment (“RA”): RA = {[(AR
t
/ sales
t
) x sales
c
] - AR
c
} x {i/[1+(i x h
c
)]}
Payables Adjustment (“PA”): PA = {[(AP
t
/ sales
t
) x sales
c
] - AP
c
} x {i/[1+(i x h
c
)]}
Inventory Adjustment (“IA”): IA = {[(INV
t
/ sales
t
) x sales
c
] - INV
c
} x i
PP&E Adjustment (“PPEA”): PPEA = {[(PPE
t
/ sales
t
) x sales
c
] - PPE
c
} x i
If Sales are controlled (generally, costs in the denominator of PLI):
10
Receivables Adjustment (“RA”): RA = {[(AR
t
/ tc
t
) x tc
c
] - AR
c
} x {i/[1+(i x h
c
)]}
Payables Adjustment (“PA”): PA = {[(AP
t
/ tc
t
) x tc
c
] - AP
c
} x {i/[1+(i x h
c
)]}
Inventory Adjustment (“IA”): IA = {[(INV
t
/ tc
t
) x tc
c
] - INV
c
} x i
PP&E Adjustment (“PPEA”): PPEA = {[(PPE
t
/ tc
t
) x tc
c
] - PPE
c
} x i
Then Adjust Comparables as Follows:
adjusted sales
c
= sales
c
+ RA
adjusted cogs
c
= cogs
c
+ PA - IA
adjusted opex
c
= opex
c
- PPEA
10
Depending on the specific facts, the equations below may use total costs (“tc”) or cost of goods sold (“cogs”).Continua la tua ricerca in ChatGPT o Claude
Collega Omnilex per cercare nel corpus legale dal tuo assistente IA.