There has been a significant amount of negative press recently concerning tax rulings and advance pricing agreements (APAs); negativity that has been fuelled by the European Commission's state aid investigations, Lux leaks and reports by various public interest groups. In light of this there have been numerous articles in the tax media indicating that appeal of APAs is in decline, for example: "Appeal of APAs Fades in Light of EU State Aid Rulings", BNA, 30 August 2016.

Such articles, however, do not always draw the important distinction between unilateral and bilateral APAs.

Why is this distinction important?

Unilateral APAs involve a multinational enterprise group (MNE group) reaching (advance) agreement on their transfer pricing policy with the tax administration in a single tax jurisdiction. In contrast, bilateral APAs involve the MNE group seeking agreement from the governments of two tax jurisdictions as to the transfer pricing policy applicable to transactions between the MNE group taxpayers located in those countries. The legal basis for governments to negotiate and reach agreement in such cases is the Mutual Agreement Procedure (MAP) Article of an applicable tax treaty.

Bilateral APAs on the rise

Recently, bilateral APAs have become the preferred route for businesses seeking certainty as to their transfer pricing policies. There are various reasons for this and we look at some of these here.

In contrast to unilateral APAs, to date there have been no bilateral APAs that have been the subject of state aid investigations, nor have any bilateral APAs faced any criticism in the press. This is not expected to change, particularly when taking into account the recent recommendations of the OECD/G20 concerning bilateral APAs, draft positions put forward by the European Commission, and updates to the United States Revenue Procedure on APAs:

  • Best practice #4 of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Action Item 14 Final Report ("Making Dispute Resolution More Effective") recommends that "Countries should implement bilateral APA programmes".[1]
  • The European Commission's working paper on tax rulings[2] notes that when a two-sided approach to an APA is adopted, which is inherently the approach taken in a bilateral APA, there is less room to deviate from a market outcome as under this approach both companies that are party to the intra-group transaction are analysed.
  • United States Revenue Procedure 2015-41 also states in Section 2.02(4)(d) that the IRS will have a strong preference for bilateral APAs when a treaty makes it possible (and practical) to do so.[3]

The appeal of bilateral APAs today

It's not just governments and international organizations calling for greater use of bilateral APAs, in many countries taxpayer applications have increased due to the formalisation of APA programmes and increased risk in the current environment.

According to Séverine Grüber, a member of the Swiss Competent Authority, in the last few years there has been an increase in both bilateral APA applications overall as well as APAs with an increasing number of treaty partners. In addition, Monica Todose, head of the transfer pricing unit within the Romanian tax administration, confirms that bilateral APA applications have now surpassed unilateral applications in Romania.

Increased interactions between Competent Authorities (who ultimately negotiate bilateral APAs on behalf their governments) as a result of BEPS meetings and conferences have helped foster new and enhanced relationships between them, and have provided an additional opportunity for government representatives to meet and resolve bilateral APA cases.

On top of this, increasing use of technology (such as videoconferencing and encrypted email) has helped remove some of the administrative hurdles historically encountered in the bilateral APA process, and with a proactive presence from the taxpayer side, can vastly improve processing times.

Given these developments, bilateral APAs are an increasingly attractive option. That being said, the analysis of when and where a bilateral APA is the appropriate course of action requires a country-by-country, taxpayer-by-taxpayer, and transaction-by-transaction analysis. For example, certain countries are currently known to be subjecting applicants to quasi-audits upon application, while others are actively promoting their bilateral APA programs as a way of proactively managing cases and building experience. In addition, the cost / benefit of seeking bilateral APAs on certain transactions simply may not warrant an investment in the process. On the other hand, in many cases the absence of certainty can mean prolonged and contentious fact-based audits from tax authorities who may not be experts in transfer pricing.

In addition to protection from penalties and potential double taxation, there are a number of additional benefits to having a bilateral APA. For instance, APAs alleviate the need to discuss or ultimately book provisions in financial statements. APAs also allow companies to better resource plan their tax departments, effectively help manage their overall tax rate, as well as realize compliance cost savings in the long run.

There can be considerable reputational benefits as well. Aside from the future transfer pricing related benefits, being part of a governments' bilateral APA program can help provide for smoother access to MAP if challenges to previous years arise, and also has the advantage of familiarising the Competent Authority with the business operations should other tax treaty issues arise. In addition, the potential role of bilateral APAs in managing the interface of customs valuation and transfer pricing can further add to the appeal for business' involved in the trade of physical goods.[4]

What next?

As a result of BEPS and related developments, transfer pricing and related issues such as permanent establishments are in the crosshairs of most tax authorities (and the media). MNE groups are facing increasing levels of transparency (eg European Union tax ruling sharing) and disclosure (eg Country by Country Reporting and the new OECD Master File / Local File transfer pricing documentation requirements).

While disclosure of such information has historically been a reason to avoid seeking an APA, the new requirements have neutralized one of the key reasons a company may want to avoid the APA process. In such an environment it therefore makes sense for MNE groups to assess on a global level where it might make sense to seek certainty on transfer pricing arrangements in a proactive and cooperative manner through a bilateral APA. Given this, in the authors' view, the appeal of bilateral APAs will continue to fuel interest in APAs for some time to come.