INSIGHT: U.S.-Japan Advance Pricing Agreements Remain Valuable to Japan-based Multinationals

Japan-based multinationals (“MNCs”) have historically embraced U.S.-Japan bilateral advance pricing agreements, constituting over 50 percent of all U.S. APA cases resolved in recent years.

APAs allow a taxpayer to prospectively negotiate transfer pricing determinations with the affected governments to avoid future disputes.

Since APAs represent an alternative to the regular transfer pricing enforcement process of examination, administrative appeals process, litigation and mutual agreement procedure, a comparison of two factors determine the desirability of a U.S.-Japan APA: 1) the anticipated cost, effort, and outcome of the regular transfer pricing enforcement process, and 2) the anticipated cost, effort, and outcome of the APA process.

We will review the impact of recent changes in global transfer pricing enforcement and changes in the U.S. and Japan APA processes to determine the impact of these changes on the current desirability of an APA. Then, we will look to recent APA statistics to identify any trends in U.S.-Japan APAs. Although the decision whether any MNC should pursue an APA is unique to that MNC, this overview should be helpful to any corporation considering the APA process for U.S.-Japan transactions.

Recent Changes to the Global Transfer Pricing Enforcement Regime

Global increase in transfer pricing disputes. Each year, more countries initiate active transfer pricing enforcement, inevitably increasing the number of transfer pricing disputes. According to statistics kept by the Organisation for Economic Co-operation and Development (“OECD”), the global inventories of disputes between treaty partners, largely composed of transfer pricing issues, more than doubled in seven years, from 3,328 cases in 2010 to 7,190 cases in 2017.

BEPS impact on global transfer pricing disputes. In 2015, the OECD released the Base Erosion and Profit-Shifting (“BEPS”) project report which attempts to restrict the ability of MNCs to artificially shift income from higher-tax locations to lower-tax locations. BEPS Actions 8-10 attempt to align income with value creation, Action 13 addresses documentation and country–by-country (“CbyC”) reporting requirements in a manner that will increase taxpayer compliance efforts. Action 14 encourages improvements to dispute resolution mechanisms. In addition to the compliance effort and costs, the reporting requirements are expected to produce an incremental increase in the number of transfer pricing disputes between treaty countries.

U.S. Tax Reform. Recent U.S. tax legislation will increase the uncertainty surrounding the impact of transfer pricing adjustments. Public Law 115-97 (“the Act”), signed into law on December 22, 2017, introduced many new international tax provisions that can have a significant impact on U.S. taxpayers considering an APA or with an existing APA. In addition to the reduction of the corporate federal tax rate from 35 percent to 21 percent, the provisions of the Act most likely to impact APAs are the base erosion and anti-abuse tax (“BEAT”), the modifications to the definition of intangibles under Sec. 936, modifications to Sec. 482, the introduction of the global intangible low tax income (“GILTI”) defined in Sec. 951A, foreign derived intangible income (“FDII”) defined in Sec. 250, and interest expense limitations defined in Sec. 163(j). Taken together, these changes impose numerous competing tax regimes, each of which relies on income characterization and allocation to determine the tax outcome.

With the limited guidance surrounding the new tax provisions, the certainty provided by an APA has become more attractive. APAs can be used to gain certainty regarding the application of provisions such as BEAT, which focuses on certain cross-border related party payments from a U.S. entity to a foreign related party. The transactions affected by the BEAT provisions can be proactively discussed during the course of APA negotiations.

U.S. transfer pricing enforcement. The IRS has become more active in pursuing transfer pricing issues in examination and beyond. An IRS memorandum stated that the International Business Compliance and Transfer Pricing units of its LB&I division had 1,060 cases under examination as of December 31, 2013, involving between $90 billion and $194 billion of estimated potential adjustments. Also, statistics gathered by the Transfer Pricing Report indicate the IRS currently has 21 transfer pricing cases under the jurisdiction of the U.S. Tax Court.

