Internal Revenue Bulletin:  2007-12 

March 19, 2007 

Announcement 2007-31

Announcement and Report Concerning Advance Pricing Agreements


Table of Contents

February 26, 2007
This Announcement is issued pursuant to § 521(b) of Pub. L. 106-170, the Ticket to Work and Work Incentives Improvement Act of 1999, which requires the Secretary of the Treasury to report annually to the public concerning Advance Pricing Agreements (APAs) and the APA Program. The first report covered calendar years 1991 through 1999. Subsequent reports covered separately each calendar year 2000 through 2005. This eighth report describes the experience, structure and activities of the APA Program during calendar year 2006. It does not provide guidance regarding the application of the arm’s length standard.
Matthew W. Frank Director, Advance Pricing Agreement Program
Background
Internal Revenue Code (IRC) § 482 provides that the Secretary may distribute, apportion, or allocate gross income, deductions, credits, or allowances between or among two or more commonly controlled businesses if necessary to reflect clearly the income of such businesses. Under the § 482 regulations, the standard to be applied in determining the true taxable income of a controlled business is that of a business dealing at arm’s length with an unrelated business. The arm’s length standard has also been adopted by the international community and is incorporated into the transfer pricing guidelines issued by the Organization for Economic Cooperation and Development (OECD). OECD, TRANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES AND TAX ADMINISTRATORS (1995). Transfer pricing issues by their nature are highly factual and have traditionally been one of the largest issues identified by the IRS in its audits of multinational corporations. The APA Program is designed to resolve actual or potential transfer pricing disputes in a principled, cooperative manner, as an alternative to the traditional examination process. An APA is a binding contract between the IRS and a taxpayer by which the IRS agrees not to seek a transfer pricing adjustment under IRC § 482 for a covered transaction if the taxpayer files its tax return for a covered year consistent with the agreed transfer pricing method (TPM). In 2006, the IRS and taxpayers executed 82 APAs and amended three APAs.
Since 1991, with the issuance of Rev. Proc. 91-22, 1991-1 C.B. 526, the IRS has offered taxpayers, through the APA Program, the opportunity to reach an agreement in advance of filing a tax return on the appropriate TPM to be applied to related party transactions. In 1996, the IRS issued internal procedures for processing APA requests. Chief Counsel Directives Manual (CCDM), ¶¶ 42.10.10 - 42.10.16 (November 15, 1996). Also in 1996, the IRS updated Rev. Proc. 91-22 with the release of Rev. Proc. 96-53, 1996-2 C.B. 375. In 1998, the IRS published Notice 98-65, 1998-2 C.B. 803, which set forth streamlined APA procedures for small business taxpayers. Then on July 1, 2004, the IRS updated and superseded both Rev. Proc. 96-53 and Notice 98-65 by issuing Rev. Proc. 2004-40, 2004-2 C.B. 50, effective for all APA requests filed on or after August 19, 2004.
On December 19, 2005, the IRS again updated the procedural rules for processing and administering APAs with the release of Rev. Proc. 2006-9, 2006-2 I.R.B. 278. Rev. Proc. 2006-9 supersedes Rev. Proc. 2004-40 and is effective for all APA requests filed on or after February 1, 2006.
Advance Pricing Agreements
An APA generally combines an agreement between a taxpayer and the IRS on an appropriate TPM for the transactions at issue (Covered Transactions) with an agreement between the U.S. and one or more foreign tax authorities (under the authority of the mutual agreement process of our income tax treaties) that the TPM is correct. With such a “bilateral” APA, the taxpayer ordinarily is assured that the income associated with the Covered Transactions will not be subject to double taxation by the U.S. and the foreign jurisdiction. It is the policy of the United States, as reflected in §§ 2.08 and 7 of Rev. Proc. 2006-9, to encourage taxpayers that enter the APA Program to seek bilateral or multilateral APAs when competent authority procedures are available with respect to the foreign country or countries involved. However, the IRS may execute an APA with a taxpayer without reaching a competent authority agreement (a “unilateral” APA).
A unilateral APA is an agreement between a taxpayer and the IRS establishing an approved TPM for U.S. tax purposes. A unilateral APA binds the taxpayer and the IRS, but does not prevent foreign tax administrations from taking different positions on the appropriate TPM for a transaction. As stated in § 7.07 of Rev. Proc. 2006-9, should a transaction covered by a unilateral APA be subject to double taxation as the result of an adjustment by a foreign tax administration, the taxpayer may seek relief by requesting that the U.S. Competent Authority consider initiating a mutual agreement proceeding pursuant to an applicable income tax treaty (if any).
When a unilateral APA involves taxpayers operating in a country that is a treaty partner, information relevant to the APA (including a copy of the APA and APA annual reports) may be provided to the treaty partner under normal rules and principles governing the exchange of information under income tax treaties.
The APA Program
An IRS team headed by an APA team leader is responsible for the consideration of each APA. As of December 31, 2006, the APA Program had 20 team leaders. The team leader is responsible for organizing the IRS APA team. The IRS APA team leader arranges meetings with the taxpayer, secures whatever information is necessary from the taxpayer to analyze the taxpayer’s related party transactions and the available facts under the arm’s length standard of IRC § 482 and the regulations thereunder, and leads the discussions with the taxpayer.
The APA team generally includes an economist, an international examiner, LMSB field counsel, and, in a bilateral case, a U.S. Competent Authority analyst who leads the discussions with the treaty partner. The economist may be from the APA Program or the IRS field organization. As of December 31, 2006, the APA Program had eight economists. The APA team may also include an LMSB International Technical Advisor, other LMSB exam personnel, and an Appeals Officer.
The APA Process
The APA process is voluntary. Taxpayers submit an application for an APA, together with a user fee as set forth in Rev. Proc. 2006-9, § 4.12. The APA process can be broken into five phases: (1) application; (2) due diligence; (3) analysis; (4) discussion and agreement; and (5) drafting, review, and execution.
(1) Application
In many APA cases, the taxpayer’s application is preceded by a pre-file conference with the APA staff in which the taxpayer can solicit the informal views of the APA Program. Pre-file conferences can occur on an anonymous basis, although a taxpayer must disclose its identity when it applies for an APA. Taxpayers must file the appropriate user fee on or before the due date, including extensions, of the tax return for the first taxable year that the taxpayer proposes to be covered by the APA. (If the taxpayer receives an extension to file its tax return, it must file its user fee no later than the actual filing date of the return.) Many taxpayers file a user fee first and then follow up with a full application later. The procedures for pre-file conferences, user fees, and applications can be found in §§ 3 and 4 of Rev. Proc. 2006-9.
The APA application can be a relatively modest document for small businesses. Section 9 of Rev. Proc. 2006-9 describes the special APA procedures for small business taxpayers. For most taxpayers, however, the APA application is a substantial document filling several binders.
The application is assigned to an APA team leader who is responsible for the case. The APA team leader’s first responsibility is to organize the APA team. This involves contacting the appropriate LMSB International Territory Manager to secure the assignment of an international examiner to the APA case and the LMSB Counsel’s office to secure a field counsel lawyer. In a bilateral case, the U.S. Competent Authority will assign a U.S. Competent Authority analyst to the team. In a large APA case, the international examiner may invite his or her manager and other LMSB personnel familiar with the taxpayer to join the team. If the APA may affect taxable years in Appeals, the appropriate appellate conferee will be invited to join the team. In appropriate cases, the APA team leader contacts the Manager, LMSB International Technical Advisors, to determine whether to include a technical advisor on the team. The IRS APA team will generally include a technical advisor if the APA request concerns cost sharing, or a complex intangibles or services transaction. The APA team leader then distributes copies of the APA application to all team members and sets up an opening conference with the taxpayer. The APA office strives to hold this opening conference within 45 days of the assignment of the case to a team leader. At the opening conference, the APA team leader proposes a case plan designed, if feasible, to complete a unilateral APA or, in the case of a bilateral APA, the recommended U.S. negotiating position within 12 months from the date the full application is filed. The actual median and average times for completing unilateral APAs, recommended negotiating positions for bilateral APAs, and APAs for small business taxpayers are shown below in Tables 2, 5, and 11, respectively.
(2) Due Diligence
The APA team must satisfy itself that the relevant facts submitted by the taxpayer are complete and accurate. This due diligence aspect of the APA is vital to the process. It is because of this due diligence that the IRS can reach advance agreements with taxpayers in the highly factual setting of transfer pricing. Due diligence can proceed in a number of ways. Typically, the APA team leader will submit in advance of the opening conference a list of questions to the taxpayer for discussion at the conference. The opening conference may result in additional questions and an agreement to meet one or more times in the future. These questions and meetings are not an audit and are focused on the transfer pricing issues associated with the transactions in the taxpayer’s application, or such other transactions that the taxpayer and the IRS may agree to add.
(3) Analysis
A significant part of the analytical work associated with an APA is done typically by the APA economist and/or an IRS field economist assigned to the case. The analysis may result in the need for additional information. Once the IRS APA team has completed its due diligence and analysis, it begins discussions with the taxpayer over the various aspects of the APA including the covered transactions, the TPM, the selection of comparable transactions, asset intensity and other adjustments, the appropriate critical assumptions, the APA term, and other key issues. The APA team leader will discuss particularly difficult issues with his or her managers, but generally the APA team leader is empowered to negotiate the APA.
(4) Discussion and Agreement
The discussion and agreement phase differs for bilateral and unilateral cases. In a bilateral case, the discussions proceed in two parts and involve two IRS offices — the APA Program and the U.S. Competent Authority. In the first part, the APA team will attempt to reach a consensus with the taxpayer regarding the recommended position that the U.S. Competent Authority should take in negotiations with its treaty partner. This recommended U.S. negotiating position is a paper drafted by the APA team leader and signed by the APA Director that provides the APA Program’s view of the best TPM for the Covered Transaction, taking into account IRC § 482 and the regulations thereunder, the relevant tax treaty, and the U.S. Competent Authority’s experience with the treaty partner.
The experience of the APA office and the U.S. Competent Authority is that APA negotiations are likely to proceed more rapidly with a foreign competent authority if the U.S. negotiating position is fully supported by the taxpayer. Consequently, the APA office works together with the taxpayer in developing the recommended U.S. negotiating position. On occasion, the APA team will agree to disagree with a taxpayer. In these cases, the APA office will send a recommended U.S. negotiating position to the U.S. Competent Authority that includes elements with which the taxpayer does not agree. This disagreement is noted in the paper. The APA team leader also solicits the views of the field members of the APA team, and, in the vast majority of APA cases, the international examiner, LMSB field counsel, and other IRS field team members concur in the position prepared by the APA team leader.
Once the APA Program completes the recommended U.S. negotiating position, the APA process shifts from the APA Program to the U.S. Competent Authority. The U.S. Competent Authority analyst assigned to the APA takes the recommended U.S. negotiating position and prepares the final U.S. negotiating position, which is then transmitted to the foreign competent authority. The negotiations with the foreign competent authority are conducted by the U.S. Competent Authority analyst, most often in face-to-face negotiating sessions conducted periodically throughout the year. At the request of the U.S. Competent Authority analyst, the APA team leader may continue to assist the negotiations.
In unilateral APA cases, the discussions proceed solely between the APA Program and the taxpayer. In a unilateral case, the taxpayer and the APA Program must reach agreement to conclude an APA. As in bilateral cases, the APA team leader almost always will achieve a consensus with the IRS field personnel assigned to the APA team regarding the final APA. The APA Program has a procedure in which the IRS field personnel are solicited formally for their concurrence in the final APA. This concurrence, or any item in disagreement, is noted in a memorandum prepared by the APA team leader that accompanies the final APA sent forward for review and execution.
(5) Drafting, Review, and Execution
Once the IRS and the taxpayer reach agreement, the drafting of the final APA generally takes little time because the APA Program has developed standard language that is incorporated into every APA. The current version of this language is found in Attachment A. APAs are reviewed by the APA Branch Chief and the APA Director. In addition, the team leader prepares a summary memorandum for the Associate Chief Counsel (International) (ACC(I)). On March 1, 2001, the ACC(I) delegated to the APA Director the authority to execute APAs on behalf of the IRS. See Chief Counsel Notice CC-2001-016. The APA is executed for the taxpayer by an appropriate corporate officer.
Model APA at Attachment A [§ 521(b)(2)(B)]
Attachment A contains the current version of the model APA language.
The Current APA Office Structure, Composition, and Operation
In 2006, the APA office consisted of four branches with Branches 1 and 3 staffed with APA team leaders and Branch 2 staffed with economists. Branch 4, the APA West Coast branch, is headquartered in Laguna Niguel, California, with an additional office in San Francisco, and is staffed with both team leaders and economists.
Overall, the APA staff increased by seven, to 40 from 33, from the end of 2005 to the end of 2006. Three team leaders, three economists, and a branch chief were added to the Program.
As of December 31, 2006, the APA staff was as follows:
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The staffing increase in 2006 was achieved through the hiring of eight persons and the addition of a second person detailed to the APA Program from the IRS Appeals Office. This hiring, most of which occurred mid-year, allowed the APA Program to realize a 6 percent increase in staffing in 2006 over 2005 measured by total work hours and a 12 percent increase in staffing for the second half of 2006 over the same period in 2005, again measured by total work hours. The change in APA staffing levels over the last six years is reflected in the table below.
Hours of APA attorneys, economists, and paralegal staff by year (excluding holiday and leave)
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APA Issue/Industry Coordination Teams
In May 2005, the IRS Chief Counsel announced a series of initiatives to improve APA Program performance. One initiative was to increase specialization within the office by creating teams of select individuals to handle all cases of a particular type. The purpose was to increase efficiency, quality, and consistency.
The APA Program selected five categories of cases for specialization - cases involving cost sharing arrangements, financial products, the semiconductor industry, the automotive industry, and the pharmaceutical industry. These categories were selected because they each had a sufficient number of cases and commonality of issues to warrant their assignment to teams. Cases falling within these five categories have historically accounted for about 40 percent of the APA Program’s case load (excluding Small Business Taxpayer (“SBT”) cases) and more than half of its total case time. At the end of 2006, cases within these five categories account for 31 of the 90 non-SBT cases pending in the office that were either unilateral APAs or bilateral APAs that had not yet been forwarded to Competent Authority.
Staffing of the coordination teams at the end of 2006 is indicated below.
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The APA Program is mindful that the purpose of the coordination effort is not to impose the same transfer pricing method on all taxpayers in an industry. The appropriate transfer pricing method remains a case-by-case determination, influenced by numerous factors that are not common to all companies operating in a particular industry. While the coordination effort may result in the APA Program promoting a common approach on some issues where appropriate, the Program expects that the greater industry familiarity developed through the coordination effort will also allow it to develop a more sophisticated understanding of issues that will permit more tailored approaches, thereby promoting more (appropriately) varied results than might otherwise be the case.
APA Training
In 2006, the APA office continued its training activities. Training sessions addressed APA-related current developments, new APA office practices and procedures, and international tax law issues. The training materials used for new hires are available to the public through the APA internet site at http://www.irs.gov/businesses/corporations/article/0,,id=96221,00.html. These materials do not constitute guidance on the application of the arm’s length standard and are not to be relied upon or cited as precedent.
APA Program Statistical Data [§ 521(b)(2)(C) and (E)]
The statistical information required under § 521(b)(2)(C) is contained in Tables 1 and 10 below; the information required under § 521(b)(2)(E) is contained in Tables 2 and 3 below:
TABLE 1: APA APPLICATIONS, EXECUTED APAs, AND PENDING APAs
  Unilateral Bilateral Multilateral Year Total Cumulative Total
APA applications filed during year 2006 42 67   109 1037
All APAs executed          
  Year 2006 42 39 1 82 692
  1991-2005 282 320 8 610  
APA renewals executed during year 2006 21 14   35 180
Revised or Amended APAs executed during year 2006 2 1   3 33
Pending requests for APAs 46 203   249  
  Pending requests for new APAs 30 137   167  
  Pending requests for renewal APAs 16 66   82  
APAs canceled or revoked 0 0   0 5
APAs withdrawn 3 13   16 121
TABLE 2: MONTHS TO COMPLETE APAs
Months to Complete Advance Pricing Agreements in Year 2006
All New All Renewals All Combined
Average 33.9 Average 27.5 Average 31.2
Median 35.3 Median 25.9 Median 28.1
 
