Global APA programmes: Get ready to apply BEPS guidance prospectively

For many global multinational enterprises (MNEs), advance pricing agreements (APAs) have been a key element of their transfer pricing compliance strategies. APA programmes were first introduced in the late 1980s as a procedure to allow MNEs to achieve certainty with tax authorities on a unilateral, bilateral, or multilateral basis, with the goal of prospectively resolving potential transfer pricing disputes in an efficient, principled, and cooperative manner. Overall, global APA programmes have been successful in achieving these goals, and that success has led to the introduction of APA programmes in more than 40 countries, with several national APA programmes reporting hundreds of APA submissions in their case inventories.

APA negotiations are based on the arm's-length principle as described in the respective countries' transfer pricing laws, the associated enterprises articles or mutual agreement procedure (MAP) article of relevant tax treaties, and the OECD transfer pricing guidelines. The last two of those authorities are undergoing their most significant update in the last 20 years by means of the October 2015 release of the OECD's final reports to address base erosion and profit shifting (BEPS). Several of those reports will update the OECD transfer pricing guidelines and introduce significant changes to substantive transfer pricing rules, information disclosure requirements, and dispute resolution procedures.

The interpretation of the changes to these authorities, whether simply in terms of the point-in-time of application or in terms of substantive issues, such as differences in the determination of value creation, is expected to lead to increased numbers of transfer pricing disputes. This is something the OECD itself has recognised – part of the BEPS work has to been to encourage dispute resolution through MAPs but also dispute prevention through APAs.

An APA is a multiyear agreement between an MNE and one or more tax authorities regarding:

• Number of years covered by the APA;

• Covered intercompany transactions;

• Transfer pricing methods for testing the covered intercompany transactions;

• A range of arm's length results;

• Rules for making transfer pricing adjustments pursuant to the APA;

• Critical assumptions that allow either the MNE or the tax authority to revise or cancel the APA; and

• Reporting requirements to document compliance with the APA.

If an MNE complies with the terms of its APA, it will be protected against transfer pricing adjustments and potential tax penalties by the tax authorities that are parties to the APA. Statistically, it takes from one to four years for tax authorities to negotiate an APA. Generally, time to resolution varies with the nature of the covered intercompany transactions, the complexity of the proposed transfer pricing method, and the personnel resources of the tax authorities involved.

APA programmes have generally achieved the goal of prospectively resolving potential transfer pricing disputes in an efficient, principled, and cooperative manner (compared to the alternative of undergoing a transfer pricing examination and pursuing local administrative appeals or judicial remedies).

Bilateral or multilateral APAs ensure that double taxation will not arise. Undergoing a transfer pricing audit, local administrative appeals, or judicial remedies that still leave an adjustment on the table will often result in double taxation, and the need to go through an MAP to obtain redress and repayment of tax "at the other end of the transaction". An APA removes the need to be subject to all of this, and provides the benefits of forward-looking certainty.

The US APA programme, which has made the most statistical data available publicly, has negotiated more than 1,400 APAs since the 1990s. MNEs are frequently repeat customers to APA programmes. Approximately 44% of the US APA case-inventory consists of APA renewals of existing agreements and, based on experience, many MNEs have negotiated three or more consecutive APAs with the IRS.

Many of the issues identified in the BEPS Actions 8-10 report are likely to lead to more transfer pricing disputes. One such issue is the reduced suitability of one-sided transfer pricing methods such as the transactional net margin method (TNMM). This has been the subject of global APA negotiations for the last several years, resulting in tax authorities requesting more information and doing more analysis than might otherwise be necessary for the application of one-sided TNMM analysis. Such information requests often include BEPS-related issues such as:

• Reviewing system profitability;

• Transparency with respect to transfer pricing policies for other group members;

• Holistic view of value creation and mapping of all intercompany transactions;

• Existence or nonexistence of location-specific advantages;

• Comparison of intercompany agreements with conduct of the parties;

• Inquiries about the relative value of the OECD DEMPE (development, enhancement, maintenance, protection, exploitation) functions; and

• Inquiries about managerial ability and financial capacity to control and bear risk.

Notwithstanding this, one-sided transfer pricing methods continue to be frequently applied by APA programmes. The US APA programme applied the TNMM for 78% of covered intercompany transactions in 2014, according to the IRS's 2014 annual APA report. Similarly, Canada's APA programme reported in the 2014-15 APA annual report that TNMM was used in 62% of cases in process as of June 2015. The Japanese APA programme reported in its 2014 annual report that TNMM was used in 63% of its cases in 2014. It's impossible to predict whether these rates will continue into the future, but for now the TNMM seems to be an important feature of APAs.

