April 2, 2021
IRS issues annual APA report for 2020
The IRS Advance Pricing and Mutual Agreement (APMA) Program issued the 22nd annual Advance Pricing Agreement (APA) report (the Report) on March 23, 2021, in Announcement 2021-06. The Report discusses APMA, including its activities and structure for calendar year 2020, and gives useful insights into the operation of the APA Program.
The number of APA filings remained the same in 2020 as in 2019, with taxpayers filing 121 APA requests each year. The total number of APAs concluded, however, increased from 120 to 127 and the median amount of time to finalize an APA decreased from 38.8 months in 2019 to 32.7 months in 2020.
— During 2020, 121 APA applications were filed and 127 APAs were executed. APMA closed more APAs than it received in 2020. The number of APAs completed during 2020 is generally consistent with the number of APAs completed during the last several years. Additionally, there has been a continued interest in bilateral APAs filed with Japan (41%), India (11%) and Canada (10%), representing 62% of all US bilateral APAs filed.
— At year end, 448 APA requests were pending (384 bilateral, 21 multilateral and 43 unilateral), down from 454 in 2019.
— The median time required to complete an APA decreased from 38.8 months in 2019 to 32.7 months in 2020.
— Overall APMA headcount increased to 98 professionals (including the Director) as of December 31, 2020 (from 77 at the end of 2019).
— Details are provided on the treaty partners to bilateral APAs concluded during the year. APAs with Japan (52%), India (11%) and Canada (8%) comprised approximately 70% of all US bilateral APAs executed in 2020. The percentage of US-Japan bilateral APAs increased by 4% in 2020 compared to 2019.
— Unilateral APA requests decreased from 17 in 2019 to 15 in 2020.
— The number of applications withdrawn in 2020 decreased from 12 in 2019 to 7 in 2020.
— Approximately 61% of the APAs executed in 2020 were completed for transactions between foreign parented companies and their US subsidiaries, while 27% were completed with transactions between US parent companies and their foreign subsidiaries.1
— Among the transfers of tangible or intangible property that used the Comparable Profits Method/Transactional Net Margin Method (CPM/TNMM), the operating margin (OM) was once again the profit level indicator (PLI) most commonly applied, being used in 69% of cases.
— The CPM/TNMM was applied in 85% of the APAs with intercompany service transactions. The most commonly selected PLI with the CPM/TNMM was the operating margin (57%).
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 Section 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 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
— Potential reduction of 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 transfer-pricing 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
Revenue Procedure 2015-41 instructs taxpayers to request a term of at least five prospective years, which can be extended through renewal procedures. The revenue procedure allows taxpayers to request "roll-back" years to be covered by an APA. In 2020, 11% of the completed agreements included roll-back years. Although 62 of the APAs executed were for terms of five years, 55 of the cases were for six or more years (including roll-back years).
When competent authority procedures are available in the other countries involved (under an applicable tax treaty), the IRS encourages bilateral or even multilateral APAs. These agreements are also binding on the foreign tax authority for the same period and help avoid instances of double taxation.
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 on 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 December 31, 2020, the IRS has received a total of 2,791 APA applications and executed 2,067 APAs. The following table reports summary statistics about 2020 APA applications, executed APAs and pending APAs. Data are reported separately for unilateral and bilateral APAs, and completion times for 2020, 2019 and 2018 are compared.
* In some cases, the totals include additional multilateral cases
IRS staffing changes and operating efficiencies
The total number of APMA employees has remained fairly constant over the past several years, although the mix of economists and team leaders occasionally changes. The number of economists increased in 2020 (21) compared to 2019 (16), and the number of team leaders (a mix of lawyers and accountants) also increased in 2020 (64) from 2019 (52). There were 9 managers and 3 assistant directors in 2020. Each assistant director supervised 3 managers who lead teams comprised of both team leaders and economists. The IRS APMA contacts are listed here.
Months to complete APAs
The following data indicate that the average time to completion for new bilateral APAs increased from 47.2 months in 2019 to 50.8 months in 2020. The average time to completion for new unilateral APAs increased from 33.8 months in 2019 to 36.2 months in 2020.
Treaty partners in bilateral APAs
As shown in the following chart, APAs with Japan represent more than any other one country at 52% of bilateral APAs executed in 2020. 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 third most frequently involved treaty partner in executed APAs in 2020 at 8%, as a result of its role as the third largest trading partner with the US (following China and Mexico in 2020) and the fact that it has been a US tax treaty partner for almost 80 years.
In addition, the number of India APA requests filed continues to increase steadily, in part as a result of the improved relationship between the IRS and India's tax authorities during the last several years. In 2020, India represented 11% of bilateral APAs filed, 20% of pending bilateral APAs and 11% of executed bilateral APAs (second only to Japan in all three categories). This constitutes an extremely positive outcome given the uncertainty and severe risk of double taxation faced by multinationals investing in India.
Bilateral APAs filed by country
Bilateral APAs executed by country
As shown in the following chart, manufacturing and wholesale/retail trade continue to comprise the largest share of APA cases, representing 65% of all APAs completed in 2020.
Approximately 49% of manufacturing cases involved computer and electronic products, chemicals and transportation equipment, while the wholesale/retail trade cases were dominated by wholesalers of durable goods (60%).
Covered transactions and tested parties
The Report describes, in overall terms, the covered transactions and sets out the types of tested parties in each transaction. Note that one APA may cover more than one transaction.
Types of tested parties
Transfer pricing methods applied
The CPM/TNMM continues to be the most commonly applied method (69%) in cases involving transfers of tangible and intangible property, as well as for services transactions.
A critical assumption is a fact on which the taxpayer's TPM depends. 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 2020 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 2020 relating to the failure of a critical assumption (or any other reason).
The APA Program's impressive results contained in this year's Report include the following:
These achievements were accomplished under unprecedented and very challenging conditions.
APMA currently has 21 requests for multilateral APAs pending — as many as APMA executed in the prior 30 years. It appears that multilateral APA requests are no longer limited to the financial services sector; rather, more and more taxpayers appear to be looking to multilateral APAs to resolve the multijurisdictional transfer pricing issues wrought by their supply chains.
As a result of the COVID-19 pandemic, multinationals are rethinking their supply chains and transfer pricing frameworks. In addition, tax authorities around the world will likely be seeking to increase tax revenue to pay for the stimulus programs their governments have created. Transfer pricing controversy has been increasing. Given APMA's improved results, APAs are an increasingly attractive way to obtain transfer pricing certainty in an increasingly uncertain tax environment.
APMA has adapted well to the virtual environment resulting from the COVID-19 pandemic. In May 2020, the IRS announced modifications for filing APAs. In the same announcement, the IRS also addressed questions about how the current economic environment affected the handling of pending and executed APAs by APMA (see Tax Alert 2020-1302). As a result, case closures have been robust for 2020 despite the fact that the work has become completely virtual.
1 The rest consists of transactions between subsidiaries of US- and foreign-parented groups, i.e. sister companies (11%) and all other relationships (1%).