IRS issues annual APA report for 2013

Transcription

1 31 March 2014 International Tax Alert News from Transfer Pricing EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Services/Tax/International- Tax/Tax-alert-library#date IRS issues annual APA report for 2013 Executive summary The IRS issued the 15th annual Advance Pricing Agreement (APA) report (the Report) on 27 March 2014, in Announcement The Report provides an updated discussion of the APA program, including its activities and structure for calendar year 2013, gives useful insights into the operation of the program and indicates some of the treatment and processes that companies applying for an APA can expect to encounter. The Report shows that the Advanced Pricing and Mutual Agreement program (APMA program) continues to make great strides in improving the efficiency of APA administration, surpassing many of the milestones achieved in 2012 following the merger of the APA and competent authority programs. The Report mirrors the streamlined structure first unveiled last year, and continues to include information on program trends not discussed prior to 2012, which can be useful for taxpayers considering an APA. Highlights During 2013, 111 APA applications were filed and 145 APAs were completed. This represents a single-year record high number of closures and is more than three times the program s 2011 output. For the second year in a row, the number of case closures exceeded the number of applications received, leading to progress in reducing the program s inventory of pending cases. At year end, 331 APA requests were pending, down from 391 pending requests at the end of Continuing the practice begun with the 2012 Annual report, details on the treaty partners to the bilateral APAs concluded during the year are provided. APAs with Japan (53%), Canada (19%) and the UK (8%) combined comprised 80% of all US bilateral APAs executed in 2013.

2 The median time required to complete an APA decreased significantly, from 39.8 months in 2012 to 32.7 months in Overall headcount decreased from approximately 104 professionals in March 2013 to 91 in March Unilateral APA requests decreased slightly from 24 in 2012 to 20 in Approximately 55% of the APAs executed in 2013 were completed with companies having a foreign parent while 40% were completed with US parent companies. The remaining 5% involved transactions that included either a partnership or a branch. The Comparable Profits Method/ Transactional Net Margin method (CPM/TNMM), using an operating margin as the profit level indicator (PLI), was once again the Transfer Pricing Method (TPM) most commonly applied to APA transactions involving tangible and intangible property (77%). The Services Cost Method (SCM) was applied in 39% of the APAs with intercompany service transactions. A close second was the CPM/TNMM, which was used in 36% of intercompany service transactions, with the Berry Ratio as the most commonly selected PLI. This represents a break from the historical dominance of markup on total cost (MTC) as the most commonly selected PLI in service 1 Staff levels are reported as of the date of the each year s Announcement. transactions. However, the MTC was used as the PLI in 38% of the transactions, and was just barely edged out by the Berry Ratio, which was applied in 39% of the transactions. Background An APA is an agreement between the IRS and a taxpayer under which the IRS agrees not to seek a transfer pricing adjustment under IRC 482 for one or more specific covered transaction(s) if the taxpayer files its tax return for a covered year based on the agreed TPM(s). The APA process is a voluntary program designed to resolve actual or potential transfer pricing disputes in a principled, cooperative manner, as an alternative to the traditional examination process. The Revenue Procedure (Rev. Proc.) covering APAs has seen many updates and revisions since 1991 when Rev. Proc was issued. The current Rev. Proc was released in December of 2005 and was amended by Rev. Proc in May of In November 2013, proposed revenue procedures governing APA and MAP applications were released for public comment in Notice , I.R.B. 653 and Notice , I.R.B. 633, respectively. These proposed changes triggered vigorous public discourse and voluminous commentary, and APMA has indicated the proposed revenue procedures will likely be revised significantly and re-released for public comment. The benefits of an APA include: Reduction or elimination of the risk of transfer pricing adjustments, penalties, and interest as well as the risk of double taxation. Reduction of financial statement reserves and administrative costs associated with transfer pricing compliance. Certainty of prospective tax treatment for APA covered transactions and a consequent increase in tax and management flexibility. Flexibility in adopting transferpricing methods to deal with unique transactions, or a lack of good comparables. Cost effective management of multiple past and prospective years compared to the traditional examination process. The APMA Program favors agreements with terms of at least five years, which can be extended through renewal procedures. In 2013, 41% of the completed agreements were for terms of five years. Approximately 93% of all cases had terms of nine years or less, with the average term being six years. When competent authority procedures are available in the other countries involved (under an effective tax treaty), the IRS encourages bilateral or even multilateral APAs. These agreements are also binding on the foreign tax authority for the same period of time and help avoid instances of double taxation. 2 International Tax Alert Transfer Pricing

3 Detailed discussion In 1999, Congress mandated that the APA Program publish an annual report summarizing key information regarding the various APAs filed, pending, and executed during the previous calendar year. This requirement is framed so as to achieve a compromise between providing the public information as to how the IRS resolves transfer pricing issues in the APA process, and protecting the confidential tax information of taxpayers participating in the APA Program. APA applications, executed APAs, and pending APAs Since the APA program s inception in 1991 through 31 December 2013, the IRS has received a total of 1,856 APA applications, and executed 1,300 APAs. The table below reports summary statistics about 2013 APA applications, executed APAs, and pending APAs. Data are reported separately for unilateral and bilateral APAs, and completion times for 2013, 2012, and 2011 are compared. Of particular note is the total of 145 APAs completed in 2013, which continued APMA s trend of more than tripling the output obtained during the last year prior to the consolidation of the competent authority and APA teams, and again established a new single-year record high number of closures. Also noteworthy is APMA s continuation of significantly more renewals executed in 2013 compared to As with last year, more renewals were executed during 2013 than those completed from 2009 through This is likely indicative of APMA s effort to streamline the APA renewal process. It is unclear why applications were down somewhat in Unilateral Bilateral Total* Year APA applications New APAs executed Renewals executed Pending requests for APAs Pending requests for new APAs Pending requests for renewals APAs canceled or revoked APAs withdrawn * In some cases, the totals include additional multilateral cases International Tax Alert Transfer Pricing 3