Unilateral New Unilateral Renewals Unilateral Combined
Average 22.0 Average 18.5 Average 20.3
Median 22.9 Median 17.4 Median 18.7
 
Bilateral/Multilateral New Bilateral/Multilateral Renewals Bilateral/Multilateral Combined
Average 43.6 Average 40.9 Average 42.7
Median 45.4 Median 38.5 Median 43.7
TABLE 3: APA COMPLETION TIME - MONTHS PER APA
Months Number of APAs Months Number of APAs Months Number of APAs Months Number of APAs
1   18 3 35 2 52  
2   19 2 36 1 53 1
3 1 20   37 1 54 1
4   21 2 38 3 55 1
5   22 1 39   56 1
6   23 8 40 2 57  
7   24 1 41 2 58  
8   25 1 42   59 1
9 2 26 2 43 1 60  
10 2 27 2 44 1 61 3
11 3 28 2 45 1 62  
12 1 29   46 2 63  
13 1 30 2 47   64  
14   31 1 48 2 65 1
15 6 32 1 49   66  
16 1 33 3 50 3 67  
17 1 34   51 3 68  
TABLE 4: RECOMMENDED NEGOTIATING POSITIONS
Recommended Negotiating Positions Completed in Year 2006 62
TABLE 5: MONTHS TO COMPLETE RECOMMENDED NEGOTIATING POSITIONS
New Renewal Combined
Average 26.1 Average 26.5 Average 26.2
Median 23.9 Median 28.9 Median 23.9
TABLE 6: RECOMMENDED NEGOTIATING POSITIONS COMPLETION TIME - MONTHS PER APA
Months Number Months Number Months Number Months Number
1   17 4 33 2 49  
2   18 3 34 3 50  
3   19   35   51 1
4   20 1 36   52  
5 1 21 3 37 1 53  
6   22 2 38   54  
7 2 23 5 39   55 1
8 1 24 6 40   56  
9   25 1 41 1 57  
10   26 1 42   58 1
11 2 27 1 43   59  
12   28 4 44 2 60  
13   29 2 45   61  
14   30 3 46   62 1
15 3 31 2 47   63  
16   32 2 48   64  
Tables 7 and 8 below show how long each APA request pending at the end of 2006 has been in the system as measured from the filing date of the APA submission. The numbers for pending unilateral and bilateral cases differ from the numbers in Table 1 because Tables 7 and 8 reflect only cases for which submissions have been received while Table 1 includes any case for which a user fee has been paid.
TABLE 7: UNILATERAL APAs - TIME IN INVENTORY - MONTHS PER APA
Months Number of APAs Months Number of APAs Months Number of APAs Months Number of APAs
1 2 8 4 15 1 22  
2   9   16 1 23 2
3   10   17   24 1
4 2 11 5 18   25  
5 1 12 1 19   26  
6 2 13   20   27  
7 11 14   21 1 28 1
TABLE 8: BILATERAL APAs - TIME IN INVENTORY - MONTHS PER APA
Months Number of APAs Months Number of APAs Months Number of APAs Months Number of APAs
1 1 27 5 53   79  
2   28 1 54 3 80  
3 10 29 4 55   81  
4 7 30 3 56 2 82  
5 3 31 3 57   83  
6 8 32 2 58 1 84  
7 7 33 6 59 2 85  
8 4 34 5 60   86  
9 1 35 2 61   87  
10 5 36   62   88  
11 7 37 1 63   89 2
12 5 38   64   90  
13 4 39   65   91  
14 7 40 4 66 1 92  
15 3 41   67 2 93  
16 5 42 2 68   94  
17 2 43 3 69   95  
18 1 44 1 70   96  
19 1 45 1 71 1 97  
20 5 46 1 72 2 98  
21 5 47   73   99  
22 5 48 3 74   100-105 1
23 9 49 1 75   106-110  
24   50 5 76   111-115  
25 2 51   77   116-120 1
26 4 52   78 1    
Of the 218 cases in the APA Program’s inventory shown in Tables 7 and 8, 108 cases (all of which are reflected in Table 8) are bilateral cases that have been forwarded to the Competent Authority office for discussion with a treaty partner. This leaves 110 cases in the APA Program’s active inventory at the end of 2006 that are either unilateral APAs (35 cases) or bilateral APAs for which the APA Program has not yet completed a recommended negotiating position (75 cases).
The table below shows the average age (in months) of the 110 active cases in inventory at the end of 2006, along with a comparison of the number of active cases and their average age at year-end for each year back to 2002. The table also shows the same information for cases that were at least 6 months old or 1 year old (the latter being a subset of the former) at the end of each year to allow comparison without potential distortions caused by year-to-year variations in the number of cases received in the latter half or during the course of the year.
TABLE 9: NUMBER AND AVERAGE AGE OF ACTIVE CASES IN INVENTORY AT YEAR-END
  2002 2003 2004 2005 2006
           
