IRS Reports on Advance Pricing Agreements for 2012

As described in greater detail below, in the first quarter of calendar year 2012, the APA Program was moved from the Office of Chief Counsel and merged with that portion of the Office of the U.S. Competent Authority (USCA) that resolves transfer pricing cases under the mutual agreement procedures of the United States' bilateral income tax conventions. As the successor to the APA Program, the new Advance Pricing and Mutual Agreement (APMA) Program has prepared and finalized this report.

During 2012, the APMA Program saw immediate returns from the merger of functions, increased resources available, and processing efficiencies implemented throughout the year, and increased the number of APAs executed from 42 in 2011 to a single-year high of 140 in 2012. The average time to complete an APA decreased from 40.7 months in 2011 to 39.8 months in 2012, and for the first year in the program's history there were more APAs executed (140) than applications filed (126). It is expected that the average processing time for APAs will continue to decrease over the next few years as the APMA Program continues to use its increased resources to reduce the older inventory of pending cases and accelerate the processing of newer cases.

As part of the evolution of the APA Program into the APMA Program, those who have read this report in past years will notice significant changes in how the APMA Program is communicating its results for 2012 to Congress and the public. Sections describing the background and general procedures regarding APAs have been deleted, and readers are referred to the revenue procedures that currently govern APA submissions and the relevant Treasury regulations for the details previously included therein. Part I of the report summarizes the merger of programs and operations; Part II presents APMA program results, both in table and graphical format; and Part III includes general descriptions of various elements of the executed APAs, e.g., transfer pricing methods used, types of transactions covered in APAs, and the countries with which the United States reached agreements.

Calendar year 2012 provided many challenges to the leadership and staff of both legacy APA and legacy USCA, but as will be seen below, the new APMA Program has achieved many of its goals for 2012 and expects to continue its progress in the years to come.

Staffing Increases, Focus on Economists

Beginning in mid-2011, the USCA office began a hiring process that continues to the present, to add both analysts (now called team leaders) and economists to the USCA (now APMA) staff. Overall staffing increased from a total of approximately 70 staff (analysts, team leaders and economists) and seven managers between the APA Program and the USCA office in early 2011, to a total of 92 team leaders and economists and 12 APMA managers at present. In particular the hiring focused on economists, with the addition of two economist managers and 20 economists drawn from both the private sector and the IRS field economist group. This focus on economist hiring was intended, among other things, to improve the ability of the IRS to develop APA positions expeditiously, and reduce the average time from submission to resolution. Further, by adding experienced transfer pricing economists to the team the APMA Program is creating a "deep bench," that allows resources to be deployed strategically. By more than doubling the number of economists within APMA, and tripling the number of economist managers from one to three, the Program is better able to perform the proper level of analysis for every case, which in turn should continue to result in reduced processing times while maintaining the same high quality of analysis.

Impact of Merger, Office Move

As with any organizational merger, the combination of the APA Program with the USCA office presented challenges. These challenges were heightened by the fact that Washington, DC personnel, which represents the largest cadre of APMA, also went through an office move in September. In addition, the rapid increase in headcount, including the addition of economists located in Chicago and New York, necessitated additional training as the merged organization began to develop and implement new processes for both APA and double tax cases.

Operating Efficiencies Include Elimination of "Handoffs"

Despite the challenges noted above, the merger nonetheless created significant benefits, in addition to the positive impact of staffing increases noted above. One result of the merger that has paid immediate dividends in the processing of bilateral APAs is the elimination of two "handoffs" that existed under the legacy system. That is, before the merger a developed APA position was "handed off" from an APA team leader to a USCA analyst, the latter of whom would then discuss the case with the treaty partner. When the USCA office reached agreement with the treaty partner and entered into a mutual agreement under the treaty, that agreement was "handed off" from the USCA analyst back to the APA Director and team leader to draft the domestic APA.

