IRS Reports on Advance Pricing Agreements for 2017

ANNOUNCEMENT AND REPORT
CONCERNING
ADVANCE PRICING AGREEMENTS

March 30, 2018

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 Advance Pricing and Mutual Agreement Program (APMA Program), formerly known as the Advance Pricing Agreement Program (APA Program). The first report covered calendar years 1991 through 1999. Subsequent reports covered each calendar year 2000 through 2016 separately. This nineteenth report describes the experience, structure, and activities of the APMA Program during calendar year 2017. It does not provide guidance regarding the application of the arm's length standard.

Part I of this report includes information on the structure, composition, and operation of the APMA Program; Part II presents statistical data; and Part III includes general descriptions of various elements of the APAs executed in 2017, including types of transactions covered, transfer pricing methods used, and completion time.

John C. C. Hughes
Director, Advance Pricing and Mutual Agreement Program

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Part I. The APMA Program — Structure, Composition, and Operation
[PUB. L. 106-170 § 521(b)(2)(A)]

In February 2012, the former APA Program was moved from the Office of Chief Counsel to the Office of Transfer Pricing Operations¹ within the Large Business and International Division of the IRS and combined with the U.S. Competent Authority staff responsible for transfer pricing cases, thereby forming the APMA Program.

As of December 29, 2017, the APMA Program included 55 team leaders, 17 economists, and 10 senior managers organized into 10 groups (7 team leader groups and 3 economist groups). The APMA Program's main office is in Washington, DC, and it also has a significant presence in San Francisco and the Los Angeles area.

On August 31, 2015, new revenue procedures governing MAP and APA applications were published in 2015-35 I.R.B. on pages 236 and 263, respectively. Revenue Procedure (Rev. Proc.) 2015-41 provides guidance and instructions on filing APA requests as well as guidance and information on the administration of APAs. Rev. Proc. 2015-41 updates and supersedes Rev. Proc. 2006-9, 2006-1 C.B. 278, as modified by Rev. Proc. 2008-31, 2008-1 C.B. 1133, which is also superseded. Rev. Proc. 2015-40 provides procedures and guidance on requesting assistance from the U.S. Competent Authority where the taxpayer believes that the actions of the United States or a treaty country result or will result in the taxpayer being subject to taxation not in accordance with the applicable U.S. tax treaty. Rev. Proc. 2015-40 updates and supersedes Rev. Proc. 2006-54, 2006-2 C.B. 1035.

The 2009 model APA agreement appears in this report as Appendix 1. In the fall of 2017, APMA solicited comments on a proposed major revision. A list of primary APMA contacts is available at https://www.irs.gov/businesses/corporations/apma-contacts

Part II. APMA Program Statistical Data
[Pub. L. 106-170 § 521(b)(2)(C)(i-viii)]

Table 1: APA Applications Filed
§ 521(b)(2)(C)(i)

	Unilateral	Bilateral	Multilateral	Total
Filed 1991-19992				401
Filed 2000-2016	556	1278	10	1844
Filed in 2017	14	86	1	101
Total Filed 1991-2017				2346

 

The table above illustrates the number of complete applications filed per year. As of December 31, 2017, APMA had also received 37 user fee filings that were not yet accompanied by substantially complete APA applications, in addition to the 101 complete APA applications.

Table 2: Executed and Pending APAs § 521(b)(2)(C)(ii-vi)

	Unilateral	Bilateral	Multilateral	Total
Total Executed 1991-2016	560	1,023	14	1,597
Total Executed in 2017	30	85	1	116
Total Executed 1991-2017	590	1,108	15	1,713
Total Pending as of 12/31/2017	57	321	8	386
Renewals Executed in 2017	22	48	0	70
Renewals Pending	29	133	2	164

Of the 116 agreements executed in 2017, 40 percent were new APAs (i.e., not a renewal of a prior APA). This is consistent with prior years.

As the chart above illustrates, nearly three quarters of the total number of bilateral APAs executed in 2017 involved the United States entering into mutual agreements with either Japan or Canada.

The number of pending APAs has continued to decline since 2015 with Japan, India, and Canada accounting for more than half of all pending bilateral APAs.