Active cases 80 106 130 133 110
Average age (months) 14.1 15.1 15.2 13.2 10.6
           
Active cases 6+ months 40 78 106 87 81
Average age (months) 25.5 19.4 17.8 18.5 13.0
           
Active cases 1+ year 22 46 60 55 32
Average age (months) 38.9 26.8 24.2 23.3 19.4
TABLE 10: SMALL BUSINESS TAXPAYER APAs
Small Business Taxpayer APAs Completed in Year 2006 19
New 10
Renewals 9
Unilateral 15
Bilateral 4
TABLE 11: MONTHS TO COMPLETE SMALL BUSINESS TAXPAYER APAs
Months to Complete Small Business Taxpayer APAs in Year 2006
New Renewal Combined
Average 24.2 Average 21.4 Average 22.9
Median 20.9 Median 21.2 Median 21.2
TABLE 12: INDUSTRIES COVERED[a]

[a] The categories in this table are drawn from the North American Industry Classification System (NAICS), which has replaced the U.S. Standard Industrial Classification (SIC) system. NAICS was developed jointly by the U.S., Canada, and Mexico to provide new comparability in statistics about business activity across North America.

Industry Involved - NAICS Codes Number
Electronic equipment, appliance and component manufacturing - 335 10-12
Wholesale trade, durable goods - 421 10-12
Computer and electronic product manufacturing - 334 7-9
Chemical manufacturing - 325 4-6
Information service and data processing services - 514 4-6
Miscellaneous manufacturing - 339 4-6
Machinery manufacturing - 333 4-6
Food manufacturing - 311 1-3
Securities, commodity contracts and other intermediary and related activities - 523 1-3
Transportation equipment manufacturing - 336 1-3
Wholesale trade, nondurable goods - 422 1-3
Motor vehicle and parts dealers - 441 1-3
Beverage and tobacco manufacturing - 312 1-3
Fabricated metal manufacturing - 332 1-3
Sporting goods, hobby, book and music stores - 451 1-3
Food and beverage stores - 445 1-3
Air transportation - 481 1-3
Clothing and clothing accessories stores - 448 1-3
Broadcasting and telecommunications - 513 1-3
Plastics and rubber products manufacturing - 326 1-3
Petroleum and coal manufacturing - 324 1-3
Wood product manufacturing - 321 1-3
Water transportation - 483 1-3
Publishing industries - 511 1-3
Motion pictures and sound recording industries - 512 1-3
Trades or Businesses [§ 521(b)(2)(D)(i)]
The nature of the relationships between the related organizations, trades, or businesses covered by APAs executed in 2006 is set forth in Table 13 below:
 
TABLE 13: NATURE OF RELATIONSHIPS BETWEEN RELATED ENTITIES
Relationship Number of APAs
Foreign Parent - U.S. Subsidiary (-ies) 42
Unilateral 21
Bilateral 21
U.S. Parent - Foreign Subsidiary (-ies) 36
Unilateral 15
Bilateral 21
Foreign Company and U.S. branch(es) 0
Unilateral 0
Bilateral 0
Partnership 4
Unilateral ≤ 3
Bilateral ≤ 3
U.S. Company and non-U.S. branch(es) 0
Unilateral 0
Bilateral 0
Covered Transactions [§ 521(b)(2)(D)(ii)]
The controlled transactions covered by APAs executed in 2006 are set forth in Table 14 and Table 15 below:
TABLE 14: TYPES OF COVERED TRANSACTIONS
Transaction Type Number
Sale of tangible property into the U.S. 41
Use of intangible property by Non-U.S. entity 25
Sale of tangible property from the U.S. 18
Performance of services by Non-U.S. entity 16
Use of intangible property by U.S. entity 11
Performance of services by U.S. entity 11
R&D cost sharing - U.S. parent ≤ 3
R&D cost sharing - Non-U.S. parent ≤ 3
Financial products - U.S. parent ≤ 3
Other ≤ 3
TABLE 15: TYPES OF SERVICES INCLUDED IN COVERED TRANSACTIONS
Intercompany Services Involved in the Covered Transactions Number
Distribution 24
Technical support services 20
Marketing 19
Logistical support 19
Administrative 19
Sales support 14
Product support 11
Management 11
Communication service 10
Purchasing 10
Research and development 7
Accounting 6
Headquarters costs 6
Manufacturing services 6
Legal 4
Contract research & development ≤ 3
Warranty services ≤ 3
Assembly ≤ 3
Billing services ≤ 3
Testing and installation services ≤ 3
Business Functions Performed and Risks Assumed [§ 521(b)(2)(D)(ii)]
The general descriptions of the business functions performed and risks assumed by the organizations, trades, or businesses whose results are tested in the Covered Transactions in the APAs executed in 2006 are set forth in Tables 16 and 17 below:
 
TABLE 16: FUNCTIONS PERFORMED BY THE TESTED PARTY
Functions Performed Number
Distribution functions 64
Marketing functions 44
Manufacturing 41
Transportation and warehousing 30
Managerial, legal, accounting, finance, personnel, and other support services 29
Product assembly and/or packaging 25
Purchasing and materials management 24
Research and development 17
Technical training and tech support for sales staff (including sub-distributors) 17
Product testing and quality control 17
Product design and engineering 12
Licensing of intangibles 11
Product service (repairs, etc.) 11
Process engineering 7
Engineering and construction related services 5
Consulting services ≤ 3
Trading and risk management of financial products ≤ 3
TABLE 17: RISKS ASSUMED BY THE TESTED PARTY
Risks Assumed Number
Market risks, including fluctuations in costs, demand, pricing, & inventory 89
Credit and collection risks 67
General business risks (e.g., related to ownership of PP&E) 60
Financial risks, including interest rates & currency 36
Product liability risks 32
R&D risks 17
Discussion
The majority of APAs have Covered Transactions that involve numerous business functions and risks. For instance, with respect to functions, companies that manufacture products typically conduct research and development, engage in product design and engineering, manufacture the product, market and distribute the product, and perform support functions such as legal, finance, and human resources services. Regarding risks, companies are subject to market risks, R&D risks, financial risks, credit and collection risks, product liability risks, and general business risks. In the APA evaluation process, a significant amount of time and effort is devoted to understanding how the functions and risks are allocated among the controlled group of companies that are party to the Covered Transactions.
In its APA submission, the taxpayer must provide a functional analysis. The functional analysis identifies the economic activities performed, the assets employed, the economic costs incurred, and the risks assumed by each of the controlled parties. The importance of the functional analysis derives from the fact that economic theory posits that there is a positive relationship between risk and expected return and that different functions provide different value and have different opportunity costs associated with them. It is important that the functional analysis go beyond simply categorizing the tested party as, say, a distributor. It should provide more specific information because, in the example of distributors, not all distributors undertake similar functions and risks.
The functional analysis is critical in determining the TPM (including the selection of comparables). In evaluating the functional analysis, the APA Program considers contractual terms between the controlled parties and the consistency of the conduct of the parties with respect to the allocation of risk. In accordance with the section 482 regulations, the APA Program also gives consideration to the ability of controlled parties to fund losses that might be expected to occur as a result of the assumption of risk. Another relevant factor considered in evaluating the functional analysis is the extent to which a controlled party exercises managerial or operational control over the business activities that directly influence the amount of income or loss realized. The section 482 regulations posit that parties at arm’s length will ordinarily bear a greater share of those risks over which they have relatively more control.
In addition to the functional analysis, the APA evaluation process considers broader economic factors and conditions including the economic condition of the particular industry.
Related Organizations, Trades, or Businesses Whose Prices or Results are Tested to Determine Compliance with APA Transfer Pricing Methods [§ 521(b)(2)(D)(iii)]
The related organizations, trades, or businesses whose prices or results are tested to determine compliance with TPMs prescribed in APAs executed in 2006 are set forth in Table 18 below:
TABLE 18: RELATED ORGANIZATIONS, TRADES, OR BUSINESSES WHOSE PRICES OR RESULTS ARE TESTED[a]

[a] “Multiple tested parties” includes covered transactions that utilize profit splits, CUPs, and CUTs.

Type of Organization Number
Multiple tested parties 37
U.S. distributor 31
U.S. provider of services 14
U.S. manufacturer 13
Non-U.S. manufacturer 12
Non-U.S. distributor 10
Non-U.S. provider of services 5
Non-U.S. licensee of intangible property 5
U.S. licensee of intangible property ≤ 3
U.S. dealer in financial products ≤ 3
U.S. participant in cost sharing agreement ≤ 3
Other ≤ 3
Transfer Pricing Methods and the Circumstances Leading to the Use of Those Methods [§ 521(b)(2)(D)(iv)]
The TPMs used in APAs executed in 2006 are set forth in Tables 19-20 below:
 
TABLE 19: TRANSFER PRICING METHODS USED FOR TRANSFERS OF TANGIBLE AND INTANGIBLE PROPERTY[a]

[a] Profit Level Indicators (PLIs) used with the Comparable Profit Method of Treas. Reg. § 1.482-5, and as used in these TPM tables, are as follows: (1) operating margin (ratio of operating profit to sales); (2) Berry ratio (ratio of gross profit to operating expenses); (3) gross margin (ratio of gross profit to sales); (4) markup on total costs (percentage markup on total costs); and (5) rate of return on assets or capital employed (ratio of operating profit to operating assets).

