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Advance Pricing Agreements
This material must be read in conjunction with the Responsibility Statement
CONTENTS
Scope of APAs
The APA Process
Expression of Interest
When is an APA appropriate?
Formal Application
Evaluation
Agreement
Ongoing compliance
Bilateral or multilateral APAs
Given the inexact nature of determination of the arm’s length rule, the ability to agree its application with the Inland Revenue, particularly in complex circumstances, is invaluable. Although informal agreements of this kind have been possible for many years, sections 85 to 87, FA 1999 provide a formal structure authorising Advance Pricing Agreements (‘APA’s). APAs made for these purposes are written agreements between a business and the Inland Revenue which determine a method for resolving transfer pricing issues in advance of a return being made. Where the terms of the agreement are complied with, they provide assurance that the treatment in accordance with the agreement of those transfer pricing issues will be accepted by both the Revenue and the business for the period covered by the agreement.
Scope of APAs
Under domestic law (section 85(2), FA 1999)), advance pricing agreements can cover any of the following:-
(1) The attribution of income to a branch or agency in the UK through which a trade is carried on or to be carried on.
(2) The attribution of income to a permanent establishment wherever situated through which business is carried on or proposed to be carried on.
(3) The extent to which income is to be taken as arising in a country or territory outside the United Kingdom.
(4) The treatment for tax purposes of any provision made or imposed as between a taxpayer and an associate.
(5) The treatment for tax purposes of any provision made or imposed as between a ring fence trade carried on by the taxpayer and any other activities it carries on.
The APA Process
The APA process is broken down into four stages: expression of interest, formal submission of application, evaluation and agreement.
Expression of Interest
Normally, a business wishing to apply for an APA will want to explore and clarify various aspects of a potential application before making a formal submission. The Revenue will also typically want to discuss this before detailed work is undertaken, particularly to ensure that the APA covers issues that they are prepared to agree on and that resources are not wasted on the application process. This includes the complexity of the issue. They say that where reliable market comparables can be established that enable the methods employed in the OECD Guidelines, then the application of the transfer pricing legislation should not be complex and agreement is unnecessary. Where there is difficulty in establishing reliable market comparables or doubts about how the methods can be accurately employed, then the application does become complex. They have emphasised that size alone will not be a reason for declining an application. This is, however, predicated on the assumption that the more complex transactions will occur more frequently in larger multinational businesses. Whether in fact this will be the case, particularly given the rise of small and medium enterprises undertaking cross-border business, particularly in the e-commerce field, remains to be seen.
The Inland Revenue may decline requests for an APA at the expression of interest stage or when formal proposal is submitted. Requests are likely to be declined if:
(1) sufficient information for proper and full consideration of the request is not provided; or
(2) the proposal does not comply with the terms of UK transfer pricing legislation or the OECD Guidelines; or
(3) the affected transactions are thought to be of a hypothetical nature or not seriously contemplated; or
(4) it appears to be an inefficient use of resources to pursue an APA.
Requests may also be declined if the business is not cooperating to provide timeously the information necessary to consider a request. A business may also withdraw the application at any stage.
When is an APA appropriate?
Assuming that a business has a transfer pricing issue on which the Revenue is prepared to enter into discussions, what are the criteria from a business point of view in deciding whether to seek an APA? The most obvious is that it can protect against a transfer pricing adjustment in the same way as any clearance. Similarly, it can protect against penalties. The certainty to both parties has been described as a ‘win win’ arrangement. It may give additional flexibility to develop an approach which the Revenue accept as fair. It also may have advantages in that it is negotiated by the individuals responsible for transfer pricing in International Division, and not with other Inland Revenue personnel whose principal experience is not in the transfer pricing field. There may also be disadvantages. Enquiry into transfer pricing is not inevitable and the cost implications of an APA may be substantial and may be incurred earlier than would be the case if an enquiry were to be made into the same issues. Since most transfer pricing enquiries are settled by agreement in any event, the enquiry process may in some ways not be dissimilar. Some businesses and advisers might find the amount of information required in order to conclude an APA is not that different from an examination and the time and cost incurred in dealing with this upfront may not be viewed as proportionate to the result. There is also no guarantee that once the process has been started, that an agreement will in fact be concluded.
Formal Application
Formal written application may be made once the Revenue has indicated that it is prepared to consider it and the business wishes to proceed.
