IRS Issues New APA Template

Summary

On May 11, 2018, the Internal Revenue Service (IRS) Advance Pricing and Mutual Agreement Program (APMA) released on its webpage the finalized advance pricing agreement (APA) template under Revenue Procedure 2015-41, 2015-35 I.R.B. 263 (Rev. Proc. 2015-41).  Below, we have highlighted and commented on several updates.  A more detailed explanation of the changes and guidance on using the template is available on the IRS website. 
 

Changes and BDO Commentary

1. There were clarifications to the definitions of APA “Covered Issues” and “Tested Party.” A covered issue should be described as the pricing for a transaction, rather than simply as a transaction (the Covered Issues example in section 3 of Appendix A has been revised accordingly). “Tested Party” as defined in Appendix A of the APA template is employed in a slightly more expansive sense in the APA template than normally used by transfer pricing practitioners. APMA affirmed its preference for applying the term to cases in which a particular entity’s results are “formally tested,” without regard to the specific method employed.

BDO Commentary: We find it helpful that the template clarifies for taxpayers that the covered issues should focus on the pricing of the covered transaction. APMA’s continued references to an APA “Tested Party” in a different context than applicable U.S. and international transfer pricing standards are not expected to create significant difficulties for taxpayers as they negotiate their respective APAs.

2. Two optional provisions regarding periodic adjustments have been added in the new section 4.e of Appendix A: covered platform contribution transactions (PCTs) will not be treated as Trigger PCTs to make periodic adjustments, and covered intangible transactions (other than PCTs) will not be subject to periodic adjustments.

BDO Commentary: Both of these updates are consistent with Rev Proc 2015-41 and affirm taxpayer-friendly guidance. The periodic adjustments mentioned in this section refer to PCT payments and intangible transfers, and were intended to provide taxpayers with a bright-line test with which to apply adjustments if actual results of the relevant transactions materially deviated from initial projections. The APA process is intended to provide taxpayers with certainty regarding the transfer pricing of covered issues for the covered years, therefore the periodic adjustment tests referenced should not be necessary, as the APA’s transfer pricing method for the covered issue and related testing mechanism(s) would suffice.

The existing inventory of completed and in-process APAs does not include many cost sharing arrangements as a covered transaction, and this change is unlikely to spur a large increase in APA requests including such transactions. More broadly, intangible assets are not typically included as a covered transaction within APAs.  According to the most recent Statutory Report to Congress, intangibles usage comprised approximately 20 percent of the total covered transactions in APAs executed by the IRS during 2017.  Most new and in-process APA requests will not be impacted by this clarification.

3. Section 7 of Appendix A, “Effect of Certain Adjustments by Tax Authorities and Resulting Competent Authority Proceedings” was removed.  The section was previously proposed to address situations where a covered method could be re-applied to a non-APA covered entity, taking into account certain adjustments between the non-APA covered entity and the APA covered entity and the resulting competent authority resolution that would affect APA testing.  At this time, APMA has concluded that additional research is needed to answer this question, and has invited comments.

BDO Commentary: In general, transfer pricing analyses apply to the specific facts of each taxpayer’s business and related intercompany transactions. APAs by definition cover the transactions and issues that the taxpayer agreed to include in the scope of the APA; therefore our general expectation is that most taxpayers would not be receptive to application of the transfer pricing method agreed in their APA to a non-APA covered entity. The inclusion of additional, non-covered entities’ results would potentially complicate the administration of the APA as well. The IRS has requested additional commentary on the issue, which we will monitor.

4. Perhaps the most important IRS feedback on the APA Template is in relation to APA primary adjustments and the required secondary adjustments arising from them. Specifically, the IRS position is that intercompany payables set up in connection with APA primary adjustments should be treated as intercompany indebtedness for all other U.S. income tax purposes, including Section 956 of the Internal Revenue Code, unless the payables created are liquidated within 90 days of the close of the APA tax year pertaining to the adjustment. Therefore, APA primary adjustments that lead to creation of such intercompany payables have the potential to create additional issues for taxpayers, particularly for tax years already closed.

BDO Commentary: Taxpayers are likely disappointed but not surprised by the IRS position on this issue. The additional language in this section of the APA template is helpful, as it provides some ability for taxpayers to avoid Section 956 treatment, if the 90 day deadline is met. Taxpayers with APAs in process may work with APMA to minimize the potential for such issues by seeking APA testing and adjustment mechanisms that allocate APA primary adjustments to APA tax years not already closed, to meet the 90 day threshold on liquidation of concomitant intercompany payables.