TPM Used Number
CPM: PLI is operating margin 25
Residual profit split 20
CPM: PLI is Berry ratio 11
CPM: PLI is markup on total costs 10
Unspecified method 8
CPM: PLI is gross margin 6
CUT (intangibles only) ≤ 3
Other profit split ≤ 3
CPM: PLI is other PLI ≤ 3
Cost Plus Method (tangibles only) ≤ 3
CUP (tangibles only) - not based on published market data ≤ 3
CPM: PLI is markup on other costs ≤ 3
Resale Price Method (tangibles only) ≤ 3
CPM: PLI is return on assets or capital employed ≤ 3
CUP (tangibles only) - based on published market data ≤ 3
TABLE 20: TRANSFER PRICING METHODS USED FOR SERVICES
TPM Used Number
CPM: PLI is markup on total costs 11
Cost plus a markup 4
Cost with no markup 4
CPM: PLI is operating margin ≤ 3
CPM: PLI is Berry ratio ≤ 3
Comparable Uncontrolled Transaction ≤ 3
Other ≤ 3
Discussion
The TPMs used in APAs completed during 2006 were based on the section 482 regulations. Under Treas. Reg. § 1.482-3, the arm’s length amount for controlled transfers of tangible property may be determined using the Comparable Uncontrolled Price (CUP) method, the Resale Price Method, the Cost Plus Method, the Comparable Profits Method (CPM), or the Profit Split Method. Under Treas. Reg. § 1.482-4, the arm’s length amount for controlled transfers of intangible property may be determined using the Comparable Uncontrolled Transaction (CUT) method, CPM, or the Profit Split Method. An “Unspecified Method” may be used for both tangible and intangible property if it provides a more reliable result than the enumerated methods under the best method rule of Treas. Reg. § 1.482-1(c). For transfers involving the provision of services, Treas. Reg. § 1.482-2(b) provides that services performed for the benefit of another member of a controlled group should bear an arm’s length charge, either deemed to be equal to the cost of providing the services or an amount that would have been charged between independent parties. In addition, Treas. Reg. § 1.482-2(a) provides rules concerning the proper treatment of loans or advances.
Treas. Reg. § 1.482-7 provides rules for qualified cost sharing arrangements under which the parties agree to share the costs of development of intangibles in proportion to their shares of reasonably anticipated benefits. APAs involving cost sharing arrangements generally address both the method of allocating costs among the parties as well as determining the appropriate amount of the “buy-in” payment due for the transfer of pre-existing intangibles to the controlled participants. In 2006, the APA Program completed more than half a dozen cost sharing and/or buy-in APAs, including both outbound and inbound transactions. The majority of these were unilateral, but the APA Program also completed its recommendations on three additional bilateral cost sharing/buy-in cases and sent those on to Competent Authority. The methods used in the buy-in cases included valuations based on comparable uncontrolled transactions, on discounted cash flows, and on market capitalization. In addition, the Program is currently working on approximately half a dozen more cases involving cost sharing/buy-ins, split about evenly between bilateral and unilateral.
In reviewing the TPMs applicable to transfers of tangible and intangible property reflected in Table 19, the majority of the APAs followed the specified methods. However, several points should be made. The section 482 regulations note that for transfers of tangible property, the CUP method will generally be the most direct and reliable measure of an arm’s length price for the Controlled Transaction if sufficiently reliable comparable transactions can be identified. Treas. Reg. § 1.482-3(b)(2)(ii)(A). It was the experience of the APA Program in 2006, that in the cases that came into the APA Program, sufficiently reliable CUP transactions were difficult to find.
Similar to the CUP method, for transfers of intangible property, the CUT method will generally provide the most reliable measure of an arm’s length result if sufficiently reliable comparables may be found. Treas. Reg. § 1.482-4(c)(2)(ii). It has generally been difficult to identify external comparables, and APAs using the CUT method tend to rely on internal transactions between the taxpayer and unrelated parties. In 2006, three or fewer Covered Transactions utilized the CUT TPM.
The Cost Plus Method (tangibles only) and Resale Price Method were each applied in 2006 in three or fewer APAs. See Treas. Reg. § 1.482-3(c), (d).
The CPM is frequently applied in APAs. That is because reliable public data on comparable business activities of independent companies may be more readily available than potential CUP data, and comparability of resources employed, functions, risks, and other relevant considerations are more likely to exist than comparability of product. The CPM also tends to be less sensitive than other methods to differences in accounting practices between the tested party and comparable companies, e.g., classification of expenses as cost of goods sold or operating expenses. Treas. Reg. § 1.482-3(c)(3)(iii)(B), and -3(d)(3)(iii)(B). In addition, the degree of functional comparability required to obtain a reliable result under the CPM is generally less than required under the Resale Price or Cost Plus methods because differences in functions performed often are reflected in operating expenses, and thus taxpayers performing different functions may have very different gross profit margins but earn similar levels of operating profit. Treas. Reg. § 1.482-5(c)(2).
Table 19 reflects more than 54 uses of the CPM (with varying PLIs) in Covered Transactions involving tangible or intangible property. In some APAs, the CPM was also used concurrently with other methods.
The CPM has proven to be versatile in part because of the various PLIs that can be used in connection with the method. Reaching agreement on the appropriate PLI has been the subject of much discussion in many of the cases, and it depends heavily on the facts and circumstances. Some APAs have called for different PLIs to apply to different parts of the Covered Transactions or with one PLI used as a check against the primary PLI.
The CPM was also used regularly with services as the Covered Transactions in APAs executed in 2006. There were at least 13 services Covered Transactions using the CPM method with various PLIs according to the specific facts of the taxpayers involved. Table 20 reflects the methods used to determine the arm’s length results for APAs involving services transactions.
In 2006, 20 APAs involving tangible or intangible property used the Residual Profit Split Method. Treas. Reg. § 1.482-6(c)(3). In residual profit split cases, routine contributions by the controlled parties are allocated routine market returns, and the residual income is allocated among the controlled taxpayers based upon the relative value of their contributions of non-routine intangible property to the relevant business activity.
Profit splits have also been used in a number of financial product APAs in which the primary income-producing functions are performed in more than one jurisdiction.
Critical Assumptions [§ 521(b)(2)(D)(v)]
Critical Assumptions used in APAs executed in 2006 are described in Table 21 below:
TABLE 21: CRITICAL ASSUMPTIONS
Critical Assumptions involving the following: Number of APAs
Material changes to the business 82
Material changes to tax and/or financial accounting practices 82
Other financial ratio 7
Assets will remain substantially same 4
Cost allocations 4
Minimum sales volume ≤ 3
Changes in affiliated companies ≤ 3
Limit on product line revenues ≤ 3
Currency fluctuations ≤ 3
Material sales fluctuations ≤ 3
Catastrophic events ≤ 3
Limit on sales to related parties ≤ 3
Major regulatory changes ≤ 3
Sales territories substantially same ≤ 3
Profit projections hold ≤ 3
Other 4
Discussion
APAs include critical assumptions upon which their respective TPMs depend. A critical assumption is any fact (whether or not within the control of the taxpayer) related to the taxpayer, a third party, an industry, or business and economic conditions, the continued existence of which is material to the taxpayer’s proposed TPM. Critical assumptions might include, for example, a particular mode of conducting business operations, a particular corporate or business structure, or a range of expected business volume. Rev. Proc. 2006-9, § 4.05. Failure to meet a critical assumption may render an APA inappropriate or unworkable. Most APAs contain only the standard critical assumption language set forth in Appendix B of the Model APA (Attachment A to this Announcement and Report). Where appropriate, additional critical assumption language may be added but the APA Program generally seeks to limit additional critical assumption language to objective, measurable benchmarks.
A critical assumption may change or fail to materialize due to changes in economic circumstances, such as a fundamental and dramatic change in the economic conditions of a particular industry. In addition, a critical assumption may change or fail to materialize due to a taxpayer’s actions that are initiated for good faith business reasons, such as a change in business strategy, mode of conducting operations, or the cessation or transfer of a business segment or entity covered by the APA.
If a critical assumption has not been met, the APA may be revised by agreement of the parties. If such an agreement cannot be achieved, the APA is canceled. If a critical assumption has not been met, it requires taxpayer’s notice to and discussion with the Service, and, in the case of a bilateral APA, competent authority consideration. Rev. Proc. 2006-9, § 11.05, 11.06.
 
