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Advance Pricing Agreements With Tax Authorities: The Impact Of COVID-19 On Transfer Pricing

Advance Pricing Agreements With Tax Authorities: The Impact Of COVID-19 On Transfer Pricing

Advance pricing agreements (APAs) provide tax certainty for transfer pricing issues. However, the COVID-19 crisis is expected to cause uncertainty for taxpayers with respect to existing and pending APAs. Taxpayers who are currently pursuing APAs or have existing APAs (unilateral or bilateral) are advised to give due consideration to how changes in the market and economic conditions will likely affect their existing APA commitments, and assess any effects on ongoing APA negotiations.

Taxpayers will be affected in different ways depending on the nature of their business. Some companies, particularly those in e-commerce and certain technology, as well as household goods, may see positive effects on their revenues and profitability while those in retail, entertainment, travel, and real estate are likely to experience a decline. Countries around the world, particularly throughout Europe and in the U.S., are responding to the crisis in an unprecedented manner, and have announced salary subsidies, low or no interest loans, and grants, among other measures.

What effect will these measures, as well as non-recurring, one-time extraordinary expenses, have on APAs? This article discusses some of the possible effects and how a taxpayer can better prepare its business to respond to these changes.

COVID-19 Tax Issues: Implications On Advance Pricing Agreements

Existing APAs

Taxpayers with existing APAs will soon have to grapple with the question of how to meet the annual or term test. It is highly likely that many parent companies with losses in 2020 may not be in a position to guarantee the profitability of the limited risk distributor as agreed upon in their APAs. APAs are conditional on a set of critical assumptions, and this crisis may invalidate one or more of the assumptions for the remaining term of the APA. The May 2018 APA template released by the Internal Revenue Service (IRS) included critical assumptions language specific to “economic conditions faced.” (This specific language was removed in the December 2019 APA template.) Taxpayers should evaluate the critical assumptions language included in their existing APAs to assess whether they should approach the IRS for revisions to their APAs or request adjustments to pricing methodology and/or results.

While an APA cannot be terminated by the taxpayer unilaterally without the consent of the tax authorities, it is likely that tax authorities around the world will negotiate some type of adjustment to the pricing mechanisms agreed upon in the APAs. (Tweet this!) These adjustments may be similar to those adopted during the financial crisis of 2008. However, it remains to be seen what adjustments, if any, tax authorities will negotiate and agree to.

In the meantime, taxpayers are advised to assess the effects of the crisis on their businesses, and proactively approach the tax authorities with questions in the interest of transparency. Taxpayers may also want to consider informing tax authorities of any inability to comply with their transfer pricing commitments under the APA. Taxpayers are further advised to explore the possibility of switching to a term test if their existing APAs are based on annual tests.

APAs with term tests will have more leeway in absorbing losses in 2020, and can likely spread those losses over the term of the APA. However, the taxpayer will still have to explain how the government-provided subsidies, loans, or grants, or parent-provided support payments should be treated for transfer pricing purposes.

Given the circumstances, some taxpayers will entertain the idea of cancelling their existing APAs. Whether or not the tax authorities will grant this request is not clear. However, cancelling existing APAs cannot be ruled out given the unique circumstance of this crisis. Adjustments to the methodology and revised benchmarking of transfer pricing by tax authorities are more likely to occur.

Pending APAs

Taxpayers currently negotiating APAs have the following three options:

  1. Continue with the negotiation process and advise tax authorities of any material changes.
  2. Request a negotiation deferment until market conditions have normalized.
  3. Withdraw from the process.

Continuing the negotiation process or deferring it will require a re-assessment of the risk profile of the entities involved, as well as adjustments to the methodology and/or comparables. Over the next few months, taxpayers are advised to notify the tax authorities in a timely manner about any material changes in functions and/or risk profiles. Taxpayers should also disclose any revisions to the qualitative and quantitative data already submitted.

Taxpayers can also request a deferment in the negotiation process until the uncertainty has lifted and market conditions become clearer. Under Treasury Regulations, taxpayers can seek amendment changes to the APA until it is finalized. We expect that economic lockdowns and travel restrictions will extend the timeline for APA negotiations regardless of whether taxpayers request a deferment or not. However, taxpayers could request that tax authorities defer the process further on their own.

Taxpayers seeking to withdraw from the process should be mindful of two aspects: APA fees are typically non-refundable, and the data turned over to the tax authorities for advance pricing agreements could be used in future tax audits.

Any opinions expressed in this article are those of the author, and not necessarily those of Valentiam Group.

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Topics: Transfer pricing, COVID-19