After the merger, the team that develops the IRS position in the case is also responsible for discussing the case with the treaty partner, obtaining an agreement, and finalizing the APA with the taxpayer. This compression of functions eliminates inefficiencies, and also requires the team in a bilateral case to take the potential challenges or roadblocks that could be posed by the treaty partner into account when developing the U.S. position. This in turn is expected to also lead to a shortening of the time it takes to reach resolution once a case is set for discussion with the treaty partner.¹

Summary, Look Ahead

Although as of December 31, 2012, the APMA Program had been in existence for less than one year, the Program accomplished much during 2012. In addition to a significant increase in APA output, the recruitment and hiring of highly qualified and experienced team leaders and economists increases internal transfer pricing expertise, which in turn benefits the overall efforts of the Office of Transfer Pricing Operations. In 2013 the Program expects to release new revenue procedures governing both APA applications and MAP applications, and to replace the current revenue procedures that were released in 2006 and, in the case of APAs, supplemented in 2008. These revenue procedures will reflect the changes in structure, and also and more importantly, will be informed by the cumulative experience of more than twenty years of APA practice in the United States, which has produced more than eleven hundred unilateral and bilateral agreements since 1991.

The model APA agreement, which was last revised significantly in 2009 and is currently under review for future changes, appears in this report as Appendix A. (See Pub. L. 106-170 § 521(b)(2)(B)). A list of primary APMA contacts is included as Appendix B.

                    Table 1: APA Applications Filed

Applications Filed

 

2003-2012

 

 

 

APAs Executed

 

2003-2012

 

 

 

 

Pending APAs

 

2003-2012

 

 

 

APAs Finalized or Renewed by Industry

 

 

 

Manufacturing APAs Finalized or Renewed

 

 

 

Wholesale/Retail Trade APAs Finalized or Renewed

 

 

 

 

Part III. General Descriptions of APAs Executed in 2012

 

[Pub. L. 106-170 § 521(b)(2)(D)]

 

As shown in the graph below, of the total number of bilateral APAs executed in 2012, more than half were agreed between the United States and Japan, with the other two treaty countries with significant activity being Canada and the United Kingdom. As the IRS gains additional experience with other treaty partners it would be expected that the relative representation of other treaty partners will increase over time.

 

Bilateral APAs Finalized or Renewed by Country

 

 

 

 

Types of Tested Parties

 

 

 

 

Types of Covered Transactions

 

 

 

Functions and Risks: As shown in the graphs below, most of the functions and risks of the tested parties in the APAs executed in 2012 were routine functions and risks, with more than 70 percent of the cases involving distribution or related functions, e.g. marketing and product support. Similarly, the risks borne by the tested parties were primarily standard business risks, e.g., market risk and credit risk. A small percentage of the tested parties performed more complex or high value functions such as manufacturing and research and development, and a similarly small percentage of the tested parties bore non-routine and potentially significant risks such as product liability or research and development risk.

 

Tested Party Functions

 

 

 

 

Tested Party Risks

 

 

 

 

Tangible and Intangible Property

 

Transfer Pricing Methods

 

 

 

 

Tangible and Intangible Property

 

CPM/TNMM

 

Profit Level Indicators

 

 

 

 

Services

 

Transfer Pricing Methods

 

 

 

 

Services

 

CPM/TNMM

 

Profit Level Indicators

 

 

 

Regarding adjustments, the standard balance sheet adjustments covered by Treas. Reg. § 1.482-1(d) and -5(c), including adjustments to payables, receivables and inventory, were made in the majority of cases, and approximately 30 percent of the cases also involved an adjustment to plant, property and equipment. In addition, where appropriate, accounting adjustments were made to convert from LIFO to FIFO inventory accounting, and a small number of the cases also involved the accounting reclassification of expenses, e.g.,from COGS to operating expenses, or from operating expenses to extraordinary items.

Ranges, Targets and Adjustment Mechanisms

APAs executed in 2012 included a number of mechanisms for making adjustments to tested party results when they are outside the range or point required by the APA. Among the mechanisms included in 2012, which apply to the APA term and/or rollback years, were: a) an adjustment to the closest edge of the range applied to the results of a single year; b) adjustment to the closest edge of the range applied to the results over the APA term; c) adjustment to the specified point or royalty rate; and d) adjustment to the median of the range for a single year. For bilateral APAs, compensating adjustments that are required under the terms of the APA can sometimes be subject to further discussions between the APMA team and its counterpart in the foreign jurisdiction, and the amount and/or timing of the compensating adjustment can be the subject of an additional agreement between the countries.

