In depth

APMA continues to serve as an attractive forum for resolving transfer pricing issues as the number of applications increased from last year

More taxpayers see the advantage of resolving transfer pricing issues in several countries simultaneously through the APA program and potentially avoiding unilateral audit of intercompany transactions—the number of APA applications increased by almost 20%, from 121 applications filed in 2020 to 145 applications filed in 2021.  Of the total application pool, a vast majority of these applications were bilateral applications (121 of the total 145 applications).  Additionally, there were 16 unilateral and 8 multilateral applications filed in 2021, which is an increase compared to the 15 unilateral and 3 multilateral applications filed in 2020.  Taxpayers submitting APA applications still benefit from the IRS announcement from 2020 in response to COVID-19, specifically the acceptance of an electronic-only application containing digital signatures.  See IRS Competent Authority Filings Modifications and APMA APA Consultations Announcement (11 May 2020).

While the total number of APA’s executed slightly decreased from last year, APMA is developing more substantial and regular APA discussions and negotiations with a broader range of countries and will likely continue to grow its staff

In 2021, APMA’s staff increased 21% from last year: It had 80 team leaders (increased from 64 at the end of 2020), 25 economists (increased from 21 at the end of 2020), 9 managers (unchanged from 2020), and 3 assistant directors (unchanged from 2020).  Despite the increased staffing, APMA executed 124 APA’s in 2021, which is a slight decrease from the total number of APA’s executed in 2020 (127).  The percentage of renewals executed increased (63 percent of all APA’s executed in 2021 versus 59 percent in 2020).  Similar to prior years, the majority of the APA’s executed in 2021 involved transactions between foreign parents and US subsidiaries (61%), as compared to transactions between US parents and foreign subsidiaries (25%), and no APA’s were revoked or canceled.

Although the median time required to complete an APA increased in 2021 to 35.1 months (versus 32.7 months in 2020), it remains lower than the median completion times in 2019 (38.8 months) and in 2018 (40.2 months).  The median time to complete a new unilateral and bilateral APA was 23.5 and 49.2 months, respectively.  As expected, unilateral and bilateral renewal APA’s took less time to complete (26.1 months (median) and 35.1 months (median), respectively).

In a March 2022 statement, the acting director for APMA, Nicole Welch, stated that the IRS would prioritize hiring additional employees for the transfer pricing program, and ramp up engagements with US bilateral tax treaty partners in person that were suspended as result of the coronavirus pandemic.  Those efforts could improve APMA’s ability to complete dispute resolutions faster and handle more cases.  

Of the executed APA’s, the number of APA’s concluded with Germany significantly increased to 20% of all APA’s in 2021.  In the three prior years, executed APA’s with Germany were not even listed separately due to its low percentage.  Japan continued to be the primary bilateral APA treaty partner for the US in 2021, with 40% of concluded APA’s with Japan, followed by Canada (7%), Korea (6%), and India (5%).  Overall, the make-up of executed APA’s highlights the fact that the US is executing APA’s with an array of countries, as compared to 2016-2020.  In terms of bilateral APA requests filed in 2021, Japan likewise made up the largest percentage of requests (33%), with India and Canada comprising 16% and 10% of the total bilateral APA requests, respectively.

APA’s remain popular in the manufacturing and wholesale/retail trade industries

On an industry basis, manufacturing and wholesale/retail trade continued to make up the vast majority of APA’s executed in 2021, with 37% and 38%, respectively.  Of the manufacturing APA’s, 37% were related to the manufacturing of transportation equipment, 22% to chemical manufacturing, and 11% to computer and electronic products manufacturing.  Of the wholesale/retail trade APA’s executed in 2021, the majority fell within the merchant wholesalers/durable goods industry (62%), followed by merchant wholesalers/nondurable goods (19%) and motor vehicle and parts dealers (8%).  In the majority of these APA’s, the covered transactions involved several different functions and risks, such as research and development, design and engineering, manufacturing, marketing and distribution, and support functions.

Most of the transactions covered in the APA’s executed in 2021 continued to involve the sale of tangible goods or the provision of services.  The use of intangible property, which tends to be the most challenging type of transaction, represented only 15% of the covered issues in APA’s executed in 2021.

The comparable profits method/transactional net margin method continues to dominate

For 2021, the comparable profits method/transactional net margin method (“CPM/TNMM”) continued to be the most commonly applied TPM for tangible and intangible property transactions (applied to 85% of such transactions), and the operating margin (i.e., the ratio of operating profit to sales) was still the most common profit level indicator (“PLI”) used to benchmark results.  Operating margin was used as a PLI 65% of the time, while the Berry Ratio (i.e., the ratio of gross profit to operating expenses) and return on total costs was used as a PLI 35% of the time.

For the services transactions, a vast majority (90%) also used the CPM/TNMM with the operating margin and operating profit to operating expense being the most common PLI’s (used 56% of the time).   

Most covered transactions targeted the interquartile range, whereas both specific royalty rates and ranges were used for transactions involving a royalty payment for the use of intangible property.  For the APA’s executed in 2021, the testing periods included single-year tests, term tests, or the term of the APA plus rollback years.

APA terms maintain a reasonable amount of prospectivity

Rev. Proc. 2015-41 instructs taxpayers to request a term of at least five prospective years, and taxpayers may also request that the APA be “rolled back” to cover one or more earlier taxable years.  APA term lengths, including rollback years, averaged six years in 2021 (same as in both 2020 and 2019), with the largest number of APA’s executed with a five-year term (59% of the total).  91% of the APA’s executed in 2021 had terms of five or more years, with the total terms ranging from one year to 15 years.  Of the APA’s executed in 2021, 22% included a rollback.

Conclusion

Global transfer pricing controversy continues to rise, and, in our experience, the APA process can effectively address difficult intercompany pricing issues.  While it is not a quick process, APA’s generally provide some level of prospectivity and help taxpayers to avoid potentially prolonged, resource-intensive and aggressive unilateral audits, which may lead to costly and/or unpredictable litigation or require resolution via the Mutual Agreement Program.  As evidence of their continued commitment in the program, the IRS continues to invest in the APMA Program by increasing staffing levels and resources to process cases faster and meet taxpayer demand.  Thus, APA’s continue to be an excellent forum for resolving transfer pricing issues and providing tax certainty to taxpayers.