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APAs no longer ‘a slam dunk’ for taxpayers

Businesses that rely on intellectual property are seeking out alternatives to advance pricing agreements (APAs) because the lifespan of such deals no longer match the pace of change.

More than two thirds of the tax directors of 64 companies responding to TP Week and International Tax Review’s survey on intellectual property (IP) management said they would consider applying for an APA or may do in the future, whereas 33% said they would not. Although APAs remain a popular choice for tax certainty, the time it takes to negotiate an agreement has limited its appeal.

“If you look back 10 or 20 years, APAs were an easy choice in most circumstances because many governments were simply not up to speed with the inconsistencies in tax law,” one in-house tax consultant at a US biotech company said. “Most governments were not sharing information.”

“What has changed is that the environment is much more complex than it was historically and it’s not a slam dunk to get an APA today,” he added.

Many companies have to accept some uncertainty as part of doing business. The consultant stressed that this is normal in Silicon Valley, where the concentration of technology companies means almost every corporate group has a certain amount of uncertainty built into its business model.

This is where APAs would normally come in handy. However, the odds are against taxpayers getting the kind of certainty they had in the past. The threat of audits and disputes continues to grow with every new piece of legislation.

Competing interests

Even in jurisdictions where disputes are in decline each case continues to get more complex with transfer pricing being a focal point in most disputes. The different approaches to intangibles around the world is set to drive this trend forward.

“If you’re in a dispute five years from now you better have a great contingency plan and working papers and a number of opinions from advisors because any dispute involving intangibles in the future will be more intense than ever before,” the consultant warned.

“That’s because of competing interests,” the consultant told TP Week. “The tax authorities in a lot of countries will go after certain fact patterns and try to attach their own interpretation to those patterns.”

These APAs still offer certainty though, even if it is short-lived.

“Sometimes when you choose the APA route, you choose this route because you have uncertainty in a certain jurisdiction and you want to increase your tax certainty,” one tax director at a tech company said.

However, it’s much more difficult for certain companies to commit to the APA route “if you don’t know if your product will be invented in country A, B or C, or if you’ll be marketing those intangibles in country A, B or C”, the tax director told TP Week.

MNEs face different demands on intangibles wherever they operate. The US may have very different standards and criteria to China, Japan and India, for example. So even the most innovative companies can run into trouble.

The Chinese government is eager to protect marketing intangibles because Chinese businesses rely on such intangibles to maintain their consumer base, whereas Japanese companies focus on technical intangibles because their strategy hinges on research and development (R&D).

Meanwhile, the Indian authorities are putting service transactions under intense scrutiny. It is no coincidence that the service sector has grown rapidly in India, with the expansion of business process outsourcing (BPO) bringing many IT back offices to the country.

“The US has a lot of great people selling ice to the Eskimos,” the consultant explained. “In a perfect world, every market would have its own competitive advantages and this would match the tax structure consistently.”

“You have every country adding something to the profit pie but it’s highly subjective as to how to approach the law,” he continued. “So everybody is trying to defend their claim to a bigger piece of the pie.”

All of this is down to the differences between these economies. This would not be a problem for taxpayers if it did not lead to different accounts of value creation. As a result, taxpayers face more uncertainty than ever before.

New problems, old solutions

Unfortunately, APAs cannot guarantee the same level of certainty they once did. It can take two or three years to negotiate an APA, yet the arrangement may span five years. Most agreements can be renewed and last for 10 years in total.

“It’s hard to make sure the fact pattern fits when comparing an arrangement after five or 10 years,” the tax director said.

“Some companies are willing to take that risk because they have a stable operation and a business model that isn’t likely to change,” the director explained. “But that’s a tough commitment in the tech industry.”

If the facts change, the deal becomes invalid. The businesses most prone to change face the greatest difficulty when it comes to APAs – the transfer pricing arrangements they have today could be dramatically different in 10 years. So there is a need for a quicker, medium-term alternative.

This may be why some countries are seeking out new solutions. Austria and the Netherlands offer regular catch-up sessions to cut down on audits, whereas Poland is offering fast-tracked APAs in up to 90 days. Meanwhile, some countries are experimenting with joint audits, while taxpayers are opting for competent authority agreements where available.

“Joint audits are a good initiative, but most multinationals prefer APAs,” the international tax manager at an e-commerce platform said. “Joint audits are great up to financial closing because they happen really fast; however, such audits are not applicable for every country.”

“APAs are more well-known and the process is clearer, though I would rather do a joint audit than APA – you get much greater security faster,” the manager said.

Taxpayers face a growing rift between their need for security and the need to keep up with real-world events. APAs may offer limited certainty under these conditions, but the majority of companies will take whatever assurances they can get.

The full results of the effective IP management survey are available here.

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