Sources of Comparables, Selection Criteria, and the Nature of Adjustments to Comparables and Tested Parties [§ 521(b)(2)(D)(v), (vi), and (vii)]
The sources of comparables, selection criteria, and rationale used in determining the selection criteria for APAs executed in 2006 are described in Tables 22 through 24 below. Various formulas for making adjustments to comparables are included as Attachment B.
TABLE 22: SOURCES OF COMPARABLES
Sources Number of Times This Source Used
Compustat 73
Worldscope 19
Disclosure 13
Global Vantage 10
Mergent 7
Amadeus 5
Japanese Accounts and Data on Enterprises (“JADE”) 4
Taxpayer’s information on competition 4
Moody’s ≤ 3
Other 6
TABLE 23: COMPARABLES SELECTION CRITERIA
Selection Criteria Considered Number of Times This Criterion Used
Comparable functions 90
Comparable risks 71
Comparable industry 59
Comparable products 43
Comparable intangibles 38
Comparable terms 10
TABLE 24: ADJUSTMENTS TO COMPARABLES OR TESTED PARTIES
Adjustment Number of Times Used
Balance sheet adjustments  
  Inventory 64
  Payables 62
  Receivables 62
  Property, plant, equipment 16
  Other ≤ 3
Accounting adjustments  
  LIFO to FIFO inventory accounting 29
  Accounting reclassifications (e.g., from COGS to operating expenses) 7
  Marketing/ Procurement ≤ 3
  Other 7
Profit level indicator adjustments (used to “back into” one PLI from another)  
  Operating expense ≤ 3
  Other ≤ 3
Miscellaneous adjustments  
  Research & development ≤ 3
  Advertising ≤ 3
  Foreign exchange ≤ 3
  Other ≤ 3
Discussion
At the core of most APAs are comparables. The APA Program works closely with taxpayers to find the best and most reliable comparables for each Covered Transaction. In some cases, CUPs or CUTs can be identified. In other cases, comparable business activities of independent companies are used in applying the CPM or a profit split method. Generally, in the APA Program’s experience since 1991, CUPs and CUTs have been most often derived from the internal transactions of the taxpayer.
For profit-based methods in which comparable business activities or functions of independent companies are sought, the APA Program typically has selected them using a three-part process. First, a pool of potential comparables has been identified through broad searches. From this pool, companies having transactions that are clearly not comparable to those of the tested party have been eliminated through the use of quantitative and qualitative analyses, i.e., quantitative screens and business descriptions. Then, based on a review of available descriptive and financial data, a set of comparable transactions or business activities of independent companies has been finalized. The comparability of the finalized set has then been enhanced through the application of adjustments.
Sources of Comparables
Comparables used in APAs can be U.S. or foreign, depending on the relevant market, the type of transaction being evaluated, the availability of relevant data, and the results of the functional and risk analyses. In general, comparables have been located by searching a variety of databases that provide data on U.S. publicly traded companies and on a combination of public and private non-U.S. companies. Table 22 shows the various databases and other sources used in selecting comparables for the APAs executed in 2006.
Although comparables were most often identified from the databases cited in Table 22, in some cases comparables were found from other sources, such as comparables derived internally from taxpayer transactions with third parties.
Selecting Comparables
Initial pools of potential comparables generally are derived from the databases using a combination of industry and keyword identifiers. Then, the pool is refined using a variety of selection criteria specific to the transaction or business activity being tested and the TPM being used.
The listed databases allow for searches by industrial classification, by keywords, or by both. These searches can yield a number of companies whose business activities may or may not be comparable to those of the entity being tested. Therefore, comparables based solely on industry classification or keyword searches are rarely used in APAs. Instead, the pool of comparables is examined closely, and companies are selected based on a combination of screens, business descriptions, and other information found in the companies’ Annual Reports to shareholders and filings with the U.S. Securities and Exchange Commission (SEC).
Business activities are required to meet certain basic comparability criteria to be considered comparables. Functions, risks, economic conditions, and the property (product or intangible) and services associated with the transaction must be comparable. Determining comparability can be difficult - the goal has been to use comparability criteria restrictive enough to eliminate business activities that are not comparable, but yet not so restrictive as to have no comparables remaining. The APA Program normally has begun with relatively strict comparability criteria and then has relaxed them slightly if necessary to derive a pool of reliable comparables. A determination on the appropriate size of the comparables set, as well as the business activities that comprise the set, is highly fact-specific and depends on the reliability of the results.
In addition, the APA Program, consistent with the section 482 regulations, generally has looked at the results of comparables over a multi-year period. Often this has been a three-year or a five-year period, but other periods are sometimes used depending on the circumstances of the controlled transaction. Using a shorter period might result in the inclusion of comparables in different stages of economic development or use of atypical years of a comparable due to cyclical fluctuations in business conditions.
Many Covered Transactions have been tested with comparables that have been chosen using additional criteria and/or screens. These include sales level criteria and tests for financial distress and product comparability. These common selection criteria and screens have been used to increase the overall comparability of a group of companies and as a basis for further research. The sales level screen, for example, has been used to remove companies that, due to their size, might face fundamentally different economic conditions from those of the transaction or business activities being tested. In addition, APA analyses have incorporated selection criteria related to removing companies experiencing “financial distress” because of concerns that companies in financial distress often have experienced unusual circumstances that render them not comparable to the business activity being tested. These criteria include an unfavorable auditor’s opinion, bankruptcy, failure to comply with financial obligations (e.g., debt covenants), and, in certain circumstances, operating losses in a given number of years.
An additional important class of selection criteria is the development and ownership of intangible property. In some cases in which the business activity being tested is manufacturing, several criteria have been used to ensure, for example, that if the controlled entity does not own significant manufacturing intangibles or conduct research and development (R&D), then neither will the comparables. These selection criteria have included determining the importance of patents to a company or screening for R&D expenditures as a percentage of sales. Again, quantitative screens related to identifying comparables with significant intangible property generally have been used in conjunction with an understanding of the comparable derived from publicly available business information.
Selection criteria relating to asset comparability and operating expense comparability have also been used at times. A screen of property, plant, and equipment (PP&E) as a percentage of sales or assets, combined with a reading of a company’s SEC filings, has been used to help ensure that distributors (generally lower PP&E) were not compared with manufacturers (generally higher PP&E), regardless of their industry classification. Similarly, a test involving the ratio of operating expenses to sales has helped to determine whether a company undertakes a significant marketing and distribution function.
Table 25 shows the number of times various screens were used in APAs executed in 2006:
TABLE 25: COMPARABILITY SCREENS
Comparability/Financial Distress Screen Times Used
Comparability screens used  
  Sales 48
  R&D/ sales 43
  Foreign sales/ total sales 15
  Advertising expense/ sales 14
  PP&E/ sales 6
  SG&A/ sales 5
  Non-startup or start-up 5
  PP&E/ total assets ≤ 3
  Operating expenses/ sales ≤ 3
  Non-startup or startup ≤ 3
  Government sales/ sales ≤ 3
  Inventory/ sales ≤ 3
  Intangible property/ total assets ≤ 3
  Work in process inventory/ total inventory ≤ 3
Financial distress  
  Bankruptcy 48
  Losses in one or more years 33
  Unfavorable auditor’s opinion 31
  Stopped filing public documents ≤ 3
  No sales growth ≤ 3
Adjusting Comparables
After the comparables have been selected, the regulations require that “[i]f there are material differences between the controlled and uncontrolled transactions, adjustments must be made if the effect of such differences on prices or profits can be ascertained with sufficient accuracy to improve the reliability of the results.” Treas. Reg. § 1.482-1(d)(2). In almost all cases involving income-statement-based PLIs used in the CPM or the Residual Profit Split Method, certain “asset intensity” or “balance sheet” adjustments for factors that have generally agreed-upon effects on profits are calculated. In addition, in specific cases, additional adjustments are performed to improve reliability.
The most common balance sheet adjustments used in APAs are adjustments for differences in accounts receivable, inventories, and accounts payable. The APA Program generally has required adjustments for receivables, inventory, and payables based on the principle that there is an opportunity cost for holding assets. For these assets, it is generally assumed that the cost is appropriately measured by the interest rate on short-term debt.
To compare the profits of two business activities with different relative levels of receivables, inventory, or payables, the APA Program estimates the carrying costs of each item and adjusts profits accordingly. Although different formulas have been used in specific APA cases, Attachment B presents one set of formulas used in many APAs. Underlying these formulas are the notions that (1) balance sheet items normally should be expressed as mid-year averages, (2) formulas should try to avoid using data items that are being tested by the TPM (for example, if sales are controlled, then the denominator of the balance sheet ratio should not be sales), (3) a short term interest rate should be used, and (4) an interest factor should recognize the average holding period of the relevant asset. During the course of 2006, the APA Program often used an interest rate equal to LIBOR (3 months) plus 200 basis points for purposes of calculating adjustments for accounts receivable and accounts payable for U.S. companies. However, the facts and circumstances surrounding a given case will ultimately determine the reliability of making balance sheet adjustments and the selection of the most reliable interest rate.
The APA Program also requires that data be compared on a consistent accounting basis. For example, although financial statements may be prepared on a first-in first-out (FIFO) basis, cross-company comparisons are less meaningful if one or more of the comparables use last-in first-out (LIFO) inventory accounting methods. This adjustment directly affects costs of goods sold and inventories, and therefore affects both profitability measures and inventory adjustments.
Still important in some cases is the adjustment for differences in relative levels of PP&E between a tested business activity and the comparables. Ideally, comparables and the business activity being tested will have fairly similar relative levels of PP&E, since major differences can be a sign of fundamentally different functions and risks. Typically, the PP&E adjustment is made using a medium term interest rate. During the course of 2006, the APA Program often used the Corporate Bonds (Moody’s) Baa rate as the interest rate for purposes of calculating adjustments for inventory and PP&E for U.S. companies. Again, however, the facts and circumstances surrounding a given case will ultimately determine the reliability of making balance sheet adjustments and the selection of the most reliable interest rate.
Additional adjustments used less frequently include those for differences in other balance sheet items, operating expenses, R&D, or currency risk. Accounting adjustments, such as reclassifying items from cost of goods sold to operating expenses, are also made when warranted to increase reliability. Often, data are not available for both the controlled and uncontrolled transactions in sufficient detail to allow for these types of adjustments.
The adjustments made to comparables or tested parties in APAs executed in 2006 are reflected in Table 24 above.
 
Ranges, Targets, and Adjustment Mechanisms [§ 521(b)(2)(D)(viii)-(ix)]
The types of ranges, targets, and adjustment mechanisms used in APAs executed in 2006 are described in Table 26 and 27 below.
 
TABLE 26: RANGES AND TARGETS[a]

[a] The numbers do not include TPMs with cost or cost-plus methodologies.