BEPS Action 13 calls for a three-tier approach to transfer pricing documentation (master file, local file, and country-by-country report) that will provide tax administrations with useful information to assess transfer pricing risks.

Under the BEPS guidance, taxpayers must provide, as part of their master file submission, a list and brief description of the MNE group's existing unilateral APAs, and other tax rulings relating to the allocation of income among countries.

Similarly, the guidance requires disclosure with the local file of a copy of all existing unilateral and bilateral/multilateral APAs and other tax rulings to which the local tax jurisdiction is not a party and that are related to controlled transactions in which the local entity is involved.

The master file and local file are to be provided by the MNE directly to the local tax authority. Consequently, there is a possibility that the disclosure of APAs may have a salutary effect on MNEs' APA strategies. For instance, if an MNE negotiates a unilateral APA with a required level of profitability higher than regional benchmarking, that unilateral APA would be disclosed in the master file and may encourage tax authorities in other jurisdictions to propose adjustments based on the higher profit level in the unilateral APA. While the unilateral APA will likely be distinguishable on comparability grounds, MNEs must reevaluate the benefits of such a unilateral APA in light of the possible spillover effect on other APA applications.

Unilateral APAs by their very nature do not eliminate or prevent double taxation. The unilateral APA has advantages – for instance, it may be faster to obtain because the taxpayer interacts with only one tax administration. But the advantages of bilateral or multilateral agreements over unilateral agreements are clear. In the EU, state aid considerations also mean that unilateral agreements sometimes bring their own problems.

The increased level of transfer pricing controversy that may arise because of the BEPS guidance may lead to an increase in the number of MAP and APA cases in most countries. Some MNEs have adopted a strategy of negotiating bilateral APAs with select countries to build a portfolio of agreements to use as persuasive authority in other tax jurisdictions. The MNE's argument would be that "if countries 1, 2, and 3 agree with my proposal, so should country 4".

The popularity of APAs will further benefit from two items in the BEPS Action 14 guidance that are particularly relevant to address transfer pricing controversy. First, the BEPS Action 14 final report includes a series of "best practices", one of which calls for countries to develop and include in their published MAP and APA guidance appropriate guidance on multilateral MAPs and APAs. The second item is mandatory treaty arbitration.

While countries have been attempting to negotiate multilateral MAPs/APAs for many years, such efforts have not been resolved quickly. The development and implementation of multilateral MAP and APA guidance would be a welcome development, in light of the static nature of domestic administrative appeals and judicial remedies.

The OECD and G20 countries did not reach consensus on the adoption of arbitration as a mandatory mechanism to ensure the resolution of MAP cases, as many had hoped. While the final report notes that a group of 20 countries has committed to adopt and implement mandatory binding arbitration, it is clear that even within this group of countries there are differing views on the scope of such a provision.

The 20 countries include Australia, Austria, Belgium, Canada, France, Germany, Ireland, Italy, Japan, Luxembourg, the Netherlands, New Zealand, Norway, Poland, Slovenia, Spain, Sweden, Switzerland, the United Kingdom and the United States. These countries were involved in more than 90% of the outstanding MAP cases at the end of 2013, as reported to the OECD. While global experience with mandatory arbitration provisions is not reported publicly, anecdotal evidence in the US indicates that such provisions have been somewhat successful in effecting MAP settlements in a timely manner.

As tax administrations acquire more powers and receive more information as a consequence of the BEPS initiatives, they are likely to use that power and information. As a result, the number of tax disputes is likely to increase. Any approaches that prevent those disputes from arising in the first place should be part of MNEs' tax strategies. Increasingly, the old dynamic of "file and forget" will become a less viable tactic for dealing with tax administrations. MNEs' approach to dispute prevention through APAs will become increasingly important over the next few years, as the BEPS changes push transfer pricing to the forefront of governments' and taxpayers' agendas.

Kerwin Chung Deloitte Tax 555 12th Street NW Ste 400 Washington DC 20004-1207 Tel: +1 202 879 3108 kechung@deloitte.com www.deloitte.com Kerwin Chung is a managing principal in Deloitte Tax's Washington National Tax Office, and leader of the firm's national advance pricing agreement (APA) and mutual agreement procedure (MAP) group. Kerwin has more than 20 years of transfer pricing experience, focusing on APAs, MAP, planning, examinations, and customs matters. His clients include US and foreign-based multinationals in numerous industries, including apparel, automotive, biotech, chemicals, computers, electronics, energy, food and beverage, industrial machinery, internet, logistics, office products, pharmaceuticals, professional services, publishing, semiconductors, software, and telecommunications. Kerwin's practice has involved complex transfer pricing issues, including bilateral APAs, rollbacks, and competent authority representations with respect to inbound and outbound intercompany license transactions for clients in several industries. Kerwin has coauthored numerous publications, including "Seeking Efficiencies in the New IRS APA and MAP Programmes," International Tax Review (November 2011); "Competently Negotiating the US Competent Authority Process," 59 Tax Executive No. 3, p. 257 (May/June 2007); and Transfer Pricing Rules and Compliance Handbook, (CCH 2006). Kerwin has been included in the Euromoney/Legal Media Group's Guide to the World's Leading Transfer Pricing Advisers since 2002. He is an active member of the ABA Tax Section Transfer Pricing Committee, having moderated a panel on transfer pricing down economy issues in 2009 and presented on a panel discussing the IRS APA program in 2011. He holds a JD (cum laude) from Harvard Law School and a BBA in accounting and real estate from University of Hawaii. He is admitted to practice at the bar in New York and District of Columbia.

