Demand for APAs Continues to Increase

Taxpayers continue to 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 filed with APMA in 2022 was 183 (as well as an additional 34 user fee filings not yet accompanied by an APA request), which represents a significant increase from the number of applications filed in each of the last three years, as well as a 26% increase over 2021 alone.

Of the total application pool, a vast majority of the APA applications continued to be bilateral applications (154 of the total 183 applications or 81%), which aligns with APMA’s preference to handle APAs on a bilateral (or multilateral basis). Japan, India, and Canada continued to represent the highest number of bilateral APA applications requested. Additionally, APMA received 22 unilateral and 7 multilateral applications in 2022, compared to 16 unilateral and 8 multilateral applications in 2021. Fortunately, Taxpayers submitting APA applications continue to benefit from the IRS announcement from 2020 in response to COVID-19 that permits the submission of an electronic application containing digital signature. See IRS Competent Authority Filings Modifications and APMA APA Consultations Announcement (May 11, 2020).

APMA's Staffing, Number of Executed APAs Decreased; But Negotiations with a Broad Range of Countries Continued

APMA experienced an overall decline in its staffing during 2022, in contrast to the growth it experienced during 2021. In particular, APMA’s staff size decreased by 17% in 2022 compared to 2021, to the same total amount of staff at APMA during 2020 (97). This consisted of 59 team leaders (decreased from 80 as of December 31, 2021), 26 economists (increased from 25 as of December 31, 2021), 9 managers (unchanged from 2021), and 3 assistant directors (unchanged from 2021). This reduction in staffing may have impacted APMA’s ability to execute APAs during 2022 as compared to the prior year.

During 2022, APMA executed 77 APAs, including 66 multilateral APAs, 1 multilateral APA, and 10 unilateral APAs, which is a decrease from the total number of APAs executed in 2021 (124). Similar to prior years, the majority of the APAs executed in 2022 involved transactions between foreign parents and US subsidiaries. No APAs were revoked or cancelled last year. The average time required to complete a renewal APA decreased slightly in 2022 to 33.6 months (versus 34 months in 2021), while the average time to complete a new APA increased to 53 months (versus 48.5 months in 2021). Median completion time for all APAs also continued to increase in 2022 from 43.4 months (up from 35.1 months in 2021 and 32.7 months in 2020). These longer timeframes may be due, in part, to pandemic-driven scheduling issues and the reduction in APMA’s staffing.

Of the executed APAs, Japan continued to be the primary bilateral APA treaty partner for the US in 2022, with 39% of the concluded APAs being with Japan, followed by Canada (14%), India (8%), and Switzerland (8%). Overall, the make-up of executed APAs highlights the fact that the US is executing APAs with many more countries, as compared to 2016-2021.

APAs Remain Popular in Manufacturing and Wholesale/Retail Trade Industries

On an industry basis, wholesale/retail trade and manufacturing industries continued to make up the vast majority of APAs executed in 2022, with 42% and 40% of the APAs, respectively. Of the manufacturing APAs, 42% were related to chemical manufacturing, 29% to computer and electronic product manufacturing, and 19% to transportation equipment manufacturing. Of the wholesale/retail trade APAs executed in 2021, the majority fell within the merchant wholesales/durable goods industry (75%), followed by merchant wholesales/nondurable goods (12.5%). In the majority of these APAs, the covered transactions involved several different functions and risks, including research and development, design and engineering, manufacturing, marketing and distribution, and support functions. Most of the types of covered transactions in APAs executed in 2022 continued to involve the sale of tangible goods or the provision of services, while 22% of the transactions involved the use of intangible property, up from 15% during 2021. APMA again noted that these intangible property transactions tend to be the most challenging transactions in APMA’s inventory.

Comparable Profits Method/Transactional Net Margin Method Continues to Dominate

For 2022, 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 77% 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. The operating margin was used as a PLI 73% of the time, while other PLIs, including the Berry Ratio (i.e., the ratio of gross profit to operating expenses) and return on total costs, comprised the remaining 27%.

For the services transactions, a majority (80%) of APAs also used the CPM/TNMM as the transfer pricing method, with the operating margin and operating profit to operating expense being the most common PLIs (used 53% of the time).

Most covered transactions targeted an interquartile range or point within the interquartile range, whereas both specific royalty rates and ranges were used for transactions involving a royalty payment for the use of intangible property. The APAs executed in 2022 included testing periods for a single year, the term of the APA, 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 2022 (same as in both 2021 and 2020), with the largest number of APAs executed with a five-year term (48% of the total). Of the APAs executed in 2022, 94% had terms of five or more years, with the total terms ranging from one year to eleven years. Of the APAs executed in 2021, 16% included a rollback.

Conclusion

While the number of APAs executed in 2022 is down from last year, there has been a significant increase in the number of APA requests filed, reflecting the increased desire of taxpayers to avoid prolonged, resource-intensive and aggressive audits, which may lead to costly and/or unpredictable litigation or require resolution via MAP. While the time to process and reach an agreement on an APA continues to be lengthy, APAs continue to be an effective forum for taxpayers to proactively manage their transfer pricing disputes in a manner that minimizes exposure to potential penalties and double taxation, as well as to efficiently resolve disputes with tax authorities in multiple jurisdictions. In our experience, the APA process continues to be an excellent forum for preventing and resolving transfer pricing issues, and providing certainty to taxpayers (particularly regarding difficult intercompany pricing issues).