Top Trends in IRS’ 2018 APA Annual Report

The IRS released on March 22, 2019, the “Announcement and Report Concerning Advance Pricing Agreements,” an annual report provided to Congress on the advance pricing agreements (APAs) negotiated by the IRS Advance Pricing and Mutual Agreement (APMA) group. The report highlights trends in the APA inventory during the year ended December 31, 2018. These are the top five trends in 2018:

• Significant increase in APA requests, vis-à-vis 2017.
• Continued growth in bilateral APA (BAPA) requests with India and inventory.
• Slight decrease in APA executions, vis-à-vis 2017.
• Increased processing time for APA requests.
• Continued reliance on the CPM/TNMM as the transfer pricing method for most APAs.

We comment on these trends below.
 

Growth in APA Requests and Inventory

The IRS APA inventory grew significantly in 2018, which was primarily driven by a spike in demand for new and renewal APA requests. Specifically, there were 203 APA requests in 2018, which represents a 101 percent increase over the 103 requests filed in 2017. In contrast, in 2018 there were 107 APAs executed, which represents an 8 percent decrease from 2017’s 116 closures.  The net effect was a 19 percent increase in pending APA inventory, from 386 cases at the beginning of the year to 458 cases by the end of 2018. The drivers of the increase may include U.S. tax reform, taxpayers filing before increases in APA user fees that took effect during 2018, and increased levels of transfer pricing scrutiny and controversy by many treaty partners.

In 2018 the proportion of renewal APAs executed was approximately 60 percent, with the remaining 40 percent corresponding to new APA requests, which is broadly consistent with 2017 (and prior years).

 

Review of APA Requests and Executions by Treaty Partner

Although BAPAs with Japan retained the top spot in both 2018 requests and executions, growth in the Indian APA inventory notched significant gains. Below are the top five countries covered in BAPA requests for 2018 and 2017.

 

Table 1: BAPA Requests by Treaty Partner

Rank	2018	% of Requests	2017	% of Requests
1	Japan	31%	Japan	38%
2	India	20%	India	21%
3	Canada	9%	Canada	8%
4	Germany	8%	Switzerland	6%
5	Korea	5%	Germany	5%
	Subtotal	73%	Subtotal	78%
	Rest of World	27%	Rest of World	22%

To understand changes in the IRS APA inventory, we also review the executions of BAPA in 2018 versus 2017, by treaty partner, as shown below.
 

Table 2: BAPA Executions by Country/Treaty Partner

Country	2018	% of Closures	2017	% of Closures
1	Japan	39%	Japan	57%
2	Canada	20%	India	16%
3	Korea	10%	Canada	9%
4	Mexico	6%	Switzerland	6%
5	Netherlands	4%	Germany	4%
	Subtotal	73%	Subtotal	79%
	Rest of World	27%	Rest of World	21%

 

Increase in Pending Indian APAs

From these two tables, we can discern that the APA inventory turnover is concentrated among relatively few treaty partners (i.e., Japan, Canada, Korea), however India is conspicuously absent from Table 2. Given the continued strength in Indian BAPA requests but low rate of closures (less than 4 percent of the inventory in either year), the inventory of Indian BAPAs increased markedly in 2018. Given that the IRS began accepting Indian APA requests in 2016, much of this can be explained by the normal lag time in processing BAPAs (see commentary below). Unofficial reports from the India-U.S. Competent Authority meeting in spring 2019 indicate that significant progress was made, which hopefully will translate into increased BAPA executions in 2019. If not, taxpayers may (again) become concerned about the ability of the U.S. and Indian Competent Authorities to efficiently process their caseload.

 

Increase in APA Processing Time

Median APA processing time for APAs executed in 2018 was 40.2 months, versus a median of 33.8 months for 2017 executions, and represents a 19 percent increase. Surprisingly, median processing time for renewal APAs in 2018 was not significantly faster than for new APAs: 40.1 months for APA renewals versus 41.7 months for new APA requests. For reference, median processing time for renewal APAs in 2017 was 30.5 months – almost 10 months faster. We can surmise that APMA applied greater scrutiny to the renewal requests executed in 2018 than in prior years; a potential driver of this is that the taxpayers’ renewal requests may reflect changes to the operating business structure that require significant APMA due diligence.

Consistent with prior years, unilateral APAs were processed faster than BAPAs. Specifically, median processing time for unilateral APAs executed in 2018 was 33.5 months, versus 42.1 months for BAPAs.

 

Services and Tangible Goods Transactions Dominate Covered Issues

Consistent with prior years, approximately 80 percent of the issues and transactions covered in the 2018 APA executions comprised of tangible goods and services transactions, and the approximate 20 percent remaining included IP-related transactions. Of course, this delineation may likely be more complex than its presentation, since tangible goods bought and sold among affiliates often include embedded intangibles. APMA cases usually involve a thorough review of the value chain as relevant to the proposed tested transactions, which would include analysis of each related party’s contributions to the intangible assets that are relevant to the transaction.

 

CPM/TNMM as Chief Transfer Pricing Method

Also consistent with prior years, the Comparable Profits Method/Transactional Net Margin Method was employed in approximately 86 percent of executed APAs, and the operating margin is the most common profit level indicator.