Mining for nuggets in the IRS APA report.

• Author: Lewis, Patricia Gimbel
• Position: Advance pricing agreements

The Internal Revenue Service's APA Report is here.(2) Mandated last year by legislation to provide generic guidance to all taxpayers while ensuring the confidentiality of individual advance pricing agreements (APAs), the comprehensive report covers all APAs entered into since the inception of the program. The report is under scrutiny by members of the tax community to determine if it satisfies the legislative mandate and, perhaps more important, provides useful guidance. Early reviews have generally been favorable, although there have been some predictable, reflexive, and rather unconvincing criticisms by Tax Analysts, one of the publishers that had sought the release of APAs under the Freedom of Information Act (FOIA).(3)

As a practitioner who has worked extensively with the APA program, I am impressed by the Report's utility and candor. It assembles pertinent information in a far more coherent and usable way than a roomful of redacted APAs would have. Along with insight into the IRS's approach on some important issues, it provides a menu of ideas for structuring -- or restructuring -- APAs.

Taxpayers with potential transfer pricing issues -- whether in the context of an annual pricing study or a potential APA -- should carefully review the report. This article is intended to start that process by identifying many substantive "nuggets" of information to help taxpayers understand the IRS's APA approaches and accordingly plan transfer pricing structures or design APA applications.

Background of the Report

The APA program was instituted by the IRS in 1991 through the issuance of Rev. Proc. 91-22, 1991-1 C.B. 526. The program was part of a multi-faceted government attempt to improve compliance and reduce extended audit controversies with respect to the application of Code section 482 to intercompany (primarily cross-border) transfer pricing of goods, services, and technology. The purpose of the APA program was to permit reasonably prompt resolution of potential transfer pricing issues in advance of the covered transactions to provide taxpayers and the IRS alike with certainty in respect of compliance with section 482. During the early years of the program, the IRS was simultaneously working to issue substantial revisions of the substantive section 482 rules; proposed regulations were issued in 1992 and 1993 and finalized in 1994 ("the Regulations"), based in part on the concepts explored in the 1988 Treasury/IRS intercompany pricing "White Paper."(4)

The APA program provided the procedural framework for resolving transfer pricing issues on a prospective basis, with the Regulations providing the substantive framework. The Regulations, however, do not provide a cookbook approach to transfer pricing. Rather, they set forth broad principles and rules to be applied on a case-by-case basis to each taxpayer's particular facts and circumstances. The IRS rejected establishment of safe harbors in the Regulations because of concerns about the inappropriate use of published measures, as well as the objections of U.S. treaty partners.

This has generated a keen interest in how the IRS applies the Regulations' precepts in real cases, i.e., on audit or in APAs. Early in the APA program, the IRS expressed an intent to provide generic guidance regarding the application of section 482 standards in particular industries or situations as soon as it could do so without violating the confidentiality of the taxpayers involved. An example (and, unfortunately, the only one) was IRS Notice 94-40, which set forth APA approaches for global trading operations. The IRS also published a model APA agreement (Notice 98-65), but it provided only procedural, not substantive, guidance.

Despite hope that additional guidance would be issued as the IRS gained experience with the growing APA program and final Regulations, this was not forthcoming. Some attributed this lack of additional guidance to the filing (beginning in 1996) of FOIA requests by Tax Analysts and the Bureau of National Affairs ("BNA"), which sought disclosure of the individual APAs. The IRS resisted these requests on the ground that APAs were tax return information and therefore protected under section 6103 -- the position espoused in Rev. Proc. 91-22 and its successor, Rev. Proc. 96-53. The result was a lawsuit filed in federal district court by BNA. The IRS's failure to issue any further substantive guidance emanating from the APA program may have reflected litigation sensitivities.