Section 85(5) FA 1999 requires applications to set out:
(1) the taxpayer’s understanding of what the effect would be in the absence of the APA of the provisions in relation to which clarification is sought;
(2) the respects in which clarification is required; and
(3) how the taxpayer proposes that matters should be clarified.
Central to the application will be a description of the method by which it is proposed to determine the transfer pricing issues in accordance with UK domestic law, any applicable tax treaty and the OECD Transfer Pricing Guidelines. Detailed supporting information should cover the specific features of the business and the transfer pricing issues in question.
SP3/99 specifies that the information required to support an application will include:-
(1) identification of the parties and accounts generally for the previous three years;
(2) the transfer pricing issues proposed to be covered, analysis of the functions and risks of the party actual and projected financial data;
(3) the worldwide organisational structure, ownership and businesses of the group, where operations are conducted and all major categories of transaction flows of the parties to whom the APA is intended to apply;
(4) a description of the records to be maintained to support the transfer pricing method proposed and the information which is proposed to be supplied each year to demonstrate compliance with the terms of the APA;
(5) details of current tax enquiries or competent authority claims relevant to the issues;
(6) the chargeable periods to be covered;
(7) identification of critical assumptions in developing the proposed methods and their application;
(8) relevant issues in dealing with foreign tax authorities such as requests for competent authority assistance in a bilateral APA or requests to refrain from exchanging particular information because, for example, trade secrets are included which should not be disclosed.
Where bilateral APAs are sought, all of the information supplied to the other authority should also be supplied.
Evaluation
The ongoing process of seeking agreement will involve evaluation of the contents of the application and may include requests for clarification and further information. In the case of bilateral APAs, discussions with the foreign tax authority may be involved including joint meetings with the taxpayer.
Agreement
Any agreement reached is a binding undertaking that the treatment will be in accordance with the agreement for the transfer pricing issues covered by the agreement. If agreement cannot be reached, the Inland Revenue will issue a formal statement recording the reasons. The Inland Revenue do not regard themselves as having any obligation to continue discussions beyond that point.
Ongoing compliance
The APA itself will identify reports that the business is required to provide. Section 86(4), FA 1999 imposes an obligation on parties to an APA to provide ‘all such reports and other information as he may be required to provide under the agreement or by virtue of any request made by an officer of the board in accordance with the terms of the agreement’. Failure to provide such reports may give rise to penalties. The Revenue indicate that these reports are intended to provide the information they require to establish that the business has complied with the terms and conditions of the APA and to verify the accuracy of representations made.
Section 86(5), FA 1999 gives power to the Revenue to nullify an APA where a business has provided false or misleading information fraudulently or negligently. The effect of this is that the taxpayer may be treated as if the APA had never been made. It may also be revoked if the business does not comply with its terms and conditions, or where the identified critical assumptions cease to be valid.
Where this is helpful, it may be possible in some APAs to agree to provisions for modification of their terms in specific circumstances such as where the agreed methodology becomes difficult to apply but which does not go so far as to invalidate a critical assumption. Similarly, provisions are made for renewal.
In addition to the nullification of an APA, a penalty of £10,000 may be imposed where false or misleading information is supplied fraudulently or negligently in connection with an application. This will apply even if no APA is in fact obtained. The Revenue has indicated, however, that it will not pursue this penalty where a tax geared penalty has been obtained following the nullification of an APA.
Bilateral or multilateral APAs
Businesses may choose to enter into APAs with the UK Inland Revenue only. Since most countries either have adopted or are adopting transfer pricing regimes, or have similar mechanisms under other rules, transfer pricing is not exclusively a UK issue. The number of countries adopting APA mechanisms is increasing and companies may wish to consider bilateral APAs in order to comprehensively resolve cross-border transfer pricing issues. These are usually made pursuant to the mutual agreement procedure contained in a relevant tax treaty. The Inland Revenue encourages bilateral APAs. This gives them certainty in relation to the UK tax base and avoids the need to renegotiate the issues with the foreign tax authority if they come to a different conclusion on the application of the arm’s length rule. In some cases, more than two tax administrations may be involved. There is, however, no mechanism for multilateral APAs. Such arrangements are in effect a series of bilateral APAs. The Revenue regard these as being appropriate where there is essentially one activity but several parts of the group contribute to it. Global financial trading is the most obvious example of this.
© Jonathan Schwarz 2001
