IRS Reports on Advance Pricing Agreements for 2019

Announcement and Report Concerning Advance Pricing Agreements

March 25, 2020

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 2018 separately. This twenty-first report describes the experience, structure, and activities of the APMA Program during calendar year 2019. 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 2019, including types of transactions covered, transfer pricing methods used, and completion time.

John C. C. Hughes
Director, Advance Pricing and Mutual Agreement Program

---

Part I. The APMA Program — Structure, Composition, and Operation
[Pub. L. 106-170 § 521(b)(2)(A)]

In February 2012, the former APA Program was moved from the Office of Chief Counsel to the Office of Transfer Pricing Operations¹ 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.

In September 2018, APMA restructured its management and realigned its teams. As of December 31, 2019, the APMA Program comprised 52 team leaders, 16 economists, 6 managers and 3 assistant directors. Each assistant director oversees 2 managers who lead teams comprised of both team leaders and economists. The APMA Program's main office is in Washington, DC, and it also has offices in northern California (San Francisco and San Jose), southern California (Los Angeles and Laguna Niguel), Chicago, and New York.

On August 31, 2015, new revenue procedures governing requests under the mutual agreement procedure (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 2009 and 2015 Model APAs appear in this report as Appendix 1 and Appendix 2, respectively. The 2015 Model APA was finalized in May 2018. The new model does not contain any major revisions from the draft revision that was released for public comment in the fall of 2017. A list of primary APMA contacts is available at https://www.irs.gov/businesses/corporations/apma-contacts.

Part II. APMA Program Statistical Data
[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 1991-19992				401
Filed 2000-2018	605	1,525	18	2,148
Filed in 2019	17	96	8	121
Total Filed 1991-2019				2,670

The charts above illustrate the number of complete applications filed per year and the bilateral requests received in 2019 by foreign country. As of December 31, 2019, APMA had also received 29 user fee filings that were not yet accompanied by substantially complete APA applications, in addition to the 122 complete APA applications.

Table 2: Executed and Pending APAs § 521(b)(2)(C)(ii-vi)

	Unilateral	Bilateral	Multilateral	Total
Total Executed 1991-2018	614	1,189	17	1,820
Total Executed in 2019	29	91	0	120
Total Executed 1991-2019	643	1,280	17	1,940
Total Pending as of 12/31/2019	46	386	22	454
Renewals Executed in 20193	20	48	0	68
Renewals Pending4	28	158	8	194

Consistent with prior years, roughly 40 percent of the APAs executed in 2019 were new APAs (i.e., not a renewal of a prior APA).

The charts above illustrate the total number of APAs executed per year and the countries involved in the executed bilateral APAs.

As the top chart illustrates, the number of pending requests decreased slightly relative to December 31, 2018. As of December 31, 2019, approximately half of the pending bilateral APA requests involved either Japan or India.

Table 3: APAs Revoked or Cancelled and Applications Withdrawn § 521(b)(2)(C)(vii)

	Unilateral	Bilateral	Multilateral	Total
Revoked or Cancelled in 2019	0	0	0	0
Total Revoked or Cancelled 1991-20195				11
Applications Withdrawn in 20196	1	11	0	12
Total Applications Withdrawn 1991-20197				265

Table 4: APAs Executed⁸ by Industry § 521(b)(2)(C)(viii)

Industry
Wholesale/Retail Trade	52
Manufacturing	38
Services	13
Management	11
All Other Industries	6

Table 4a: Wholesale/Retail Trade APAs Executed in 2019

Wholesale/Retail Trade
Merchant Wholesalers, Durable Goods	33
Merchant Wholesalers, Nondurable Goods	9
General Merchandise Stores	4
All Other Wholesalers	6

Table 4b: Manuafacturing APAs Executed in 2019

Manufacturing
Transportation Equipment Manufacturing	16
Computer and Electronic Product Manufacturing	5
Chemical Manufacturing	4
All Other Types of Manufacturing	13

Part III. General Descriptions of APAs Executed in 2019
[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 2019 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 most of the transactions⁹ covered in APAs executed in 2019 involve the sale of tangible goods or the provision of services, almost 20% covered the use of intangible property, which can be among the most challenging transactions in APMA's inventory. The IRS continues to seek opportunities to work with taxpayers and treaty partners to provide prospective certainty, wherever appropriate, for transactions involving the use of intangible property.