As the first decade of the APA program drew to a close, there were almost 200 completed APAs but little official information on their content. Suddenly, in reaction to an unfavorable court decision regarding the release of IRS field service advice,(5) the IRS changed its position in the pending BNA case and announced that it would release all APAs on a redacted basis.(6) An outcry from affected taxpayers ensued and two amicus curiae briefs were filed in opposition to the IRS's proposed capitulation (one by Tax Executives Institute and one by the author on behalf of several anonymous corporate taxpayers and two trade associations). Legislative efforts were also initiated, which eventually resulted in late 1999 in the enactment of section 521 of Pub. L. No. 106-170.(7) The BNA lawsuit, rendered moot by this legislation, was dismissed in January 2000.

Section 521 amended sections 6103 and 6110 of the Code to provide that APAs and related background information are protected tax return information and cannot be disclosed publicly, even on a redacted basis. At the same time, the legislation required the Secretary of the Treasury to publish a detailed annual report on the status of APAs, including both statistical and procedural information regarding the program as well as substantive information concerning the APAs and the approved methodologies. The report is subject to statutory confidentiality strictures: it may not include information that (1) would be protected from disclosure under the section 6110(c) restrictions applicable to private rulings and other written determinations or (2) could be associated with or otherwise identify, directly or indirectly, a particular taxpayer.

Requiring this report was in effect the trade-off for legislatively guaranteeing the confidentiality of individual APAs, and all affected parties have hoped that it will make meaningful strides toward quenching taxpayers' (and publishers') thirst for guidance on the practical application of section 482. A Joint Committee report on section 521 further noted that the legislation "is not intended to discourage the Treasury Department from issuing other forms of guidance, such as regulations or revenue rulings, consistent with the confidentiality provisions of the Code."(8)

The IRS invested significant effort in reviewing its full APA library to cull and characterize the prescribed information for public consumption. It issued the 53-page Report (covering the entire history of the APA program through the end of 1999) on schedule. The Report responds to all items on the statutory list without breaching taxpayers' confidentiality.

Do the abstracts of the IRS collection (1) satisfy the statutory requirements, (2) meet the goal of providing useful guidance to taxpayers about the practical application of section 482, and (3) temper publishers' assertions regarding private practitioner libraries accessible only to a few? (1) Yes; (2) Yes, within reason; and (3) probably No. While the Report clearly responds to all identified items and provides significant, if not soup-to-nuts, guidance, one can expect continued requests for more specific guidance despite the resulting intrusion into taxpayers' legitimate privacy spheres. The balance of this article reviews the Report's contents to permit readers to make their own judgments.

Procedural Guidance

The Report initially provides information regarding the APA program procedures. It describes the composition of an IRS APA team, including the APA Office Team Leader, an economist, the local revenue agent and his/her manager or case manager, a District Counsel attorney, perhaps a technical branch attorney with particular relevant expertise, and, for bilateral cases, an analyst from the Tax Treaty Division (i.e., the U.S. Competent Authority office). A full description of the APA process itself is set forth and the current version of the mode] APA is attached as an appendix to the Report.

Statistically, the program has grown steadily, with 40 new APAs and 13 renewals completed in the most recent year. The proportion of completed unilateral APAs(9) has gradually declined (in 1999, to less than 40 percent), perhaps reflecting IRS's encouragement of bilateral solutions, taxpayers' increasing interest in bilateral APAs, and accelerating success in reaching such agreements. Somewhat disturbing is the increasing number of withdrawals from the program (13 in 1999 vs. 46 during the entire 1991-99 period), although the Report offers no comment on or explanation of this statistic.

The data reveal predictable, albeit significant, differences in the time needed to complete unilateral APAs (an average of 20 months in 1999) compared with bilateral APAs (35 months). More startling are the subtrends that can be extracted from the data: the time to complete either a unilateral or bilateral APA has been increasing and renewals of bilateral APAs take as long as new bilateral APAs (vs. half the time in the case of unilateral APAs).

* The above data demonstrate that bilateral APAs, though desired, are not particularly efficient undertakings; the three-year average plus the necessary pre-submission planning and preparation time puts the taxpayer well into the covered period before an agreement is reached. While this may still be faster than an audit, the current pace of business changes calls for a more expeditious process if any "advance" feature is to remain in APAs. A taxpayer considering a bilateral APA...