Overall impact. Each of the global enforcement trends mentioned would increase the likelihood of a transfer pricing dispute and raise concerns about the outcome of such a dispute. BEPS changes and U.S. Tax Reform could also increase the cost of compliance and possibly the cost of disputes. Taken together, these global transfer pricing enforcement changes strongly increase the value of the certainty achieved by an APA.

The U.S. APA Process

Revised APA Revenue Procedure and new APA template. In 2015, the IRS updated the APA process with Revenue Procedure 2015-41 (“Rev. Proc. 2015-41”). Rev. Proc. 2015-41 stipulates the content and format of the APA submission package in great detail and requires inclusion of interrelated issues, statute of limitation extensions, and mandatory pre-filing meetings in certain circumstances. Although Rev. Proc. 2015-41 requires more information than previous APA guidance, the additions are intended to speed up the APA process itself. In 2017, the IRS shared a draft APA template which has been finalized in a new final template in 2018. Both the draft and the new APA template largely track the previous template, with one important change—the draft APA template would impose subpart F income treatment on the repatriation of certain adjustment amounts, and the new template would retain that treatment in more limited circumstances. For practical reasons, this subpart F impact would generally not apply to covered transactions involving a Japan-based MNC.

Internal APA process changes. Some internal APA process developments have occurred since Rev. Proc. 2015-41 that have not been addressed in formal guidance. APMA has developed an “intake process” to rank APA requests by size and level of complexity for assignment of APMA team leaders and economists. APMA has attempted to streamline the APA process and encourages “elevation” of issues that could prevent the case from moving forward. APMA has also experimented with the use of “reference sets” of comparables to limit the time and effort in the development of arm’s length ranges. All of these internal changes are intended to improve the overall efficiency of the APA process.

Revised APA user fees. In February 2018, the IRS announced a two-stage increase to APA user fees:

For APA requests filed after June 30, 2018, APA user fees will increase to:

• $86,750 from $60,000 for new APAs;
• $48,500 from $35,000 for APA renewals;
• $42,000 from $30,000 for small case APAs; and
• $17,750 from $12,500 for amendments to APAs.

After Dec. 31, 2018, APA user fees will increase to:

• $113,500 for new APAs;
• $62,000 for APA renewals;
• $54,000 for small case APAs; and
• $23,000 for amendments to APAs

No related changes to the APA process are anticipated, so this fee change will only increase the delivery price of an APA outcome, thus reducing the desirability of an APA. It is important to note that taxpayers can make what is known as a “dollar filing” to secure the lower user fee before as increase by 1) paying the user fee before the date the fee increases, 2) filing the comprehensive APA request within 120 days, and 3) addressing any minor deficiencies promptly.

Overall Impact. The Rev. Proc. 2015-41 revisions and internal process changes are all intended and expected to improve the speed of resolution for APA cases. The user fee change will increase costs. None of these changes is expected to affect the outcome of APA cases. Thus, overall, changes to the APA process will make APAs more desirable, but user-fee increases may reduce that desirability some.

The Japan APA Process

The bilateral advance pricing agreement (“BAPA”) process in Japan is similar to the U.S. APA process. The Japan BAPA process starts with a pre-filing conference with the Japanese tax authority. The taxpayer receives feedback in the pre-filing conference before finalizing its position in the official BAPA request. The official BAPA request is then filed with the Japanese tax authority along with other submission documents.

Following submission, the BAPA request is examined by the regional taxation bureau (“RTB”) through a due diligence process. The RTB develops the recommended Japan negotiating position through the due diligence process and discussion with the National Tax Agency (“NTA”). As soon as the RTB concludes the due diligence process and writes up the position paper, the case is transferred to the NTA for further development and to finalize NTA’s negotiating position, taking the RTB’s recommended settlement position into account.

Unlike the U.S. APA process, no user fee is required for the Japan BAPA submission. Also unlike the U.S., the Japan BAPA program has no separate rules for small business taxpayers; the Japan BAPA process is the same regardless of the sales volumes of the companies or the size of the covered transactions. However, relatively straightforward BAPA cases such as BAPA renewals tend to take less time. Similarly, for example, typical automotive parts cases involving the BAPA process, where the Japanese parent company plays the entrepreneurial role in the covered transactions with the U.S. subsidiary, also tend to be resolved relatively efficiently.