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. 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. For methods requiring selection of a tested party, the tested party that is chosen generally will be the least complex of the controlled taxpayers.

Consistent with prior years, approximately 80 percent of the tested parties in 2019¹⁰ were U.S. distributors, U.S. manufacturers, or U.S. service providers.

Transfer Pricing Methods Used
§ 521(b)(2)(D)(iv)

Consistent with prior years, in 2019, the primary transfer pricing method (TPM) used for both the sale of tangible property and the use of intangible property was the comparable profits method/transactional net margin method (CPM/TNMM). The CPM/TNMM was used for 81 percent of transfers of tangible and intangible property while all other methods combined accounted for the other 19 percent of such transactions.

For covered transfers of tangible and intangible property that used the CPM/TNMM, the operating margin (OM) continues to be the most common profit level indicator (PLI) used to benchmark results. It was used 64 percent of the time. Other PLIs, such as the Berry Ratio and mark up on total cost, made up the other 36 percent. As used here, OM means the ratio of operating profits to sales,¹¹ and “Berry Ratio” means the ratio of gross profit to operating expenses.¹² Most services transactions (82 percent) also used the CPM/TNMM with the OM and mark up on total costs being the most common PLIs (used 65 percent of the time).¹³

Sources of Comparables, Comparables Selection Criteria, and Nature of Adjustments to Comparables or Tested Party Data
§ 521(b)(2)(D)(v-vii)

For the APAs executed in 2019 that involved CPM/TNMM with a North American tested party, the most widely used data source for comparables was Standard and Poor's Compustat/Capital IQ database. Different sources were used in other cases (e.g., where the tested party was not a U.S. or Canadian entity or where transaction-based methods were applied). The other more commonly used databases are listed in the table below.

Table 5: Sources of Comparable Data

Avention (formerly known as OneSource)	Mergent
Bloomberg	Orbis
Disclosure	Recap
Global Vantage	RoyaltySource
ktMINE	RoyaltyStat
LoanConnector	Worldscope

In making comparability adjustments, the standard balance sheet adjustments identified in Treas. Reg. §§ 1.482-1(d) and 1.482-5(c), including adjustments for differing amounts of payables, receivables, and inventory, were made in most cases. Where appropriate, adjustments for different accounting practices were made to convert from LIFO to FIFO inventory accounting, and a small number of cases also involved the accounting reclassification of expenses, e.g., from COGS to operating expenses.

Ranges, Goals, and Adjustment Mechanisms
§ 521(b)(2)(D)(viii-ix)

Most transactions covered in APAs target an interquartile range as described in Treas. Reg. § 1.482-1(e)(2)(iii)(C). Where the transaction involves a royalty payment for the use of intangible property, both specific royalty rates and ranges have been used. Where the covered transaction is the payment of a royalty based solely on external royalty agreements, a secondary method, e.g., a test of the post-royalty operating margin or cost-plus markup, has been used. The testing periods of the APAs executed in 2019 were either: (1) a single year, (2) the term of the APA only, or (3) the term of the APA plus rollback years.

APAs executed in 2019 included several mechanisms for making adjustments to tested party results when the results fall outside the range or do not match the point required by the APA. The following are examples of the mechanisms used: an adjustment bringing the tested party's results to the closer edge of the range applied to the results of a single year; an adjustment to the closer edge of the range applied to the results over the APA term; an adjustment to the specified point or royalty rate; or an adjustment to the median of the range for a single year.