Type of Range or Target Number
Interquartile range 68
Specific point (royalty) 18
Specific point within CPM range (not floor or ceiling) 13
Full range 5
Floor (i.e., result must be no less than x) 4
Specific point (profit split) ≤ 3
Specific point (CUP) ≤ 3
Ceiling (i.e., result must be no more than x) ≤ 3
Narrower range within interquartile range ≤ 3
Other 5
TABLE 27: ADJUSTMENT MECHANISMS
Adjustment mechanism Number
Taxpayer makes an adjustment: to specified point or royalty rate 41
Taxpayer makes an adjustment: to closest edge of single year 28
Taxpayer makes an adjustment: to closest edge of multi-year average 20
Taxpayer makes an adjustment: to median of current year 12
Taxpayer makes an adjustment: to median of multi-year average 11
Taxpayer makes an adjustment: to other ≤ 3
Other ≤ 3
Discussion
Treas. Reg. § 1.482-1(e)(1) states that sometimes a pricing method will yield “a single result that is the most reliable measure of an arm’s length result.” Sometimes, however, a method may yield “a range of reliable results,” called the “arm’s length range.” A taxpayer whose results fall within the arm’s length range will not be subject to adjustment.
Under Treas. Reg. § 1.482-1(e)(2)(i), such a range is normally derived by considering a set of more than one comparable uncontrolled transaction of similar comparability and reliability. If these comparables are of very high quality, as defined in the section 482 regulations, then under Treas. Reg. § 1.482-1(e)(2)(iii)(A), the arm’s length range includes the results of all of the comparables (from the least to the greatest). However, the APA Program has only rarely identified cases meeting the requirements for the full range. If the comparables are of lesser quality, then under Treas. Reg. § 1.482-1(e)(2)(iii)(B), “the reliability of the analysis must be increased, when it is possible to do so, by adjusting the range through application of a valid statistical method to the results of all of the uncontrolled comparables.” One such method, the “interquartile range,” is ordinarily acceptable, although a different statistical method “may be applied if it provides a more reliable measure.” The “interquartile range” is defined as, roughly, the range from the 25th to the 75th percentile of the comparables’ results. See Treas. Reg. § 1.482-1(e)(2)(iii)(C). The interquartile range was used 68 times in 2006.
Thirty-eight or more Covered Transactions reflected on Table 26 were tested against a single, specific result. Thirteen of these Covered Transactions involved a CPM in which the taxpayer agreed to a “point.” Some APAs - deliberately infrequent - specify not a point or a range, but a “floor” or a “ceiling”. When a floor is used, the tested party’s result must be greater than or equal to some particular value. When a ceiling is used, the tested party’s result must be less than or equal to some particular value. Four APAs executed in 2006 used a floor and three or fewer used a ceiling.
Some APAs look to a tested party’s results over a period of years (multi-year averaging) to determine whether a taxpayer has complied with the APA. In 2006, rolling multi-year averaging was used for 15 Covered Transactions. Ten of those used three-year averages. Nine Covered Transactions used a cumulative multi-year average, while 18 Covered Transactions used term averages and three or fewer Covered Transactions used partial term averages.
Adjustments
Under Treas. Reg. § 1.482-1(e)(3), if a taxpayer’s results fall outside the arm’s length range, the Service may adjust the result “to any point within the arm’s length range.” Accordingly, an APA may permit or require a taxpayer to make an intercompany adjustment after the year’s end to put the year’s results within the range, or at the point specified by the APA. Similarly, to enforce the terms of an APA, the Service may make such an adjustment. When the APA specifies a range, the adjustment is sometimes to the closest edge of the range, and sometimes to another point such as the median of the interquartile range. Depending on the facts of each case, automatic adjustments are not always permitted. APAs may specify that in such a case there will be a negotiation between the competent authorities involved to determine whether and to what extent an adjustment should be made. APAs may permit automatic adjustments unless the result is far outside the range specified in the APA. Thus, APAs provide flexibility and efficiency, permitting adjustments when normal business fluctuations and uncertainties push the result somewhat outside the range.
Where a taxpayer’s actual transactions do not comply with the TPM, a taxpayer must nonetheless report its taxable income in an amount consistent with the TPM (an APA primary adjustment), as further discussed in § 11.02 of Rev. Proc. 2006-9.
 
APA Term and Rollback Lengths [§ 521(b)(2)(D)(x)]
The various term lengths for APAs executed in 2006 are set forth in Table 28 below:
TABLE 28: TERMS OF APAs
APA Term in Years Number of APAs
1 0
2 1
3 6
4 3
5 46
6 8
7 9
8 6
9 1
10 or more 2
The number of rollback years to which an APA TPM was applied in 2006 is set forth in Table 29 below:
 
TABLE 29: NUMBER OF YEARS COVERED BY ROLLBACK OF APA TPM
Number of Rollback Years Number of APAs
1 1
2 4
3 3
4 2
5 or more 5
Nature of Documentation Required [§ 521(b)(2)(D)(xi)]
APAs executed in 2006 required that taxpayers provide various documents with their annual reports. These documents are described in Table 30 below:
 
TABLE 30: NATURE OF DOCUMENTATION REQUIRED
Documentation Number of Times Required
Statement identifying all material differences between Taxpayer’s business operations during APA Year and description of Taxpayer’s business operations contained in Taxpayer’s request for APA, or if there have been no such material differences, a statement to that effect 82
Description of any failure to meet Critical Assumptions or, if there have been none, a statement to that effect 82
Statement identifying all material changes in Taxpayer’s accounting methods and classifications, and methods of estimation, from those described or used in Taxpayer’s request for APA, or if there have been none, statement to that effect 82
Description of, reason for, and financial analysis of, any Compensating Adjustments with respect to APA Year, including means by which any Compensating Adjustment has been or will be satisfied 82
Financial analysis demonstrating Taxpayer’s compliance with TPM 82
Organizational chart 82
Financial statements as prepared in accordance with US GAAP 71
Certified public accountant’s opinion that financial statements present fairly financial position of Taxpayer and the results of its operations, in accordance with US GAAP 71
Financial statements as prepared in accordance with a foreign GAAP 15
Certified public accountant’s opinion that financial statements present fairly financial position of Taxpayer and the results of its operations, in accordance with a foreign GAAP 11
Book to tax reconciliations 9
Schedule of costs and expenses (e.g., intercompany allocations) 8
Certified public accountant’s review of financial statements 8
Various work papers 7
United States income tax return 5
Profit & Loss statement 4
Changes in entity classifications 4
Changes in Taxpayer notice information ≤ 3
Description of special accounting treatment for certain income items ≤ 3
Reconciliation of foreign to US GAAP ≤ 3
Other 4
Approaches for Sharing of Currency or Other Risks [§ 521(b)(2)(D)(xii)]
During 2006, there were 36 tested parties that faced financial risks, including interest rate and currency risks. In appropriate cases, APAs may provide specific approaches for dealing with currency risk, such as adjustment mechanisms and/or critical assumptions.
 
Efforts to Ensure Compliance with APAs [§ 521(b)(2)(F)]
As described in Rev. Proc. 2006-9, § 11.01, APA taxpayers are required to file annual reports to demonstrate compliance with the terms and conditions of the APA. The filing and review of annual reports is a critical part of the APA process. Through annual report review, the APA Program monitors taxpayer compliance with the APA on a contemporaneous basis. Annual report review provides current information on the success or problems associated with the various TPMs adopted in the APA process.
All reports received by the APA office are tracked by one designated APA team leader who also has the primary responsibility for annual report review. Other APA team leaders and economists assist in this review, especially when the team leader who negotiated the case is available since that person will already be familiar with the relevant facts and terms of the agreement. Once received by the APA office, the annual report is sent out to the district personnel with exam jurisdiction over the taxpayer.
The statistics for the review of APA annual reports are reflected in Table 31 below. As of December 31, 2006, there were 256 pending annual reports. In 2006, 537 reports were closed.
TABLE 31: STATISTICS OF ANNUAL REPORTS
Number of APA annual reports pending as of December 31, 2006 256
Number of APA annual reports closed in Year 2006 537
Number of APA annual reports requiring adjustment in Year 2006 12
Number of taxpayers involved in adjustments 6
Number of APA annual report cases over one year old 93
ATTACHMENT AModel APA - Based on Revenue Procedure 2006-9
   
ADVANCE PRICING AGREEMENT between [Insert Taxpayer’s Name ] and THE INTERNAL REVENUE SERVICE
   
PARTIES
The Parties to this Advance Pricing Agreement (APA) are the Internal Revenue Service (IRS) and [Insert Taxpayer’s Name], EIN .
RECITALS
[Insert Taxpayer Name] is the common parent of an affiliated group filing consolidated U.S. tax returns (collectively referred to as “Taxpayer”), and is entering into this APA on behalf of itself and other members of its consolidated group.
Taxpayer’s principal place of business is [City, State]. [Insert general description of taxpayer and other relevant parties].
This APA contains the Parties’ agreement on the best method for determining arm’s-length prices of the Covered Transactions under I.R.C. section 482, any applicable tax treaties, and the Treasury Regulations.
{If renewal, add} [Taxpayer and IRS previously entered into an APA covering taxable years ending to , executed on .]
AGREEMENT
The Parties agree as follows:
1. Covered Transactions. This APA applies to the Covered Transactions, as defined in Appendix A.
2. Transfer Pricing Method. Appendix A sets forth the Transfer Pricing Method (TPM) for the Covered Transactions.
3. Term. This APA applies to Taxpayer’s taxable years ending through (APA Term).
4. Operation.
a. Revenue Procedure 2006-9 governs the interpretation, legal effect, and administration of this APA.
b. Nonfactual oral and written representations, within the meaning of sections 10.04 and 10.05 of Revenue Procedure 2006-9 (including any proposals to use particular TPMs), made in conjunction with the APA Request constitute statements made in compromise negotiations within the meaning of Rule 408 of the Federal Rules of Evidence.
5. Compliance.
a. Taxpayer must report its taxable income in an amount that is consistent with Appendix A and all other requirements of this APA on its timely filed U.S. Return. However, if Taxpayer’s timely filed U.S. Return for an APA Year is filed prior to, or no later than 60 days after, the effective date of this APA, then Taxpayer must report its taxable income for that APA Year in an amount that is consistent with Appendix A and all other requirements of this APA either on the original U.S. Return or on an amended U.S. Return filed no later than 120 days after the effective date of this APA, or through such other means as may be specified herein.
b. {Insert when U.S. Group or Foreign Group contains more than one member.} [This APA addresses the arm’s-length nature of prices charged or received in the aggregate between Taxpayer and Foreign Participants with respect to the Covered Transactions. Except as explicitly provided, this APA does not address and does not bind the IRS with respect to prices charged or received, or the relative amounts of income or loss realized, by particular legal entities that are members of U.S. Group or that are members of Foreign Group.]
c. For each taxable year covered by this APA (APA Year), if Taxpayer complies with the terms and conditions of this APA, then the IRS will not make or propose any allocation or adjustment under I.R.C. section 482 to the amounts charged in the aggregate between Taxpayer and Foreign Participant[s] with respect to the Covered Transactions.
d. If Taxpayer does not comply with the terms and conditions of this APA, then the IRS may:
  1. enforce the terms and conditions of this APA and make or propose allocations or adjustments under I.R.C. section 482 consistent with this APA;