Table 3: APAs Revoked or Cancelled and Applications Withdrawn § 521(b)(2)(C)(vii)

	Unilateral	Bilateral	Multilateral	Total
Revoked or Cancelled in 2017	0	0	0	0
Total Revoked or Cancelled 1991-20173				11
Applications Withdrawn in 2017	1	6	1	8
Total Applications Withdrawn 1991-20174				232

Table 4: APAs Finalized or Renewed⁵ by Industry § 521(b)(2)(C)(viii)

Industry
Manufacturing	48
Wholesale/Retail Trade	43
Services	12
Management	6
Finance, Insurance, and Real Estate	4
All Other Industries	3

Table 4a: Manufacturing APAs
Finalized or Renewed 2017

Manufacturing
Computer and Electronic Products	9
Chemical	9
Transportation Equipment	8
Miscellaneous Manufacturing6	10
All Other Types of Manufacturing	12

 

Table 4b: Wholesale/Retail Trade APAs
Finalized or Renewed 2017

Wholesale/Retail Trade
Merchant Wholesalers, Durable Goods	33
Merchant Wholesalers, Nondurable Goods	7
All Other Types of Other Wholesale/Retail Trade	3

Part III. General Descriptions of APAs Executed in 2017
[Pub. L. 106-170 § 521(b)(2)(D) and (E)]

Nature of the Relationships
§ 521(b)(2)(D)(i)

As in prior years, more than half of the APAs executed in 2017 involved transactions between non-U.S. parents and U.S. subsidiaries.

Covered Transactions, Functions and Risks, and Tested Parties
§ 521(b)(2)(D)(ii-iii)

Although most of the transactions⁷ covered in APAs executed in 2017 involve the sale of tangible goods and the provision of services, over 20% covered the use of intangible property, which can be among the most challenging in APMA's inventory. The IRS continues to seek opportunities to work with taxpayers and treaty partners to provide prospective certainty, wherever appropriate, for transactions involving the use of intangible property.

In the majority of APAs, the covered transactions involve numerous business functions and risks. For instance, with respect to functions, APAs involving manufactured products typically involve a controlled group that conducts research and development (R&D), engages in product design and engineering, manufactures the product, markets and distributes the product, and performs support functions such as legal, finance, and human resources services. Regarding risks, the controlled group may assume a variety of risks, including 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. Generally, for methods requiring selection of a tested party, the tested party that is chosen will be the least complex of the controlled taxpayers.

Over three quarters of the tested parties in 2017⁸ were U.S. distributors, U.S. manufacturers, or U.S. service providers.

Transfer Pricing Methods Used
§ 521(b)(2)(D)(iv)

Consistent with prior years, in 2017, the primary transfer pricing method (TPM) used for both the sale of tangible property and the use of intangible property was the comparable profits method/transactional net margin method (CPM/TNMM). The CPM/TNMM was used for 87 percent of transfers of tangible and intangible property while all other methods combined accounted for the other 13 percent of such transactions.

For covered transfers of tangible and intangible property that used the CPM/TNMM, the operating margin (OM) continues to be the most common profit level indicator (PLI) used to benchmark results. It was used 85 percent of the time. Other PLIs, such as the Berry Ratio and return on assets or capital employed, made up the other 15 percent. As used here, OM means the ratio of operating profits to sales,⁹ and “Berry Ratio” means the ratio of gross profit to operating expenses.¹⁰ Most services transactions (86 percent) also used the CPM/TNMM, and the OM was also the most common PLI (used 62 percent of the time).¹¹

Sources of Comparables, Comparables Selection Criteria, and Nature of Adjustments to Comparables or Tested Party Data
§ 521(b)(2)(D)(v-vii)

For the APAs executed in 2017 that used external comparable data in the analysis, the most widely used data source for comparables was Standard and Poor's Compustat/Capital IQ database. Other sources were also used in appropriate cases (e.g., where the tested party was not the U.S. entity or where transaction-based methods were applied). The other more commonly used databases are listed in the table below.

Table 5: Sources of Comparable Data

Avention (formerly known as OneSource)	Mergent
Bloomberg	Orbis
Disclosure	Recap
Global Vantage	RoyaltySource
ktMINE	RoyaltyStat
LoanConnector	Worldscope

In making comparability adjustments, the standard balance sheet adjustments identified in Treas. Reg. § 1.482-1(d) and § 1.482-5(c), including adjustments for differing amounts of payables, receivables, and inventory, were made in the majority of cases. Where appropriate, adjustments for different accounting practices were made to convert from LIFO to FIFO inventory accounting, and a small number of cases also involved the accounting reclassification of expenses, e.g., from COGS to operating expenses.

