An advance pricing agreement (APA) is an arrangement between a taxpayer and one or more tax authorities that settles, before the transactions take place, the method used to set prices between related companies. It covers a fixed number of future years and is used mainly by multinational groups that sell goods, services, loans or intellectual property between their own entities in different countries.
The purpose is certainty. Transfer pricing rules require related parties to deal with each other on the terms that independent parties would have agreed, and tax authorities can adjust profits where they think this was not done. An APA replaces the risk of a later dispute with an agreed approach. Guidance on APAs appears in the transfer pricing guidelines of the Organisation for Economic Co-operation and Development (OECD), and most large economies run a formal programme.
Types of agreement
APAs are grouped by the number of tax authorities involved:
- Unilateral. One tax authority agrees with the taxpayer. It is quicker to obtain, but it does not bind the other country, which may still adjust the same transaction.
- Bilateral. Two tax authorities agree with each other and with the taxpayer. The governments negotiate under the mutual agreement procedure in the relevant double taxation treaty, so the outcome protects against double taxation.
- Multilateral. Three or more authorities take part, usually where a single business model, such as a trading desk or a regional distribution hub, spans several countries.
The OECD and many administrations prefer bilateral or multilateral agreements, because a unilateral one solves only half of the problem.
What an APA covers
An agreement does not usually fix an actual price. It sets out the transactions in scope, the transfer pricing method, the comparable companies or transactions used as a benchmark, and the range of results that will be accepted. A distributor might, for example, be expected to earn an operating margin within an agreed range. The standard applied is the arm's length principle, tested against what parties in an arm's length transaction would have earned.
The agreement also lists critical assumptions: facts about the business, such as its functions, risks, product lines or exchange rates, that must stay broadly true for the agreement to hold. If they change materially, the APA can be revised or cancelled. Terms typically run for three to five years and can be renewed. Many programmes allow a rollback, in which the agreed method is also applied to earlier open tax years.
The process
Most programmes follow a similar sequence. The taxpayer holds a pre-filing meeting with the tax authority to test whether the case is suitable. It then submits a formal application with a functional analysis, financial data, the proposed method and supporting benchmarking. The authority reviews the application, asks questions and may visit the business. In a bilateral case the two competent authorities then negotiate with each other, which is often the longest stage. Once terms are settled, the agreement is signed and the taxpayer files an annual compliance report showing that it has kept to the terms and that the critical assumptions still hold.
Bilateral agreements commonly take two years or more to conclude, and some administrations charge a filing fee.
Benefits and drawbacks
For the taxpayer, an APA removes the risk of transfer pricing adjustments, penalties and interest on the covered transactions, reduces the cost of audits and makes the tax provision in the accounts more reliable. For tax authorities it saves audit resources and gives early insight into how a business operates.
The drawbacks are time, cost and disclosure. The taxpayer has to hand over detailed information about its operations before it knows whether agreement will be reached. Smaller groups often find the process disproportionate, although some countries offer simplified procedures. An APA also gives certainty only for the transactions and years it covers.
Transparency and wider tax rules
Unilateral APAs and other tax rulings came under scrutiny in the 2010s, when it emerged that some had been used to agree very low taxable profits. The OECD's base erosion and profit shifting project responded by requiring tax authorities to exchange summaries of certain rulings, including unilateral APAs, with the other countries affected. This sits alongside other transparency measures such as country-by-country reporting and the automatic exchange of information.
APAs deal with how profit is divided between countries, not with the rate at which it is taxed, so they continue to operate next to newer rules such as the Pillar Two global minimum tax. They are also distinct from general tax treaty relief, which concerns withholding taxes on payments, and they do not usually settle whether a company has a permanent establishment in another country, although some programmes will consider that question. Where no APA exists and two countries tax the same profit, the usual remedy is double taxation relief through the mutual agreement procedure after the event.