Announcement 2017-03

March 27, 2017

This Announcement is issued pursuant to § 521(b) of Pub. L. 106–170, the Ticket to Work and Work Incentives Improvement Act of 1999, which requires the Secretary of the Treasury to report annually to the public concerning advance pricing agreements (APAs) and the Advance Pricing and Mutual Agreement Program (APMA Program), formerly known as the Advance Pricing Agreement Program (APA Program). The first report covered calendar years 1991 through 1999. Subsequent reports covered each calendar year 2000 through 2015 separately. This eighteenth report describes the experience, structure, and activities of the APMA Program during calendar year 2016. It does not provide guidance regarding the application of the arm’s length standard.

Part I of this report includes information on the structure, composition, and operation of the APMA Program; Part II presents statistical data; and Part III includes general descriptions of various elements of the APAs executed in 2016, including types of transactions covered, transfer pricing methods used, and completion time.

John C. C. Hughes

Acting Director, Advance Pricing and Mutual Agreement Program

[Pub. L. 106–170 § 521(b)(2)(A)]

In February of 2012, the former APA Program was moved from the Office of Chief Counsel to the Office of Transfer Pricing Operations within the Large Business and International Division of the IRS and combined with the U.S. Competent Authority staff responsible for transfer pricing cases, thereby forming the APMA Program.

After the formation of the APMA Program, the team that developed the IRS position in a bilateral or multilateral case and finalized the APA with the taxpayer also became responsible for discussing the case and obtaining an agreement with the treaty partner. This compression of functions into a single APA team has helped to eliminate inefficiencies and has decreased the amount of time it takes to reach resolution once a case is set for discussion with the treaty partner.

As of December 30, 2016, the APMA Program was comprised of 62 team leaders, 20 economists, and 10 senior managers organized into 10 groups (7 team leader groups and 3 economist groups). Each team leader group has responsibility for cases involving certain countries with one of the economist groups also taking responsibility of a country. Because of the large volume of cases with certain treaty partners, some countries are the responsibility of more than one group. The APMA Program’s main office is located in Washington, DC, and it also has a significant presence in San Francisco and the Los Angeles area.

On August 31, 2015, new revenue procedures governing MAP and APA applications were published in 2015–35 I.R.B. on pages 236 and 263, respectively. Revenue Procedure (Rev. Proc.) 2015–41 provides guidance and instructions on filing APA requests as well as guidance and information on the administration of APAs. Rev. Proc. 2015–41 updates and supersedes Rev. Proc. 2006–9, 2006–1 C.B. 278, as modified by Rev. Proc. 2008–31, 2008–1 C.B. 1133, which is also superseded. Rev. Proc. 2015–40 provides procedures and guidance on requesting assistance from the U.S. Competent Authority where the taxpayer believes that the actions of the United States or a treaty country result or will result in the taxpayer being subject to taxation not in accordance with the applicable U.S. tax treaty. Rev. Proc. 2015–40 updates and supersedes Rev. Proc. 2006–54, 2006–2 C.B. 1035.

The model APA agreement, which was last significantly revised in 2009, is currently under review for future changes. The 2009 model appears in this report as Appendix 1. A list of primary APMA contacts is available at https://www.irs.gov/businesses/corporations/apma-contacts.

[Pub. L. 106–170 § 521(b)(2)(C)(i–viii)]

Table 1: APA Applications Filed

§ 521(b)(2)(C)(i)

	Unilateral	Bilateral	Multilateral	Total
Filed 1991–1999[a]				401
Filed 2000–2015	542	1194	10	1746
Filed in 2016	14	84	0	98
Total Filed 1991–2016				2245
[a] The first APA Statutory Report, which compiled APA data from 1991–1999, did not report the cumulative number of applications for those years by submission type, so the cumulative totals cannot be reported in that manner.

 

The table above illustrates the number of complete applications filed per year. As of December 31, 2016, APMA had also received 17 user fee filings that were not yet accompanied by substantially complete APA applications, in addition to the 98 complete APA applications.

 

Table 2: Executed and Pending APAs

§ 521(b)(2)(C)(ii–vi)

	Unilateral	Bilateral	Multilateral	Total
Total Executed 1991–2015	539	958	14	1511
Total Executed in 2016	21	65	0	86
Total Executed 1991–2016	560	1023	14	1597
Total Pending	67	322	9	398
Renewals Executed in 2016	17	32	0	49
Renewals Pending	33	131	2	166

 

Of the 86 agreements executed in 2016, 41 percent were new APAs (i.e., not a renewal of a prior APA). This was a slight increase from the 40 percent executed in 2015.