  2. cancel or revoke this APA under section 11.06 of Revenue Procedure 2006-9; or

  3. revise this APA, if the Parties agree.

e. Taxpayer must timely file an Annual Report (an original and four copies) for each APA Year in accordance with Appendix C and section 11.01 of Revenue Procedure 2006-9. Taxpayer must file the Annual Report for all APA Years through the APA Year ending [insert year] by [insert date]. Taxpayer must file the Annual Report for each subsequent APA Year by [insert month and day] immediately following the close of that APA Year. (If any date falls on a weekend or holiday, the Annual Report shall be due on the next date that is not a weekend or holiday.) The IRS may request additional information reasonably necessary to clarify or complete the Annual Report. Taxpayer will provide such requested information within 30 days. Additional time may be allowed for good cause.
f. The IRS will determine whether Taxpayer has complied with this APA based on Taxpayer’s U.S. Returns, Financial Statements, and other APA Records, for the APA Term and any other year necessary to verify compliance. For Taxpayer to comply with this APA, an independent certified public accountant must {use the following or an alternative} render an opinion that Taxpayer’s Financial Statements present fairly, in all material respects, Taxpayer’s financial position under U.S. GAAP.
g. In accordance with section 11.04 of Revenue Procedure 2006-9, Taxpayer will (1) maintain its APA Records, and (2) make them available to the IRS in connection with an examination under section 11.03. Compliance with this subparagraph constitutes compliance with the record-maintenance provisions of I.R.C. sections 6038A and 6038C for the Covered Transactions for any taxable year during the APA Term.
h. The True Taxable Income within the meaning of Treasury Regulations sections 1.482-1(a)(1) and (i)(9) of a member of an affiliated group filing a U.S. consolidated return will be determined under the I.R.C. section 1502 Treasury Regulations.
i. {Optional for US Parent Signatories} To the extent that Taxpayer’s compliance with this APA depends on certain acts of Foreign Group members, Taxpayer will ensure that each Foreign Group member will perform such acts.
6. Critical Assumptions. This APA’s critical assumptions, within the meaning of Revenue Procedure 2006-9, section 4.05, appear in Appendix B. If any critical assumption has not been met, then Revenue Procedure 2006-9, section 11.06, governs.
7. Disclosure. This APA, and any background information related to this APA or the APA Request, are: (1) considered “return information” under I.R.C. section 6103(b)(2)(C); and (2) not subject to public inspection as a “written determination” under I.R.C. section 6110(b)(1). Section 521(b) of Pub. L. 106-170 provides that the Secretary of the Treasury must prepare a report for public disclosure that includes certain specifically designated information concerning all APAs, including this APA, in a form that does not reveal taxpayers’ identities, trade secrets, and proprietary or confidential business or financial information.
8. Disputes. If a dispute arises concerning the interpretation of this APA, the Parties will seek a resolution by the IRS Associate Chief Counsel (International) to the extent reasonably practicable, before seeking alternative remedies.
9. Materiality. In this APA the terms “material” and “materially” will be interpreted consistently with the definition of “material facts” in Revenue Procedure 2006-9, section 11.06(4).
10. Section Captions. This APA’s section captions, which appear in italics, are for convenience and reference only. The captions do not affect in any way the interpretation or application of this APA.
11. Terms and Definitions. Unless otherwise specified, terms in the plural include the singular and vice versa. Appendix D contains definitions for capitalized terms not elsewhere defined in this APA.
12. Entire Agreement and Severability. This APA is the complete statement of the Parties’ agreement. The Parties will sever, delete, or reform any invalid or unenforceable provision in this APA to approximate the Parties’ intent as nearly as possible.
13. Successor in Interest. This APA binds, and inures to the benefit of, any successor in interest to Taxpayer.
14. Notice. Any notices required by this APA or Revenue Procedure 2006-9 must be in writing. Taxpayer will send notices to the IRS at the address and in the manner set forth in Revenue Procedure 2006-9, section 4.11. The IRS will send notices to:
  Taxpayer Corporation Attn: Jane Doe, Sr. Vice President (Taxes) 1000 Any Road Any City, USA 10000 (phone: )
15. Effective Date and Counterparts. This APA is effective starting on the date, or later date of the dates, upon which all Parties execute this APA. The Parties may execute this APA in counterparts, with each counterpart constituting an original.
WITNESS,  
The Parties have executed this APA on the dates below.  
[Taxpayer Name in all caps]  
By: Date: , 20
Jane Doe    
Sr. Vice President (Taxes)    
IRS  
By: Date: , 20
Matthew W. Frank  
Director, Advance Pricing Agreement Program  
APPENDIX A
COVERED TRANSACTIONS AND TRANSFER PRICING METHOD (TPM)
1.Covered Transactions.
  [Define the Covered Transactions.]
2.TPM.
  {Note: If appropriate, adapt language from the following examples.}
  [The Tested Party is .]
    CUP Method
The TPM is the comparable uncontrolled price (CUP) method. The Arm’s Length Range of the price charged for is between and per unit.
    CUT Method
The TPM is the CUT Method. The Arm’s Length Range of the royalty charged for the license of is between % and % of [Taxpayer’s, Foreign Participants’, or other specified party’s] Net Sales Revenue. [Insert definition of net sales revenue or other royalty base.]
    Resale Price Method (RPM)
The TPM is the resale price method (RPM). The Tested Party’s Gross Margin for any APA Year is defined as follows: the Tested Party’s gross profit divided by its sales revenue (as those terms are defined in Treasury Regulations sections 1.482-5(d)(1) and (2)) for that APA Year. The Arm’s Length Range is between % and %, and the Median of the Arm’s Length Range is %.
    Cost Plus Method
The TPM is the cost plus method. The Tested Party’s Cost Plus Markup is defined as follows for any APA Year: the Tested Party’s ratio of gross profit to production costs (as those terms are defined in Treasury Regulations sections 1.482-3(d)(1) and (2)) for that APA Year. The Arm’s Length Range is between % and %, and the Median of the Arm’s Length Range is %.
    CPM with Berry Ratio PLI
The TPM is the comparable profits method (CPM). The profit level indicator is a Berry Ratio. The Tested Party’s Berry Ratio is defined as follows for any APA Year: the Tested Party’s gross profit divided by its operating expenses (as those terms are defined in Treasury Regulations sections 1.482-5(d)(2) and (3)) for that APA Year. The Arm’s Length Range is between and , and the Median of the Arm’s Length Range is .
    CPM using an Operating Margin PLI
The TPM is the comparable profits method (CPM). The profit level indicator is an operating margin. The Tested Party’s Operating Margin is defined as follows for any APA Year: the Tested Party’s operating profit divided by its sales revenue (as those terms are defined in Treasury Regulations section 1.482-5(d)(1) and (4)) for that APA Year. The Arm’s Length Range is between % and %, and the Median of the Arm’s Length Range is %.
    CPM using a Three-year Rolling Average Operating Margin PLI
The TPM is the comparable profits method (CPM). The profit level indicator is an operating margin. The Tested Party’s Three-Year Rolling Average operating margin is defined as follows for any APA Year: the sum of the Tested Party’s operating profit (within the meaning of Treasury Regulations section 1.482-5(d)(4) for that APA Year and the two preceding years, divided by the sum of its sales revenue (within the meaning of Treasury Regulations section 1.482-5(d)(1)) for that APA Year and the two preceding years. The Arm’s Length Range is between % and %, and the Median of the Arm’s Length Range is %.
    Residual Profit Split Method
The TPM is the residual profit split method. [Insert description of routine profit level determinations and residual profit-split mechanism].
  [Insert additional provisions as needed.]
3.Application of TPM.
For any APA Year, if the results of Taxpayer’s actual transactions produce a [price per unit, royalty rate for the Covered Transactions] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] within the Arm’s Length Range, then the amounts reported on Taxpayer’s U.S. Return must clearly reflect such results.
For any APA year, if the results of Taxpayer’s actual transactions produce a [price per unit, royalty rate] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] outside the Arm’s Length Range, then amounts reported on Taxpayer’s U.S. Return must clearly reflect an adjustment that brings the [price per unit, royalty rate] [or] [Tested Party’s Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin] to the Median.
For purposes of this Appendix A, the “results of Taxpayer’s actual transactions” means the results reflected in Taxpayer’s and Tested Party’s books and records as computed under U.S. GAAP [insert another relevant accounting standard if applicable], with the following adjustments:
(a) [The fair value of stock-based compensation as disclosed in the Tested Party’s audited financial statements shall be treated as an operating expense]; and
(b) To the extent that the results in any prior APA Year are relevant (for example, to compute a multi-year average), such results shall be adjusted to reflect the amount of any adjustment made for that prior APA Year under this Appendix A.
4.APA Revenue Procedure Treatment
If Taxpayer makes a primary adjustment under the terms of this Appendix A, Taxpayer may elect APA Revenue Procedure Treatment in accordance with section 11.02(3) of Revenue Procedure 2006-9.
[Insert additional provisions as needed.]
APPENDIX B
CRITICAL ASSUMPTIONS
This APA’s critical assumptions are:
1. The business activities, functions performed, risks assumed, assets employed, and financial and tax accounting methods and classifications [and methods of estimation] of Taxpayer in relation to the Covered Transactions will remain materially the same as described or used in Taxpayer’s APA Request. A mere change in business results will not be a material change.
[Insert additional provisions as needed.]
   