Critical Assumptions

Term Lengths for APAs

           Table 5: Term Lengths (Including Rollback Years)

 

 

 

All reports received by the APMA Program are assigned to a designated APMA team leader or economist. Whenever possible, annual report reviews are assigned to the team leader who worked the case, or another staff member who is already familiar with the relevant facts and terms of the agreement. Other team leaders and economists may assist the assigned team leader as well. Once received by the APMA Program, the annual report is also sent to the field personnel with exam jurisdiction over the taxpayer. The field personnel conduct a parallel compliance review, and work with APMA personnel to resolve any questions or problems that might arise.

Nature of Documentation Required in Annual Report

² The first APA Statutory Report, which compiled APA data from 1991-1999, did not report the cumulative number of applications for those years by submission type, so the cumulative totals before 2012 that include that data cannot be reported in that manner.

³ Treas. Reg. § 1.482-5(b)(4)(ii)(A).

⁴ Treas. Reg. § 1.482-5(b)(4)(ii)(B).

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, the Treasury Regulations thereunder, and any applicable tax treaties.

{If renewal, add} [Taxpayer and IRS previously entered into an APA covering taxable years ending _____ to ______, executed on ________.]

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.

3. Term. This APA applies to the APA Term, as defined in Appendix A.

4. Operation.

a. Revenue Procedure 2006-9 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 2006-9 (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. Taxpayer must report its taxable income in an amount that is consistent with Appendix A and all other requirements of this APA on its timely filed U.S. Return. However, if Taxpayer's timely filed U.S. Return for any taxable year covered by this APA (APA Year) is filed prior to, or no later than 60 days after, the effective date of this APA, then Taxpayer must report its taxable income for that APA Year in an amount that is consistent with Appendix A and all other requirements of this APA either on the original U.S. Return or on an amended U.S. Return filed no later than 120 days after the effective date of this APA, or through such other means as may be specified herein.

b. {Use or edit the following 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 and Foreign Participants with respect to the Covered Transactions. 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.]

c. For each 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 amounts charged in the aggregate between Taxpayer and Foreign Participant[s] with respect to the Covered Transactions.

d. If Taxpayer does not comply with the terms and conditions of this APA, then the IRS may:

f. The IRS will determine whether Taxpayer has complied with this APA based on Taxpayer's U.S. Returns, the Financial Statements, and other APA Records, for the APA Term and any other year necessary to verify compliance. For Taxpayer to comply with this APA, {use the following or an alternative} an independent certified public accountant must render an opinion that Taxpayer's Financial Statements present fairly, in all material respects, Taxpayer's financial position under U.S. GAAP.

g. In accordance with section 11.04 of Revenue Procedure 2006-9, Taxpayer will (1) maintain the APA Records, and (2) make them available to the 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.

h. The True Taxable Income within the meaning of Treasury Regulations sections 1.482-1(a)(1) and (i)(9) 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 2006-9, section 4.05, appear in Appendix B. If any critical assumption has not been met, then Revenue Procedure 2006-9, section 11.06, governs.

7. Disclosure. This APA, and any background information related to this APA or the APA Request, are: (1) considered "return information" under I.R.C. section 6103(b)(2)(C); and (2) not subject to public inspection as a "written 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 Director of the Advance Pricing and Mutual Agreement Program, to the extent reasonably practicable, before seeking alternative remedies.

9. Materiality. In this APA the terms "material" and "materially" will be interpreted consistently with the definition of "material facts" in Revenue Procedure 2006-9, section 11.06(4).

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. Terms and Definitions. 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.

12. 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.

13. Successor in Interest. This APA binds, and inures to the benefit of, any successor in interest to Taxpayer.

14. Notice. Any notices required by this APA or Revenue Procedure 2006-9 must be in writing. Taxpayer will send notices to the IRS at the address and in the manner set forth in Revenue Procedure 2006-9, section 4.11. The IRS will send notices to:

WITNESS,

The Parties have executed this APA on the dates below.

[Taxpayer Name in all caps]

IRS

This APA applies to Taxpayer's taxable years ending __________ through ________ (APA Term).

3. TPM.

4. Application of TPM.

For any APA Year, if the results of Taxpayer's actual transactions produce a [price per unit, royalty rate for the Covered Transactions] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] within the Arm's Length Range, then the amounts reported on Taxpayer's U.S. Return must clearly reflect such results.

