Advance Pricing Agreements Are Transfer Pricing’s Go-To Model

As the popularity of advance pricing agreements continue to rise, and the IRS continues to review APA requests more stringently, multinationals may be tempted to consider alternatives.

A closer look at the alternatives, particularly the International Compliance Assurance Program, or ICAP, shows APAs will likely remain the dominant choice.

APAs, under Rev. Proc. 2015-41, are a “voluntary process whereby the IRS and taxpayers may resolve transfer pricing issues and issues for which transfer pricing principles may be relevant in a principled and cooperative manner on a prospective basis.”

Interim guidance issued last year unveiled new procedures—including for renewing existing agreements—that departed from the agency’s practice of accepting nearly all APA requests. Taxpayers that submit an APA prefiling memorandum, as well as an APA request, may find that their APA request has been rejected.

The IRS instead may recommend resolving issues through “alternative workstreams” that include a joint audit, an IRS transfer pricing practice examination, or requesting resolution through ICAP.

When considering these alternatives, taxpayers must consider the voluntary nature of the process; whether the alternative resolves the issues for which an APA would be sought; and prospective application of any resolution of the relevant issues. Joint audits or transfer pricing practice examinations aren’t voluntary taxpayer-initiated procedures.

ICAP Alternative

Like an APA, ICAP is a voluntary, taxpayer-initiated process that was launched by the OECD in 2018 to reduce transfer pricing controversies. It allows taxpayers and multiple tax authorities to agree that certain defined issues are unlikely (or likely) to result in material risk of adjustment if an examination of those issues took place.

Under ICAP, tax authorities usually consider one or two of a company’s most recent tax years plus two roll-forward years. As a result, there can be prospective application of an ICAP outcome as there is for an APA resolution.

ICAP can cover five core risk areas: tangible goods transactions, intangible property transfers, service transactions, financing transactions, and permanent establishment issues. The first four issues also can be covered by an APA.

In addition, the IRS can allocate profits between or among US and non-US taxpayers. The issues that can be covered by ICAP and APAs are nearly identical.

Unlike APAs that are generally unilateral (IRS only) or bilateral (two countries), at least three jurisdictions are required to participate in the ICAP review. Data published by Organization for Economic Cooperation and Development on Jan. 29 shows that up to nine countries have participated in ICAP cases that had been completed. Thus, an ICAP outcome generally has greater applicability than the typical bilateral APA.

Except for Argentina, Columbia, and Singapore, all 22 countries participating in ICAP have bilateral income tax treaties with the US. ICAP and APAs are available as alternative workstreams for the 19 remaining countries.

South Korea, Switzerland, and Mexico don’t participate in ICAP, but the US has entered into a material number of APAs with them, so there isn’t complete overlap between countries where bilateral APAs and ICAP are available for US taxpayers.

Levels of Certainty

The primary difference between ICAP and APAs is the level of certainty they provide taxpayers. ICAP isn’t a legally binding agreement. An ICAP resolution results in a determination that an issue is low-risk or not low-risk.

A low-risk determination creates a non-binding commitment by the participating tax authorities not to examine the issue for the tax years covered by the ICAP request. A not-low-risk determination can result in an examination or a proposed adjustment.

The OECD reports that eight of the 20 ICAP cases to date have led to all the covered issues being classified as low-risk, with 12 resulting in one or more not-low-risk outcomes. The OECD also reports that 32% of the not-low-risk outcomes were resolved, likely through a proposed adjustment followed by a competent authority agreement.

Summarizing the results of the 20 ICAP cases to date, eight resulted in non-binding low risk determinations, four in some type of adjustment that was resolved during ICAP, and eight in not-low-risk determinations that likely resulted in further administrative proceedings by one or more of the participating tax authorities.

Treating the eight cases with low-risk determinations and the four with resolutions as successful outcomes, ICAP has a 60% success rate to date. As a comparison, the IRS’s APA program has resolved 2,268 cases since 1991, with 284 APAs withdrawn or suspended, resulting in a complete resolution for 89% of the APA cases that have been closed.

These statistics are important because they demonstrate that in most APA cases, taxpayers and the IRS can resolve difficult transfer pricing issues and provide certainty through mutually binding agreements.

The recently published OECD report on ICAP acknowledges the difference between the legal certainty from an APA or mutual agreement procedure resolution and the impact of a low-risk outcome in ICAP. But it also concludes that ICAP “could be viewed as providing a degree of ‘practical certainty’ to an MNE, subject to the terms of the relevant outcome letter.”

Outlook

Most multinationals seeking APAs do so because they want certainty of outcomes for the issues that are proposed to be covered by an APA. The lack of certainty of an ICAP outcome means that ICAP isn’t a substitute for an APA.

Moreover, the APA program has a much higher percentage of positive results than ICAP does to date. While it’s early days for the ICAP program, it’s hard to imagine that most multinationals will consider ICAP as an attractive alternative to an APA.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Mike Patton is senior counsel at DLA Piper, and helped negotiate the first bilateral APA.

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