4 Staffing changes and operating efficiencies In 2012, there was a concerted hiring effort that focused on adding economist resources. This more than doubled the number of economists available to develop APA positions and therefore enabled the IRS to deploy the appropriate resources to each case while reducing case processing times. Originally, it was believed that the need to train new personnel, coupled with a September 2012 office move that consolidated all Washington, DC APMA employees in the same office, would limit APMA s efficiency during 2012 and that the full impact of the increased staffing would not be seen until However, the net impact last year was positive, and in 2013, the trend continued, as another record was surpassed for the number of APAs completed. The relatively static nature of the number of APAs executed in 2013 as compared to 2012, despite faster processing times, is likely explained by the reduction in APMA staff. The size of the APMA staff has decreased by approximately 10% since last year. Next year s results could show a decline, once the impact the reduced workforce has on the execution of new and pending cases is fully brought to bear. As of March 2014, there were 26 economists on staff at APMA. Months to complete APAs The data reported below indicate that the average time to completion for new bilateral APAs has decreased from 47.5 months in 2012 to 41.8 in The average time to completion for new unilateral APAs has increased from 28.4 months in 2012 to 34.9 months in Bilateral (new) Bilateral (renewal) Bilateral (combined) Average months Unilateral (new) Unilateral (renewal) Unilateral (combined) Average months International Tax Alert Transfer Pricing

5 Treaty partners in bilateral APAs As shown in the chart below, APAs with Japan continued to represent more than half of all bilateral APAs executed in This is attributable to the maturity of the APA programs in the United States and Japan and the negotiating experience of the APMA team and the competent authority team representing the National Tax Administration of Japan. Canada is the second most frequently involved treaty partner, owing to its role as the United States s largest trading partner. Bilateral APAs by Country International Tax Alert Transfer Pricing 5

6 Industries covered As shown in the chart below, manufacturing and wholesale/retail trade continue to comprise the largest share of APA cases, representing more than three of every four APAs completed in Industry Representation 6 International Tax Alert Transfer Pricing

7 Nearly half of all manufacturing cases involved transportation equipment or chemicals, while the wholesale/retail trade cases were dominated by wholesalers of durable goods. Manufacturing Wholesale/Retail Trade International Tax Alert Transfer Pricing 7

8 Covered transactions and tested parties The Report describes, in overall terms, the covered transactions and sets out the functions performed by the related entities, as well as the tested party in each transaction. Note that one APA may cover more than one transaction. Covered Transactions Tested Parties 8 International Tax Alert Transfer Pricing

9 Transfer pricing methods applied The CPM/TNMM continues to be the most commonly applied method in cases involving transfers of tangible and intangible property. Tangible and Intangible Property TPM Services TPM International Tax Alert Transfer Pricing 9

10 Critical assumptions A critical assumption is a fact on which the taxpayer s TPM is dependent. APAs typically list critical assumptions that involve a particular mode of conducting business operations, a particular corporate or business structure, or a range of expected business volume. The model APA used by the IRS 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, and all the APAs executed in 2013 included that standard critical assumption. A few bilateral cases have included critical assumptions tied to either 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. If a critical assumption has not been met, and the parties cannot agree on how to revise the APA, the APA can be canceled. The IRS did not cancel any APAs in 2013 due to the failure of a critical assumption (or any other reason). Adjustments to comparables or tested parties The Report notes adjustments that were made for material differences between controlled and uncontrolled transactions. Balance sheet adjustments for payables, receivables and inventory continue to be the most widely used adjustments. Implications Taxpayers should view APMA s continued trend of a record closure rate as an indication that the IRS is serious about improving the APA process. The leadership of the APMA Program recognizes that taxpayers are voluntarily approaching the IRS for prospective resolution, and that optimizing the program provides for a more efficient deployment of resources for both the IRS and the taxpayer. Taxpayers are typically most concerned about the amount of time required to resolve an APA case, and this year, APMA continued to drive processing times down, reducing last year s median by seven months. APMA s continued focus on reducing processing times is expected to lead more taxpayers to consider pursuing APAs as a way to proactively resolve their transfer pricing issues. This may be especially true within the context of the OECD base erosion and profit shifting (BEPS) environment of increased focus on transparency and impending country by country reporting. 10 International Tax Alert Transfer Pricing

11 For additional information with respect to this Alert, please contact the following: Ernst & Young LLP, ITS-Transfer Pricing, Washington, DC David Canale Karen Kirwan Loren Ponds Ernst & Young LLP, International Tax Services US Transfer Pricing Controversy Services David Arnold David Canale Purvez Captain Paul Chmiel Ken Christman kenneth.christmanjr.com Fred Johnson Per Juvkam-Wold Dan Karen Karen Kirwan Carlos Mallo John Ridgeway Craig Sharon Monique van Herksen Miller Williams Jim Wisniewski Karyn Zizza Transfer Pricing leaders Ernst & Young LLP, Houston Purvez Captain Ernst & Young LLP (Canada), Ottawa John Oatway Mancera, S.C., Mexico City Jorge Castellon Ernst & Young Ltda., Bogota Andres Parra Kost Forer Gabbay & Kasierer, Tel Aviv Lior Harary-Nitzan Ernst & Young LLP, US Area Leaders Larry Eyinla, Atlanta Colleen Warner, Chicago Mark Camp, Houston Maison Miscavage, McLean, VA Michael Merwin, New York Barbara Mace, New York (Financial Services) Curt Kinsky, San Jose David Canale, Washington, DC (National Tax) International Tax Alert Transfer Pricing 11

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