Ann. 2011-22, 2011-16 IRB 672
IRS has released its twelfth required report providing details about the structure and activities of the advance pricing agreement (APA) program. The report says the number of APA applications during 2010 represented a record one-year high for the program.
Background. An APA generally combines a voluntary agreement between a taxpayer and IRS on an appropriate transfer pricing methodology (TPM) for covered transactions with an agreement between the U.S. and one or more foreign tax authorities that the TPM is correct. This kind of bilateral APA assures the taxpayer that the income from the transactions will not be subject to double taxation by the U.S. and the foreign tax authority. IRS and taxpayers also may execute unilateral APAs, which are agreements establishing an approved transfer pricing methodology for U.S. tax purposes. A unilateral APA binds the taxpayer and IRS, but does not prevent foreign tax bodies from taking different positions. If a transaction covered by a unilateral APA is 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.
The APA process is voluntary. Taxpayers submit an application for an APA, together with a user fee. The application process is set out in Rev Proc 2006-9, 2006-1 CB 278, as modified by Rev Proc 2008-31, 2008-23 IRB.
New report. The APA report says that the 144 APA applications during 2010 represented a new one-year high for the program, following record-breaking years in 2008 (123 applications) and 2009 (127 applications). From 2000—2007, the APA program averaged 91 applications per year, and it had never received more than 110 applications in a single year. The APA program expects APA applications to continue in 2011 at the same high levels as in 2008—2010.
The APA report carries 31 tables containing statistical data from the APA program. For example, during 2010, of the 144 APA applications that were filed, 46 were unilateral and 98 bilateral. In addition, 69 APAs were executed during 2010 (20 unilateral; 49 bilateral; and 0 multilateral). A total of 19 APAs were withdrawn (8 unilateral, 11 bilateral).
The report notes that during 2010, the APA program received numerous inquiries about the potential effect of the economic downturn on existing and pending APAs. On existing APAs, the APA program, in consultation with the U.S. Competent Authority, has adopted a general policy to not reopen closed cases, absent a special Critical Assumption on point. 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. The APA program has dealt with pending APA applications on a case-by-case basis. Whether or not a special “down-economy adjustment” might be appropriate depends on a variety of factors, including whether or not the tested party and the comparables have been similarly affected by the downturn, the tested party's historic risk profile and performance, and a taxpayer's willingness to accept a symmetrical adjustment (e.g., in a renewal APA) when the economy improves. Approaches to the down economy that have been considered include changing the APA term, waiting for more current financial data, using a different set of comparables, and/or applying a longer testing period.
The APA report also describes five phases of the APA process: application; due diligence; analysis; discussion and agreement; and drafting and execution. It includes various technical appendices, including one carrying example formulas for balance sheet adjustments.
Observation: The report is must-reading for any taxpayer that wishes to enter into an APA.
References: For advance pricing agreements, see FTC 2d/FIN ¶G-4704; United States Tax Reporter ¶4824.07.