Several U.S. treaty partner jurisdictions have recently become aggressive in extending their taxation rights to cross-border acquisition transactions and the movement of assets, such as intellectual property. As a result, multinational companies should consider seeking advance unilateral or bilateral pricing agreements (also referred to “APAs”) to resolve potential disagreements with foreign tax authorities and avoid lengthy and expansive audits and litigation proceedings.
What are APAs?
Commonly, following an acquisition of a foreign company by a U.S.-based multinational company, certain IP assets of the foreign target may need to be integrated with such company’s other operating assets to better align the ownership of IP assets with such company group’s operating structure, functions, other assets, and risks. Such an alignment of assets could involve the license, sale or transfer of IP to the U.S. parent company or to another member of the multinational company group located in a jurisdiction different than that of the target. A cross-border transfer of assets could result in income recognition based on the value of the assets being transferred.
An APA is an agreement between a multinational company and a taxing authority or authorities regarding the transfer pricing methodology, valuation and pricing of assets and certain transactions. A bilateral or multilateral APA (which involves the multinational company and two or several tax authorities, respectively) provides a non-adversarial alternative to resolving potential cross-border transfer pricing disputes, among many other benefits. Furthermore, the IRS is expected to be more likely to support valuation methodologies and adjustments that are based on acceptable international tax principles and valuation methodologies. The IRS’s support of a company’s valuation methodology in an APA process could be helpful in a dispute or litigation with a treaty partner jurisdiction in support of a company’s position. As a result, a bilateral or multilateral APA process provides an opportunity to set the stage and level the playing field with the treaty partner country(ies). A bilateral or multilateral APA may be a viable alternative to consider for both treaty partners (including Canada, Germany, India, Israel, Japan, Korea, Switzerland and others) and other jurisdictions.
As a primary benefit, a bilateral or multilateral APA could eliminate the need for uncertain tax position reporting and provide for penalty protection. It would also help parties avoid repetitive tax and transfer pricing audits; limit tax authorities’ ability to change transfer prices retroactively; allow parties to manage transfer pricing real-time (rather than responding to audits years later); and mitigate the risk, cost, and burden of an audit or potentially harmful tax litigation in the U.S. and in the treaty partner jurisdiction. Other benefits may include the suspension of current tax audits or assessments relating to the transactions covered by the bilateral or multilateral APA negotiations until the APA process has been concluded, which could take several years.
For instance, recently at least one tax jurisdiction has gone so far as to argue on several occasions that the value of a target company’s IP could be higher than the entire purchase price paid to acquire such target company. The argument has been that, surely the buyer has taken into account the tax cost associated with moving the IP following the acquisition and, thus, discounted the purchased price paid for the target company and all of its assets, including its IP. Such a result, in the absence of an APA, can have a significant effect on deal structure, outcome and consideration if not addressed in advance.
While the taxing authorities and the multinational company are not obligated to reach an agreement, they are generally required to try to reach a mutual agreement pursuant to the applicable income tax treaty, including relevant provisions for the relief from double taxation and mutual agreement procedure.
In a welcome development in the U.S., the IRS released additional guidelines on the IRS’ Advance Pricing and Mutual Agreement Program ("APMA”), a program that looks to identify multinational companies and matters early in the process that are more likely to successfully reach an APA resolution based on the facts at issue. Multinational companies can contact APMA for a pre-submission review and receive a preliminary opinion on whether to proceed with the APA process within just a few weeks of submitting a pre-filing memo and providing additionally requested information.
APMA considers a number of factors, including: the significance of the transaction; the probability that transfer pricing compliance will be significantly enhanced by engaging with the treaty partner; the scope, materiality, and complexity of the company group-covered transactions in the U.S.; whether there is an actual or potential transfer pricing dispute that would be most efficiently resolved through a bilateral or multilateral APA based on the APMA’s experience; country-specific strategy considerations; and the input of the treaty jurisdiction regarding the APA.
In addition to transactions involving IP assets, a bilateral or multilateral APA can cover the provision of services by a non-U.S. entity, the provision of services by a U.S. entity, sale of tangible property into and from the U.S., use of intangible property by a U.S. entity and by a non-U.S. entity, and other transactions. In the majority of APAs, the covered transactions involve numerous business functions and risks.