Shiraj Keshvani Deloitte 100 Queen Street, Ste 800 Ottawa, ON K1P 5T8 Tel: +1 613 751 5293 skeshvani@deloitte.ca www.deloitte.com Shiraj Keshvani is a partner in the Ottawa office of Deloitte Canada's global transfer pricing and tax controversy practice. Before joining Deloitte, Shiraj was the chief economist for Canada Revenue Agency's (CRA) Competent Authority Services Division and the national APA coordinator. He has a deep understanding of CRA's policies and procedures and the CRA perspective and focus on many contentious issues. With 15 years of service with the CRA, primarily in the area of international taxation and transfer pricing, Shiraj first served with the assistant deputy minister of the Verification, Enforcement, and Compliance Research Branch. In 1999, Shiraj joined the International Tax Division as a Transfer Pricing Economist, where he provided support to the field in the course of transfer pricing audits. He was subsequently appointed to the position of senior transfer pricing economist, and in May 2007 began serving, on an interim basis, as APA coordinator and chief economist, before being permanently appointed to that position. As APA coordinator and chief economist, Shiraj took a leadership role in setting priorities, establishing policies, and issuing guidance for Canada's APA programme. He was also a member of the Transfer Pricing Review Committee, which considers taxpayers' compliance with Canadian legislation. On the global front, Shiraj was involved in developing Canada's position on international initiatives such as the OECD's work on the taxation of multinational enterprises and, having spent the greater portion of his career with Competent Authority, gained significant experience reconciling Canadian views on transfer pricing with those of other countries to resolve double tax issues. He was actively involved in negotiating the mode of application for the arbitration provisions under the 5th protocol to the Canada-US Treaty. Since joining Deloitte, Shiraj has assisted clients to manage and resolve difficult tax controversy issues. He has conducted a number of transfer pricing projects, in a variety of industries, involving audit defence, competent authority assistance, APAs, and planning and documentation studies. These have addressed a wide range of transfer pricing issues including business restructurings and the treatment of intangibles. Shiraj remains active on the policy front and is a member of the BIAC Tax Committee and the International Chamber of Commerce Commission on Taxation. Shiraj holds a BA (Hons) and MA degrees in economics.

Edward Morris Deloitte 2 New Street Square London EC4A 3BZ Tel: +44 20 7007 6568 edmorris@deloitte.co.uk www.deloitte.com Edward Morris is a partner in the London office of Deloitte UK. He served as a delegated competent authority for mutual agreement procedures and advance pricing agreements in the International Section of HMRC, was seconded to the European Commission to work on APAs and the Arbitration Convention, and joined Deloitte in December 2008. Edward is a well-known figure to the competent authorities of many of the world's finance ministries. Edward's 12-year career at HMRC involved working on dispute resolution on MAPs, as well as dispute avoidance work on APAs with fiscal authorities around the world. Edward was also involved in a broad range of international tax issues and problems, but specialised in transfer pricing, permanent establishment, and treaty matters. Edward also represented the UK and the EU Commission at OECD, and was heavily involved in the OECD work on international dispute resolution (helping to draft the new arbitration clause in the Model Treaty) and business restructuring. Building on his experience with APAs while in government (including the largest multilateral APA entered into by the UK), Edward has led several APAs for Deloitte clients, including two pan-European multilateral procedures. While at HMRC, Edward enjoyed a two-and-a-half year secondment to Brussels, where he advised the EU Commission on APAs and transfer pricing matters. Edward was responsible for steering the EU APA Guidelines through the EU Council. Edward's eminence in the wider international tax field was recognized by the OECD when he was asked to speak at the 50th anniversary celebration of the OECD model tax convention and by IFA at the 2011 Annual Congress, when he participated in the opening panel on business restructuring issues. Edward has a BA in Medieval and Renaissance history from Warwick University. He is happy to advise on the rise and fall of the Italian city states in the Quattrocento should the opportunity arise.