Ranges, Targets, and Adjustment Mechanisms
§ 521(b)(2)(D)(viii-ix)

Most transactions covered in APAs target an interquartile range as described in Treas. Reg. § 1.482-1(e)(2)(iii)(C). Where the transaction involves a royalty payment for the use of intangible property, both specific royalty rates and ranges have been used. Where the covered transaction is the payment of a royalty based solely on external royalty agreements, a secondary method, e.g., a test of the post-royalty operating margin or cost-plus mark-up, has been used. The testing periods of the APAs executed in 2017 were either: (1) a single year, (2) the term of the APA only, or (3) the term of the APA plus rollback years.

APAs executed in 2017 included several mechanisms for making adjustments to tested party results when the results fall outside the range or do not match the point required by the APA. The following are examples of the mechanisms used: an adjustment bringing the tested party's results to the closest edge of the range applied to the results of a single year; an adjustment to the closer edge of the range applied to the results over the APA term; an adjustment to the specified point or royalty rate; or an adjustment to the median of the range for a single year.

Critical Assumptions
§ 521(b)(2)(D)(v)

The model APA used by the IRS (included as Appendix 1 of this report) includes a standard critical assumption that there will be no material changes to the taxpayer's business or to its tax or financial accounting practices during the APA term. A few bilateral cases have also included critical assumptions tied either to the taxpayer's profitability in a certain year or over the term of the APA, or to the amount of non-covered transactions as a percentage of the taxpayer's revenue. Pursuant to § 7.06(3) of Rev. Proc. 2015-41, 2015 I.R.B. 263, APMA will cancel an APA in the event of a failure of a critical assumption unless the parties agree to revise the APA.

Term Lengths of APAs Executed in 2017
§ 521(b)(2)(D)(x)

Table 6: Term Lengths of APAs Executed in 2017

Term Length (years)	Number of APAs
2	1
3	3
4	6
5	38
6	9
7	16
8	16
9	11
10	6
11	5
12	2
13	2
14	1
Average	7

As described in § 3.03(1) of Rev. Proc. 2015-41, taxpayers should request an APA term that would cover at least five prospective years and may also request that the APA be “rolled back” to cover one or more earlier taxable years, although the appropriate APA term is decided on a case-by-case basis. Of the APAs executed in 2017, 22 percent included rollback years. A substantial number of those APAs with terms of greater than five years were submitted as a request for a five-year term, and the additional years were agreed to between the taxpayer and the IRS (or, in the case of a bilateral APA, between the IRS and the foreign government upon the taxpayer's request) to ensure a reasonable amount of prospectivity in the APA term.

Amount of Time Taken to Complete New and Renewal APAs
§ 521(b)(2)(E)

Table 7: Months to Complete New and Renewal APAs Executed in 2017

	Unilateral		Bilateral		Unilateral & Bilateral
	Average	Median	Average	Median	Average	Median
New	40.4	34.8	46.9	50.0	45.5	43.0
Renewal	28.7	27.2	37.3	32.2	34.7	30.5
New & Renewal	32.6	31.0	41.5	35.9	39.1	33.8

The median time required to complete an APA in 2017 increased slightly (32.8 months in 2016 versus 33.8 in 2017).

Efforts to Ensure Compliance with APAs
§ 521(b)(2)(F)

As described in § 7.02(1) of Rev. Proc. 2015-41, taxpayers are required to file annual reports to demonstrate compliance with the terms and conditions of their APA. The filing and review of these annual reports are critical parts of the APA process. Through annual report review, the APMA Program monitors taxpayer compliance with APAs on a contemporaneous basis. Annual report review also provides current information on the success or problems associated with the various TPMs adopted in the APA process.

Nature of Documentation Required in Annual Report
§ 521(b)(2)(D)(xi)

APAs require taxpayers to file timely and complete annual reports describing their operations and demonstrating compliance with the APA's terms and conditions. Not every annual report will include each of the items listed in the following table¹²; they are required where the facts demonstrate a need for such documentation.