APPENDIX C
APA RECORDS AND ANNUAL REPORT
APA RECORDS
The APA Records will consist of:
1. All documents listed below for inclusion in the Annual Report, as well as all documents, notes, work papers, records, or other writings that support the information provided in such documents.
ANNUAL REPORT
The Annual Report will include two copies of a properly completed APA Annual Report Summary in the form of Exhibit E to this APA, one copy of the form bound with, and one copy bound separately from, the rest of the Annual Report. In addition, the Annual Report will include a table of contents and the information and exhibits identified below, organized as follows.
1. Statements that fully identify, describe, analyze, and explain:
a. All material differences between any of the U.S. Entities’ business operations (including functions, risks assumed, markets, contractual terms, economic conditions, property, services, and assets employed) during the APA Year and the description of the business operations contained in the APA Request. If there have been no material differences, the Annual Report will include a statement to that effect.
b. All material changes in the U.S. Entities’ accounting methods and classifications, and methods of estimation, from those described or used in Taxpayer’s request for this APA. If any such change was made to conform to changes in U.S. GAAP (or other relevant accounting standards), Taxpayer will specifically identify such change. If there has been no material change in accounting methods and classifications or methods of estimation, the Annual Report will include a statement to that effect.
c. Any change to the Taxpayer notice information in section 14 of this APA.
d. Any failure to meet any critical assumption. If there has been no failure, the Annual Report will include a statement to that effect.
e. Any change to any entity classification for federal income tax purposes (including any change that causes an entity to be disregarded for federal income tax purposes) of any Worldwide Group member that is a party to the Covered Transactions or is otherwise relevant to the TPM.
f. The amount, reason for, and financial analysis of any compensating adjustments under paragraph 4 of Appendix A and Revenue Procedure 2006-9, section 11.02(3), for the APA Year, including but not limited to:
  1. the amounts paid or received by each affected entity;

  2. the character (such as capital, ordinary, income, expense) and country source of the funds transferred, and the specific affected line item(s) of any affected U.S. Return; and

  3. the date(s) and means by which the payments are or will be made.

g. The amounts, description, reason for, and financial analysis of any book-tax difference relevant to the TPM for the APA Year, as reflected on Schedule M-1 or Schedule M-3 of the U.S. Return for the APA Year.
2. The Financial Statements, and any necessary account detail to show compliance with the TPM, with a copy of the independent certified public accountant’s opinion required by paragraph 5(f) of this APA.
3. A financial analysis that reflects Taxpayer’s TPM calculations for the APA Year. The calculations must reconcile with and reference the Financial Statements in sufficient account detail to allow the IRS to determine whether Taxpayer has complied with the TPM.
4. An organizational chart for the Worldwide Group, revised annually to reflect all ownership or structural changes of entities that are parties to the Covered Transactions or are otherwise relevant to the TPM.
5. A copy of the APA.
APPENDIX D
DEFINITIONS
The following definitions control for all purposes of this APA. The definitions appear alphabetically below:
Term Definition
Annual Report A report within the meaning of Revenue Procedure 2006-9, section 11.01.
APA This Advance Pricing Agreement, which is an “advance pricing agreement” within the meaning of Revenue Procedure 2006-9, section 2.04.
APA Records The records specified in Appendix C.
APA Request Taxpayer’s request for this APA dated , including any amendments or supplemental or additional information thereto.
Covered Transaction(s) This term is defined in Appendix A.
Financial Statements Financial statements prepared in accordance with U.S. GAAP and stated in U.S. dollars.
Foreign Group Worldwide Group members that are not U.S. persons.
Foreign Participants [name the foreign entities involved in Covered Transactions].
I.R.C. The Internal Revenue Code of 1986, 26 U.S.C., as amended.
Pub. L. 106-170 The Ticket to Work and Work Incentives Improvement Act of 1999.
Revenue Procedure 2006-9 Rev. Proc. 2006-9, 2006-2 I.R.B. 278.
Transfer Pricing Method (TPM) A transfer pricing method within the meaning of Treasury Regulations section 1.482-1(b) and Revenue Procedure 2006-9, section 2.04.
U.S. GAAP U.S. generally-accepted accounting principles.
U.S. Group Worldwide Group members that are U.S. persons.
U.S. Return For each taxable year, the “returns with respect to income taxes under subtitle A” that Taxpayer must “make” in accordance with I.R.C. section 6012. {Or substitute for partnership: For each taxable year, the “return” that Taxpayer must “make” in accordance with I.R.C. section 6031.}
Worldwide Group Taxpayer and all organizations, trades, businesses, entities, or branches (whether or not incorporated, organized in the United States, or affiliated) owned or controlled directly or indirectly by the same interests.
APPENDIX E
APA ANNUAL REPORT SUMMARY FORM
The APA Annual Report Summary on the next page is a required APA Record. The APA Team Leader has supplied some of the information requested on the form. Taxpayer is to supply the remaining information requested by the form and submit the form as part of its Annual Report.
           
  APA Annual ReportSUMMARY   Department of the Treasury— Internal Revenue Service Office of Associate Chief Counsel (International) Advance Pricing Agreement Program APA no. Team Leader Economist Intl Examiner CA Analyst  
         
  APA Information   Taxpayer Name:  
    Taxpayer EIN: NAICS:  
    APA Term: Taxable years ending to .  
    Original APA [ ] Renewal APA [ ]  
    Annual Report due dates: , 200 for all APA Years through APA Year ending in 200; for each APA Year thereafter, on [month and day] immediately following the close of the APA Year.  
    Principal foreign country(ies) involved in covered transaction(s):  
    Type of APA: [ ] unilateral [ ] bilateral with  
    Tested party is [ ] US [ ] foreign [ ] both  
    Approximate dollar volume of covered transactions (on an annual basis) involving tangible goods and services: [ ] N/A [ ] <$50 million [ ] $50-100 million [ ] $100-250 million [ ] $250-500 million [ ] >$500 million  
    APA tests on (check all that apply): [ ] annual basis [ ] multi-year basis [ ] term basis  
    APA provides (check all that apply) a: [ ] range [ ] point [ ] floor only [ ] ceiling only [ ] other  
    APA provides for adjustment (check all that apply) to: [ ] nearest edge [ ] median [ ] other point  
         
         
  APA Annual Report Information (to be completed by the Taxpayer)   APA date executed: , 200  
    This APA Annual Report Summary is for APA Year(s) ending in 200 and was filed on , 200  
    Check here [ ] if Annual Report was filed after original due date but in accordance with extension.  
    Has this APA been amended or changed? [ ] yes[ ] no Effective Date:  
    Has Taxpayer complied with all APA terms and conditions? [ ] yes[ ] no  
    Were all the critical assumptions met? [ ] yes[ ] no  
    Has a Primary Compensating Adjustment been made in any APA Year covered by this Annual Report? [ ] yes[ ] noIf yes, which year(s): 200  
    Have any necessary Secondary Compensating Adjustments been made? [ ] yes[ ] no  
    Did Taxpayer elect APA Revenue Procedure treatment? [ ] yes[ ] no  
    Any change to the entity classification of a party to the APA? [ ] yes[ ] no  
    Taxpayer notice information contained in the APA remains unchanged? [ ] yes[ ] no  
    Taxpayer’s current US principal place of business: (City, State)  
         
  APA Annual Report Checklist of Key Contents (to be completed by the Taxpayer)   Financial analysis reflecting TPM calculations [ ] yes[ ] no    
  Financial statements showing compliance with TPM(s) [ ] yes[ ] no    
  Schedule M-1 or M-3 book-tax differences [ ] yes[ ] no    
  Current organizational chart of relevant portion of world-wide group [ ] yes[ ] no    
  Attach copy of APA [ ] yes[ ] no    
  Other APA records and documents included:      
  [The information required in the following section should be tailored to the particular case]  
    [ ] yes[ ] no    
    [ ] yes[ ] no    
    [ ] yes[ ] no    
    [ ] yes[ ] no    
    [ ] yes[ ] no    
                 
  Contact Information   Authorized Representative Phone Number Affiliation and Address  
         
   
                 
ATTACHMENT B
     
FORMULAS FOR BALANCE SHEET ADJUSTMENTS
Definitions of Variables:
AP = average accounts payable
AR = average trade accounts receivable, net of allowance for bad debt
cogs = cost of goods sold
INV = average inventory, stated on FIFO basis
opex = operating expenses (general, sales, administrative, and depreciation expenses)
PPE = property, plant, and equipment, net of accumulated depreciation
sales = net sales
tc = total cost (cogs + opex, as defined above)
h = average accounts payable or trade accounts receivable holding period, stated as a fraction of a year
i = interest rate
t = entity being tested
c = comparable
Equations:
If Cost of Goods Sold is controlled (generally, sales in denominator of PLI):
Receivables Adjustment (“RA”):   RA = {[(ARt / salest) x salesc] - ARc} x {i/[1+(i x hc)]}
Payables Adjustment (“PA”):   PA = {[(APt / salest) x salesc] - APc} x {i/[1+(i x hc)]}
Inventory Adjustment (“IA”):   IA = {[(INVt / salest) x salesc] - INVc } x i
PP&E Adjustment (“PPEA”):   PPEA = {[(PPEt / salest) x salesc] - PPEc} x i
If Sales are controlled (generally, costs in the denominator of PLI):[a]
Receivables Adjustment (“RA”):   RA = {[(ARt / tct) x tcc] - ARc} x {i/[1+(i x hc)]}
Payables Adjustment (“PA”):   PA = {[(APt / tct) x tcc] - APc} x {i/[1+(i x hc)]}
Inventory Adjustment (“IA”):   IA = {[(INVt / tct) x tcc] - INVc } x i
PP&E Adjustment (“PPEA”):   PPEA = {[(PPEt / tct) x tcc] - PPEc} x i
Then Adjust Comparables as Follows:
adjusted salesc = salesc + RA
adjusted cogsc = cogsc + PA - IA
adjusted opexc = opexc - PPEA

[a] Depending on the specific facts, the equations below may use total costs (“tc”) or cost of goods sold (“cogs”).


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