Using Advance Pricing Agreements to Mitigate Transfer Pricing Risk
Stricter customs rules can require different related-party pricing methodology
By Anthony J. Barbera, Ph.D. and Anjali D. Bhasin, Ph.D. of The Ballentine Barbera Group, a CRA International Company
Tax authorities in many jurisdictions have intensified scrutiny of transfer pricing in recent years, resulting in significant adjustments and penalties. This heightened scrutiny could have a significant impact on the tax obligations of companies engaged in related-party transactions. Many jurisdictions allow companies to mitigate this risk by entering into an Advance Pricing Agreement (“APA”) with tax authorities that establishes agreed-upon arm’s-length prices for related-party transactions.
But is it worth the time and expense to negotiate an APA? The answer depends upon the particular situation of a given company. Essentially, the decision whether to enter into an APA is similar to the decision whether to purchase insurance: it is a cost-benefit analysis that weighs an initial expenditure against a quantifiable risk. To analyze this cost-benefit equation, it is necessary to factor in some of the other advantages offered by APAs, the situation and characteristics of the company in question, the APA rules of the relevant countries, and whether the company is currently involved in a transfer pricing dispute. Once a decision is made to seek an APA, there are also some steps that can be taken to expedite the APA process.
Other Advantages of APAs
In addition to mitigating future risk, an APA can offer the opportunity to resolve transfer pricing issues over the past five years or more. The APA approach often offers creativity and flexibility where regulations may not provide clear guidance. Also, as U.S. treaty partners are not bound by U.S. regulations, for example, the IRS may consider a hybrid transfer pricing methodology or a hybrid profit level indicator, which may not necessarily be available outside of the APA program. In addition to the above, an APA virtually eliminates the risk of documentation related penalties and double taxation. No transfer pricing penalties may apply for past years once the years have been accepted for rollback treatment.
Company Characteristics and Practices
Based on our broad experience, companies with the following characteristics should consider the APA approach:
• Companies involved in exotic transactions (e.g., using swaps to transfer risk and cash flows from one related party to another related party for an arm’s length compensation)
• Companies utilizing unspecified methods for valuing arm’s length transactions, as permitted under Section 1.482-3T of the U.S. regulations.
• Companies utilizing hybrid profit level indicators.
• Companies utilizing creative working capital or risk adjustments.
• Companies currently under transfer pricing audit.
• Companies with significant tax reserves related to intercompany transactions.
• Companies that are now more likely to be challenged based on recent tax court decisions.
• Companies involved in intellectual property (“IP”) migration.
• Companies that are risk averse.
Companies that are involved in exotic transactions or non-routine type of transactions should consider going into the APA process. The economic analysis related to such transactions, while reasonable is likely to be non-traditional. In such situations, especially if the transaction is significant, the APA process could potentially offer certainty in a cooperative environment. An audit would be a difficult venue to resolve such an issue and could be extremely time consuming and expensive. The same arguments apply to companies utilizing unspecified methods.
Excerpted from the Tax Director's Guide to International Transfer Pricing. To read the rest of this article, please order your copy today.
About the Authors:
CRA International Vice President Anthony Barbera has nearly two decades of transfer pricing experience and is a former principal of the Ballentine Barbera Group. He can be reached at (202) 662-7830 or by email at firstname.lastname@example.org. Anjali Bhasin, Vice President, is a member of CRA’s Competition practice. Dr. Bhasin has over thirteen years of experience in conducting economic analyses of intercompany pricing of services and tangible and intangible property. She can be reached at (703) 201-8869 or by email at email@example.com.