 

As the chart above illustrates, nearly three quarters of the total number of bilateral APAs executed in 2016 involved the United States entering into mutual agreements with either Japan or Canada.

 

The number of pending APAs dropped slightly from 2015 to 2016 with Japan and Canada continuing to account for almost half of all pending bilateral APAs.

 

Table 4: APAs Finalized or Renewed^[4] by Industry

§ 521(b)(2)(C)(viii)

Industry
Manufacturing	40
Wholesale/Retail Trade	33
Services	6
All Other Industries	7

 

Table 4a: Manufacturing APAs Finalized or Renewed 2016

Manufacturing
Computer and Electronic Products	7
Chemical	6
Transportation Equipment	6
Miscellaneous Manufacturing[a]	9
All Other Types of Manufacturing	12
[a] Miscellaneous Manufacturing is NAICS code 339.

 

[Pub. L. 106–170 § 521(b)(2)(D) and (E)]

Nature of the Relationships

§ 521(b)(2)(D)(i)

 

As in prior years, more than half of the APAs executed in 2016 involved transactions between non-U.S. parents and U.S. subsidiaries.

Covered Transactions, Functions and Risks, and Tested Parties

§ 521(b)(2)(D)(ii–iii)

 

Although the majority of transactions^[5] covered in APAs executed in 2016 involve the sale of tangible goods and the provision of services, the IRS also has successfully completed numerous APAs involving the use of intangible property. While transactions involving intangibles may be more challenging and represent a smaller percentage of the covered transactions in 2016 (20 percent), the IRS continues to seek opportunities to work with taxpayers and treaty partners to provide prospective certainty for such transactions wherever appropriate.

In the majority of APAs, the covered transactions involve numerous business functions and risks. For instance, with respect to functions, APAs involving manufactured products typically involve a controlled group that conducts research and development (R&D), engages in product design and engineering, manufactures the product, markets and distributes the product, and performs support functions such as legal, finance, and human resources services. Regarding risks, the controlled group may assume a variety of risks including market risks, R&D risks, financial risks, credit and collection risks, product liability risks, and general business risks. In the APA evaluation process, a significant amount of time and effort is devoted to understanding how the functions and risks are allocated amongst the controlled group of companies that are party to the covered transactions. Generally, for methods requiring selection of a tested party, the tested party that is chosen will be the least complex of the controlled taxpayers.

 

75 percent of the tested parties in 2016^[6] were U.S. distributors, U.S. manufacturers, or U.S. service providers.

Table 6: Term Lengths of APAs Executed in 2016

Term Length (years)	Number of APAs
2	2
3	2
4	1
5	52
6	8
7	15
8	7
9	2
10	2
11	4
12	0
13	0
14	1
Average	6

 

As described in § 3.03(1) of Rev. Proc. 2015–41, taxpayers should request an APA term that would cover at least 5 prospective years and may also request that the APA be “rolled back” to cover one or more earlier taxable years, although the appropriate APA term is decided on a case-by-case basis. Of the APAs executed in 2016, only 20 percent included rollback years. A substantial number of those APAs with terms of greater than 5 years were submitted as a request for a 5-year term, and the additional years were agreed to between the taxpayer and the IRS (or, in the case of a bilateral APA, between the IRS and the foreign government upon the taxpayer’s request) to ensure a reasonable amount of prospectivity in the APA term.

 

The median time required to complete an APA in 2016 increased slightly from 31.9 months in 2015 to 32.8 months in 2016.

[§ 521(b)(2)(B)]

between

[Insert Taxpayer’s Name]

and

THE INTERNAL REVENUE SERVICE

The Parties to this Advance Pricing Agreement (APA) are the Internal Revenue Service (IRS) and [Insert Taxpayer’s Name], EIN ________.

[Insert Taxpayer Name] is the common parent of an affiliated group filing consolidated U.S. tax returns (collectively referred to as “Taxpayer”), and is entering into this APA on behalf of itself and other members of its consolidated group.

Taxpayer’s principal place of business is [City, State]. [Insert general description of taxpayer and other relevant parties].

This APA contains the Parties’ agreement on the best method for determining arm’s-length prices of the Covered Transactions under I.R.C. section 482, the Treasury Regulations thereunder, and any applicable tax treaties.