Critical Assumptions
§ 521(b)(2)(D)(v)

The model APAs used by the IRS (included as Appendix 1 and Appendix 2 of this report) include standard critical assumptions that there will be no material changes to the taxpayer's business or to its tax or financial accounting practices during the APA term. A few bilateral cases have also included critical assumptions tied either to 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. Pursuant to § 7.06(3) of Rev. Proc. 2015-41, APMA will cancel an APA in the event of a failure of a critical assumption unless the parties agree to revise the APA.

Term Lengths of APAs Executed in 2019
§ 521(b)(2)(D)(x)

Table 6: Term Lengths of APAs Executed in 2019

Term Length (years)	Number of APAs
1	1
2	2
3	3
4	11
5	53
6	15
7	13
8	7
9	5
10	2
11	5
13	2
15	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 five 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 2019, 25 percent included rollback years. A substantial number of those APAs with terms of greater than five years were submitted as a request for a five-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.

Amount of Time Taken to Complete New and Renewal APAs
§ 521(b)(2)(E)

Table 7: Months to Complete New and Renewal APAs Executed in 2019

	Unilateral		Bilateral		Unilateral & Bilateral
	Average	Median	Average	Median	Average	Median
New	33.8	33.2	47.2	45.9	45.0	41.9
Renewal	31.7	28.7	38.5	38.7	36.5	38.4
New & Renewal	32.2	30.4	42.5	40.5	40.0	38.8

The median time required to complete an APA in 2019 decreased to 38.8 months (from 40.2 months in 2018).

Efforts to Ensure Compliance with APAs
§ 521(b)(2)(F)

As described in § 7.02(1) of Rev. Proc. 2015-41, taxpayers are required to file annual reports to demonstrate compliance with the terms and conditions of their APAs. The filing and review of these annual reports are critical parts of the APA process. Through annual report review, the APMA Program monitors taxpayer compliance with APAs on a contemporaneous basis. Annual report review also provides current information on the success or problems associated with the various TPMs adopted in the APA process.

Nature of Documentation Required in Annual Report
§ 521(b)(2)(D)(xi)

APAs require taxpayers to file timely and complete annual reports describing their operations and demonstrating compliance with the APAs' terms and conditions. Not every annual report will include each of the items listed in the following table¹⁴; they are required where the facts demonstrate a need for such documentation.

1.	Statement regarding all material differences between Taxpayer's business operations during APA year and description of Taxpayer's business operations contained in Taxpayer's APA request. If there are no material differences, a statement to that effect.
2.	Statement concerning all material changes in Taxpayer's accounting methods and classifications, and methods of estimation, from those described or used in Taxpayer's request for the APA. If there has been no material change in accounting methods and classifications or methods of estimation, a statement to that effect.
3.	Any change to the taxpayer notice information.
4.	Description of any failure to meet critical assumptions. If there has been none, a statement to that effect.
5.	Statement identifying whether or not any material information submitted while the APA request was pending is discovered to be false, incorrect, or incomplete.
6.	The amount, reason for, and financial analysis of any compensating adjustment, for the APA year, including but not limited to: the amounts paid or received by each affected entity; the character (such as capital or ordinary expense) and country source of the funds transferred, and the specific line item(s) of any affected U.S. tax return; and any change to any entity classification for federal income tax purposes of any member of Taxpayer's group that is relevant to the APA.
7.	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.
8.	Statement regarding whether Taxpayer contemplates requesting, or has requested, to renew, modify, or cancel the APA.
9.	Financial statements and any necessary account detail to show compliance with the TPM, with a copy of the opinion from an independent certified public accountant or other documentation required by paragraph 5(f) of the APA.
10.	Financial analysis demonstrating Taxpayer's compliance with TPM.
11.	Organizational chart.
12.	A copy of the APA and any amendment.
13.	A penalty of perjury statement.

Approaches for Sharing of Currency or Other Risks 
§ 521(b)(2)(D)(xii) 

In appropriate cases, APAs may provide specific approaches for dealing with risks, including currency risk, such as adjustment mechanisms and/or critical assumptions.