1.	Statement regarding all material differences between Taxpayer's business operations during APA year and description of Taxpayer's business operations contained in Taxpayer's APA request. If there are no material differences, a statement to that effect.
2.	Statement concerning all material changes in Taxpayer's accounting methods and classifications, and methods of estimation, from those described or used in Taxpayer's request for the APA. If there has been no material change in accounting methods and classifications or methods of estimation, a statement to that effect.
3.	Any change to the taxpayer notice information.
4.	Description of any failure to meet critical assumptions. If there has been none, a statement to that effect.
5.	Statement identifying whether or not any material information submitted while the APA request was pending is discovered to be false, incorrect, or incomplete.
6.	The amount, reason for, and financial analysis of any compensating adjustment, for the APA year, including but not limited to: the amounts paid or received by each affected entity; the character (such as capital or ordinary expense) and country source of the funds transferred, and the specific line item(s) of any affected U.S. tax return; and any change to any entity classification for federal income tax purposes of any member of Taxpayer's group that is relevant to the APA.
7.	The amounts, description, reason for, and financial analysis of any book-tax difference relevant to the TPM for the APA year, as reflected on Schedule M-1 or Schedule M-3 of the U.S. return for the APA year.
8.	Statement regarding whether Taxpayer contemplates requesting, or has requested, to renew, modify, or cancel the APA.
9.	Financial statements and any necessary account detail to show compliance with the TPM, with a copy of the opinion from an independent certified public accountant or other documentation required by paragraph 5(f) of the APA.
10.	Financial analysis demonstrating Taxpayer's compliance with TPM.
11.	Organizational chart.
12.	A copy of the APA and any amendment.
13.	A penalty of perjury statement.

Approaches for Sharing of Currency or Other Risks
§ 521(b)(2)(D)(xii)

In appropriate cases, APAs may provide specific approaches for dealing with risks, including currency risk, such as adjustment mechanisms and/or critical assumptions.

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APPENDIX 1 — Model APA (based on Rev. Proc. 2006-9)
[§ 521(b)(2)(B)]

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 ________.

RECITALS

[Insert Taxpayer Name] is the common parent of an affiliated group filing consolidated U.S. tax returns (collectively referred to as “Taxpayer”), and is entering into this APA on behalf of itself and other members of its consolidated group.

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 ________.]

AGREEMENT

The Parties agree as follows:

WITNESS,

The Parties have executed this APA on the dates below.

[Taxpayer Name in all caps]

By:___________________________
Jane Doe
Sr. Vice President (Taxes)

Date: ___________________, 201___

IRS

By:___________________________
John C. C. Hughes
Director, Advance Pricing and Mutual Agreement Program

Date: ___________________, 201___

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APPENDIX A

COVERED TRANSACTIONS AND TRANSFER PRICING METHOD (TPM)

1. Covered Transactions.

[Define the Covered Transactions.]

2. APA Term.

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

3. TPM.

• CUP Method

• CUT Method

• Resale Price Method (RPM)

• Cost Plus Method

• CPM with Berry Ratio PLI

• CPM using an Operating Margin PLI

• CPM using a Three-year Rolling Average Operating Margin PLI

• Residual Profit Split Method

[Insert additional provisions as needed.]

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:

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.]

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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.]

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APPENDIX C

APA RECORDS AND ANNUAL REPORT

APA RECORDS

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:

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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 2006-9, section 11.01.
APA	This Advance Pricing Agreement, which is an “advance pricing agreement” within the meaning of Revenue Procedure 2006-9, section 2.04.
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.
APA Year	This term is defined in paragraph 5(a) of this APA.
Covered Transaction(s)	This term is defined in Appendix A.
Financial Statements	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 2006-9	Rev. Proc. 2006-9, 2006-1 C.B. 278.
Transfer Pricing Method (TPM)	A transfer pricing method within the meaning of Treasury Regulation section 1.482-1(b) and Revenue Procedure 2006-9, section 2.04.
U.S. GAAP	U.S. generally-accepted accounting principles.
U.S. Group	Worldwide Group members that are U.S. persons.
U.S. Return	For each taxable year, the “returns with respect to income taxes under subtitle A” that Taxpayer must “make” in accordance with I.R.C. section 6012. {Or substitute for partnership: For each taxable year, the “return” that Taxpayer must “make” 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.

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APPENDIX E

APA ANNUAL REPORT SUMMARY FORM

The APA Annual Report Summary on the next page is a required APA Record. The APA Team Leader supplies some of the information requested on the form. Taxpayer is to supply the remaining information requested by the form and submit the form as part of its Annual Report.