As the growth of transfer pricing examination and controversy expands around the world, it is increasingly common to find situations in which a multinational enterprise (MNE) group needs to have advance pricing agreements (APAs) with more than two countries. In such situations, the procedural process can become complex, requiring patience and persistence. A common situation is reflected in the following illustration.
DomCo, a Dominian manufacturer of scanning devices that are designed in Dominia, has controlled foreign corporations in many countries. In countries where it does not have subsidiaries, DomCo typically has a distribution agreement with an unrelated distributor.
In recent years, DomCo’s foreign subsidiaries have had profits in some cases and losses in others. In both situations, DomCo’s transfer pricing relationships with its subsidiaries have been challenged in foreign countries.
DomCo’s foreign subsidiary that manufactures the devices is MafCo, a Euronian corporation. The tax administration of Euronia has regularly challenged the royalties that MafCo pays to DomCo. Dominia and Euronia have an income tax treaty that is similar to the Organisation for Economic Co-Operation and Development Tax Convention.
DomCo determined to resolve these matters via an APA for the most recent five-year period, with a rollback to address examination proposals that had been proposed by the Euronia tax authority in early years. The APA has been an effective process for the DomCo group.
MafCo also functions as the administrative center and holding company for the DomCo business on its continent, North Narnia. The respective tax authorities in many North Narnia countries have proposed various transfer pricing adjustments relating to the relationships of their domestic DomCo affiliates with either or both DomCo and/or MafCo.
DomCo has determined that when it renews its APA-1 with MafCo, it should also address transfer pricing issues with other major North Narnia countries. Accordingly, it has inquired about the feasibility of an APA-2 incorporating Dominia, Euronia and other North Narnia countries.
Approaches to Multilateral APAs
The process of achieving APAs at about the same time with more than two countries is typically referred to as a multilateral APA. There are generally at least three broad approaches to achieving multilateral agreement.
- Collective. One approach is to negotiate with all pertinent tax authorities at the same time. In the context of the Illustration, this would require that DomCo, as the parent, seek to renew APA-1 between Dominia and Euronia, which would be a normal process. It would also seek to extend the agreement to include, say, two to four other North Narnia countries, so that there would be a single agreement signed by each of the countries.
- Bilateral. A second approach would be to renew APA-2 between Dominia and Euronia. At the same time, DomCo could undertake to negotiate bilateral APAs with the other pertinent countries. This could be done with MafCo or Euronia and the other countries, or DomCo or Dominia and the other countries, depending on the functions and risks of the parties.
- Bilateral with Unilateral. A third approach often used is to negotiate APA-2 between Dominia and Euronia, then extend its pertinent terms with unilateral agreements with the other North Narnia countries. Such an arrangement might be appropriate if there were not treaty relationships between certain countries.
There is a potentially infinite variety of other approaches depending on the nature of the situation, including the respective functions and risks of the parties.
Regardless of the mechanics of a multilateral APA, there are a variety of issues to be taken into account when determining whether such an approach could be appropriate in a specific situation. These include:
Receptiveness of the Tax Authorities. The first step is to make sure the respective tax authorities are receptive to the process. Our experience is that many tax authorities have had favorable experience with the process and are open to the prospect, provided that the MNE, or its representatives, is able to coordinate the process. On the other hand, some major tax authorities, while they have sufficient experience to undertake the process, are not receptive, perhaps for some of the reasons noted below.
One reason why tax authorities are receptive is because the factual determination process involves more than two countries, which is likely to provide comfort that the functions and risks have been appropriately developed with commonly agreed transfer pricing methodology.
- Patience of MNEs. If the tax authorities are receptive, the next most important issue is the ability of the MNE and its affiliates to be patient with the process. The reality of trying to convince a range of tax authorities to agree to the same terms is a complex undertaking. In the context of the Illustration, the process would likely involve first convincing Dominia and Euronia to renew APA-2, then seeking to expand its terms, as appropriate, to the other affiliates and countries. This process requires patience, as well as skill and positive relationships with the parties.
- Coordination. DomCo or its external advisors will likely need to coordinate the process. Experience and positive relationships will facilitate this process, and the absence of either or both will increase the complexity proportionally.
Multilateral APAs are often used in connection with global financial and other types of activities where it is difficult to determine where critical functions are performed.
This newsletter was developed with contributions from a member of American Appraisal’s financial valuation practice: Gerald Mehm, senior managing director.© 2014 McDermott Will & Emery