{If renewal, add} [Taxpayer and IRS previously entered into an APA covering taxable years ending _____ to ______, executed on ________.]

The Parties agree as follows:

The Parties have executed this APA on the dates below.

[Taxpayer Name in all caps]

By: ___________________________ Date: ___________________, 201___

Jane Doe

Sr. Vice President (Taxes)

By: ___________________________ Date: ___________________, 201___

John C. C. Hughes

Acting Director, Advance Pricing and Mutual Agreement Program

1. Covered Transactions.

[Define the Covered Transactions.]

2. APA Term.

This APA applies to Taxpayer’s taxable years ending __________ through ________ (APA Term).

3. TPM.

{Note: If appropriate, adapt language from the following examples.}

[The Tested Party is __________.]

• CUP Method

The TPM is the comparable uncontrolled price (CUP) method. The Arm’s Length Range of the price charged for _________ is between _______ and ___________ per unit.

• CUT Method

The TPM is the CUT Method. The Arm’s Length Range of the royalty charged for the license of ______is between ____% and ___ % of [Taxpayer’s, Foreign Participants’, or other specified party’s] Net Sales Revenue. [Insert definition of net sales revenue or other royalty base.]

• Resale Price Method (RPM)

The TPM is the resale price method (RPM). The Tested Party’s Gross Margin for any APA Year is defined as follows: the Tested Party’s gross profit divided by its sales revenue (as those terms are defined in Treasury Regulations sections 1.482–5(d)(1) and (2)) for that APA Year. The Arm’s Length Range is between ____% and ___ %, and the Median of the Arm’s Length Range is ___%.

• Cost Plus Method

The TPM is the cost plus method. The Tested Party’s Cost Plus Markup is defined as follows for any APA Year: the Tested Party’s ratio of gross profit to production costs (as those terms are defined in Treasury Regulations sections 1.482–3(d)(1) and (2)) for that APA Year. The Arm’s Length Range is between ___% and ___%, and the Median of the Arm’s Length Range is ___%.

• CPM with Berry Ratio PLI

The TPM is the comparable profits method (CPM). The profit level indicator is a Berry Ratio. The Tested Party’s Berry Ratio is defined as follows for any APA Year: the Tested Party’s gross profit divided by its operating expenses (as those terms are defined in Treasury Regulations sections 1.482–5(d)(2) and (3)) for that APA Year. The Arm’s Length Range is between ____ and ___, and the Median of the Arm’s Length Range is ___.

• CPM using an Operating Margin PLI

The TPM is the comparable profits method (CPM). The profit level indicator is an operating margin. The Tested Party’s Operating Margin is defined as follows for any APA Year: the Tested Party’s operating profit divided by its sales revenue (as those terms are defined in Treasury Regulations section 1.482–5(d)(1) and (4)) for that APA Year. The Arm’s Length Range is between ____% and ___ %, and the Median of the Arm’s Length Range is ___%.

• CPM using a Three-year Rolling Average Operating Margin PLI

The TPM is the comparable profits method (CPM). The profit level indicator is an operating margin. The Tested Party’s Three-Year Rolling Average operating margin is defined as follows for any APA Year: the sum of the Tested Party’s operating profit (within the meaning of Treasury Regulation section 1.482–5(d)(4) for that APA Year and the two preceding years, divided by the sum of its sales revenue (within the meaning of Treasury Regulation section 1.482–5(d)(1)) for that APA Year and the two preceding years. The Arm’s Length Range is between ____% and ____%, and the Median of the Arm’s Length Range is ___%.

• Residual Profit Split Method

The TPM is the residual profit split method. [Insert description of routine profit level determinations and residual profit-split mechanism].

[Insert additional provisions as needed.]

4. Application of TPM.

For any APA Year, if the results of Taxpayer’s actual transactions produce a [price per unit, royalty rate for the Covered Transactions] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] within the Arm’s Length Range, then the amounts reported on Taxpayer’s U.S. Return must clearly reflect such results.

For any APA year, if the results of Taxpayer’s actual transactions produce a [price per unit, royalty rate] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] outside the Arm’s Length Range, then amounts reported on Taxpayer’s U.S. Return must clearly reflect an adjustment that brings the [price per unit, royalty rate] [or] [Tested Party’s Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin] to the Median.