For any APA year, if the results of Taxpayer's actual transactions produce a [price per unit, royalty rate] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] outside the Arm's Length Range, then amounts reported on Taxpayer's U.S. Return must clearly reflect an adjustment that brings the [price per unit, royalty rate] [or] [Tested Party's Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin] to the Median.

For purposes of this Appendix A, the "results of Taxpayer's actual transactions" means the results reflected in Taxpayer's and Tested Party's books and records as computed under U.S. GAAP [ insert another relevant accounting standard if applicable ], with the following adjustments:

(a) [The fair value of stock-based compensation as disclosed in the Tested Party's audited financial statements shall be treated as an operating expense]; and

(b) To the extent that the results in any prior APA Year are relevant (for example, to compute a multi-year average), such results shall be adjusted to reflect the amount of any adjustment made for that prior APA Year under this Appendix A.

5. APA Revenue Procedure Treatment

If Taxpayer makes an adjustment under paragraph 4 of this Appendix A (a "primary adjustment"), Taxpayer and its related foreign entity may elect APA Revenue Procedure Treatment in accordance with section 11.02(3) of Revenue Procedure 2006-9 and avoid the possible adverse tax consequences of a secondary adjustment that would otherwise follow the primary adjustment.

[ Insert additional provisions as needed. ]

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. ]

The APA Records will consist of 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.

ANNUAL REPORT

The Annual Report (and each of the four copies required by paragraph 5(e) of this APA) will include:

1. Two copies of a properly completed APA Annual Report Summary in the form of Appendix E to this APA, one copy of the form bound with, and one copy provided separately from, the rest of the Annual Report.

2. A table of contents, organized as follows:

3. Statements that fully identify, describe, analyze, and explain:

a. All material differences between the U.S. Group's business operations (including functions, risks assumed, markets, contractual terms, economic conditions, property, services, and assets employed) during the APA Year from the business operations described in the APA Request. If there have been no material differences, the Annual Report will include a statement to that effect.

b. All material differences between the U.S. Group's accounting methods and classifications, and methods of estimation used during the APA Year, from those described or used in the APA Request. If any change was made to conform to changes in U.S. GAAP (or other relevant accounting standards) Taxpayer will specifically identify the change. If there has been no material change in accounting methods and classifications or methods of estimation, the Annual Report will include a statement to that effect.

c. Any change to the Taxpayer notice information in paragraph 14 of this APA.

d. Any failure to meet any critical assumption. If there has been no failure, the Annual Report will include a statement to that effect.

e. Whether or not material information submitted while the APA Request was pending is discovered to be false, incorrect, or incomplete.

f. 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.

g. The amount, reason for, and financial analysis of (1) any primary adjustments made under Appendix A for the APA Year; and (2) any (a) secondary adjustments that follow such primary adjustments or (b) accounts receivable that Taxpayer establishes, in lieu of secondary adjustments, by electing APA Revenue Procedure Treatment pursuant to paragraph 5 of Appendix A and Revenue Procedure 2006-9, section 11.02(3), for the APA Year, including but not limited to:

i. Whether Taxpayer contemplates requesting, or has requested, to renew, modify, or cancel the APA.

4. The Financial Statements, and any necessary account detail to show compliance with the TPM, including consolidating financial statements, segmented financial data, records from the general ledger, or similar information if the assets, liabilities, income, or expenses relevant to showing compliance with the TPM are a subset of the assets, liabilities, income, or expenses presented in the Financial Statements.

5. {Use the following or the alternative prescribed by paragraph 5(f) of this APA:} A copy of the independent certified public accountant's opinion required by paragraph 5(f) of this APA.

6. A financial analysis that reflects Taxpayer's TPM calculations for the APA Year. The calculations must reconcile with and reference the information required under item 4 above in sufficient account detail to allow the IRS to determine whether Taxpayer has complied with the TPM.

7. 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.

8. A copy of the APA and any amendment.

9. A penalty of perjury statement, executed in accordance with Revenue Procedure 2006-09, section 11.01(6) and (7).

       Term                              Definition

 

 

 

* * * * *

 

 

Appendix B -- APMA Contacts