Recent APA Statistics

The U.S. APMA Program recently issued the APA Annual Report for calendar year 2017. The IRS’ overall number of APAs executed grew from 86 in 2016 to 116 in 2017. The 2017 APA Annual Report also included country-specific information that is consistent with a solid U.S.-Japan negotiating relationship. The Japanese percentage of overall U.S. APA filings increased from 31% in 2016 to 38% in 2017. U.S.-Japan APAs account for 57 % of U.S. bilateral APAs agreed in 2017, over twice the percentage of the next country. Based on these statistics, U.S.-Japan APAs remain valuable to Japan-based MNCs.

U.S. APA Program Information

Japan APA Program

According to the BAPA statistics disclosed below by the NTA for tax year 2017, BAPAs continue to be concluded by the NTA in consistently high numbers, and BAPAs with Americas account for over one-third of the BAPA in-process inventory of the Japanese tax authority (nearly all of the Americas APA cases are with the U.S.).

Conclusion

As an alternative to the regular transfer pricing enforcement process, APAs continue to be desirable for MNCs with U.S.-Japan transactions. External factors uch as the continued increase in global transfer pricing disputes, the BEPS-encouraged increase in transfer pricing reporting requirements, U.S. tax reform uncertainty, and increased U.S. transfer pricing enforcement continue to increase the value of the certainty achieved in the APA process. Further, most of the recent changes to the U.S. APA process, except for the increased fee structure, should improve the speed and reduce the cost of an APA. Statistics, both in the U.S. and Japan support the continued general popularity of APAs, and the continued popularity of U.S.-Japan bilateral APAs in particular.

Author Information

Steven C. Wrappe is the deputy global leader of the global transfer pricing dispute resolution network for KPMG’s global transfer pricing services. Atsuko Kamen is the U.S. practice leader of Japanese transfer pricing within KPMG’s global transfer pricing services. Koichiro Fujimori is a partner and Yuri Numata is a senior manager in KPMG Tax Corp. in Japan, specialized in transfer pricing.

The information in this article is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230 because the content is issued for general informational purposes only. The information contained in this article is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author or authors only, and does not necessarily represent the views or professional advice of KPMG LLP.

Bibliography

Announcement 2018-08, 2018-19 I.R.B. 552 (May 7, 2018).

Organization for Economic Co-operation and Development, Mutual Agreement Statistics for 2016, available at http://www.oecd.org/tax/dispute/mutual-agreement-procedure-statistics.htm

OECD (2015), Explanatory Statement, OECD/G20 Base Erosion and Profit Shifting Project, OECD, available at http://www.oecd.org/tax/beps-explanatory-statement-2015.pdf.

Public Law No: 115-97 (12/22/2017).

M. Martin, S. Foley and T. Bettge, BEAT’s Impact on Transfer Pricing Dispute Resolution, Transfer Pricing Report (Feb. 22, 2018).

D. Gregory and P. Shukovski, IRS: As of 2014, 1,000 Transfer Pricing Cases Under Audit, 24 Transfer Pricing Report 553 (Sept. 4, 2015).

S. Kassam, Court Roundup: IRS to Get $608 Million From Boston Scientific, 27 Transfer Pricing Report (June 14, 2018).

Rev. Proc. 2015-41, 2015-35 I.R.B. 263, Appendix 1. Rev. Proc. 2006-09 also listed required information, but did not dictate the ordering and format.

New APA Template Under Rev. Proc. 2015-41, available at https://www.irs.gov/businesses/corporations/new-advance-pricing-agreement-apa-under-rev-proc-2015-41-2015-35-irb-263.

I.R.S. Statement (2-6-18).

National Tax Agency, “Outline of the Revision of the Transfer Pricing Documentation,” June 2016 (Japan), unofficial translation at http://www.nta.go.jp/shiraberu/ippanjoho/pamph/pdf/h28iten-kakaku_en.pdf. The BEPS-related documentation rule in Japan was effective as of April 1, 2016.