For purposes of this Appendix A, the “results of Taxpayer’s actual transactions” means the results reflected in Taxpayer’s and Tested Party’s books and records as computed under U.S. GAAP [insert another relevant accounting standard if applicable], with the following adjustments:

5. APA Revenue Procedure Treatment

If Taxpayer makes an adjustment under paragraph 4 of this Appendix A (a “primary adjustment”), Taxpayer and its related foreign entity may elect APA Revenue Procedure Treatment in accordance with section 11.02(3) of Revenue Procedure 2006–9 and avoid the possible adverse tax consequences of a secondary adjustment that would otherwise follow the primary adjustment.

[Insert additional provisions as needed.]

This APA’s critical assumptions are:

1. The business activities, functions performed, risks assumed, assets employed, and financial and tax accounting methods and classifications [and methods of estimation] of Taxpayer in relation to the Covered Transactions will remain materially the same as described or used in Taxpayer’s APA Request. A mere change in business results will not be a material change.

[Insert additional provisions as needed.]

The APA Records will consist of all documents listed below for inclusion in the Annual Report, as well as all documents, notes, work papers, records, or other writings that support the information provided in such documents.

The Annual Report (and each of the four copies required by paragraph 5(e) of this APA) will include:

1. Two copies of a properly completed APA Annual Report Summary in the form of Appendix E to this APA, one copy of the form bound with, and one copy provided separately from, the rest of the Annual Report.

2. A table of contents, organized as follows:

3. Statements that fully identify, describe, analyze, and explain:

a. All material differences between the U.S. Group’s business operations (including functions, risks assumed, markets, contractual terms, economic conditions, property, services, and assets employed) during the APA Year from the business operations described in the APA Request. If there have been no material differences, the Annual Report will include a statement to that effect.

b. All material differences between the U.S. Group’s accounting methods and classifications, and methods of estimation used during the APA Year, from those described or used in the APA Request. If any change was made to conform to changes in U.S. GAAP (or other relevant accounting standards) Taxpayer will specifically identify the change. If there has been no material change in accounting methods and classifications or methods of estimation, the Annual Report will include a statement to that effect.

c. Any change to the Taxpayer notice information in paragraph 14 of this APA.

d. Any failure to meet any critical assumption. If there has been no failure, the Annual Report will include a statement to that effect.

e. Whether or not material information submitted while the APA Request was pending is discovered to be false, incorrect, or incomplete.

f. Any change to any entity classification for federal income tax purposes (including any change that causes an entity to be disregarded for federal income tax purposes) of any Worldwide Group member that is a party to the Covered Transactions or is otherwise relevant to the TPM.

g. The amount, reason for, and financial analysis of (1) any primary adjustments made under Appendix A for the APA Year; and (2) any (a) secondary adjustments that follow such primary adjustments or (b) accounts receivable that Taxpayer establishes, in lieu of secondary adjustments, by electing APA Revenue Procedure Treatment pursuant to paragraph 5 of Appendix A and Revenue Procedure 2006–9, section 11.02(3), for the APA Year, including but not limited to:

h. The amounts, description, reason for, and financial analysis of any book-tax difference relevant to the TPM for the APA Year, as reflected on Schedule M-1 or Schedule M-3 of the U.S. Return for the APA Year.

i. Whether Taxpayer contemplates requesting, or has requested, to renew, modify, or cancel the APA.

4. The Financial Statements, and any necessary account detail to show compliance with the TPM, including consolidating financial statements, segmented financial data, records from the general ledger, or similar information if the assets, liabilities, income, or expenses relevant to showing compliance with the TPM are a subset of the assets, liabilities, income, or expenses presented in the Financial Statements.

5. {Use the following or the alternative prescribed by paragraph 5(f) of this APA:} A copy of the independent certified public accountant’s opinion required by paragraph 5(f) of this APA.

6. A financial analysis that reflects Taxpayer’s TPM calculations for the APA Year. The calculations must reconcile with and reference the information required under item 4 above in sufficient account detail to allow the IRS to determine whether Taxpayer has complied with the TPM.

7. An organizational chart for the Worldwide Group, revised annually to reflect all ownership or structural changes of entities that are parties to the Covered Transactions or are otherwise relevant to the TPM.

8. A copy of the APA and any amendment.

9. A penalty of perjury statement, executed in accordance with Revenue Procedure 2006–9, section 11.01(6) and (7).

The following definitions control for all purposes of this APA. The definitions appear alphabetically below:

The APA Annual Report Summary on the next page is a required APA Record. The APA Team Leader supplies some of the information requested on the form. Taxpayer is to supply the remaining information requested by the form and submit the form as part of its Annual Report.