More and more countries are implementing and enhancing their transfer pricing regimes, compounded by the fact that some follow the OECD Guidelines to different extents and interpret the guidelines differently.
It has resulted in more country-specific TP requirements, and the global tax environment has become more complicated in the last few years. Furthermore, other recently passed international tax directives and regulations, such as The Anti-Tax Avoidance Directive 2 (“ATAD 2”) followed by the impending ATAD 3, Directive on Administrative Cooperation amended by Council Directive (EU) 2018/822 (“DAC6”) and again by Council Directive (EU) 2021/514 (“DAC7”) on the way, as well as BEPS 2.0 (i.e., Pillar One and Pillar Two), etc. complicated cross-border transactions and the related tax affairs.
These facts have complexed the TP matters for global market players and brought considerable uncertainties to them as well. Needless to say, a comprehensive, well-maintained transfer pricing documentation remains essential to secure MNEs from the possible exposure of double taxation or non-compliance tax adjustments and/or penalties, but due to the abovementioned complexity of the modern global tax environment, in some cases having only transfer pricing documentation at place may not be the panacea for MNEs to avoid the risk entirely.
In addition to retrospectively preparing TP documentation, MNEs can resolve these uncertainties either by proactively lodging the advanced pricing agreements (“APAs”) before the tax audit or by resorting to the mutual agreement procedures (“MAPs”) after receiving the tax decision from tax authorities.
An APA is an agreement between an MNE and one or more tax authorities regarding appropriate transfer pricing methodology. It aims to reduce or eliminate transfer pricing-related disputes such as double taxation resulting from inconsistent tax treatments. If the terms and conditions set in the APA are fulfilled, the tax authority would agree not to make tax adjustments to such transfer pricing arrangements implemented by the agreed transfer pricing methodology.
An APA provides MNEs certainty in terms of its tax liability over a certain period covered by the agreement, which usually has a five-year term and sometimes may be rolled back. It may also be renewed upon another mutual agreement between the parties involved.
APAs can be further classified as unilateral APAs (“UAPAs”) when negotiated with one tax authority only; bilateral (“BAPAs”) when negotiated with two tax authorities; or multilateral (“MAPAs”) when negotiated with more than two tax authorities.
Regarding compliance, some APA programs allow taxpayers to skip preparing typical TP documentation; however, in most cases, annual APA compliance documentation is required instead. Considering that APAs are also costly and usually cover only the riskiest and material transactions, it isn’t easy to see APAs as a replacement for TP documentation.
Similar to an APA, a MAP also aims to resolve disputes regarding interpretations of tax positions and eliminate double taxation for MNEs. However, MAPs are used in cases when the tax adjustment has already been made. It is a mechanism for two or more tax authorities to a relevant tax treaty to negotiate their cross-border taxation regarding specific transactions entered by the MNE involved. MAPs provide flexibility to MNEs in the way that they can choose to exit the process at any point and seek other means of resolutions, such as appealing for domestic remedies.
On the other side of the coin, although the majority of the APAs and MAPs lead to mutual agreements between tax authorities on resolving double taxation, it is not always the case since there is no strict binding requirement in bilateral/multilateral APAs and MAPs that all tax authorities are obliged to reach an agreement. Besides, MNEs usually have limited involvement in negotiating bilateral/multilateral APAs, and are almost excluded from MAPs. This prevents them from expressing their tax positions to the tax authorities, which would be a potential risk when MNEs receive the decision. Furthermore, MNEs should justify the required resources, such as the time commitment and associated cost for pursuing APAs and MAPs, and compare them with other alternatives. The average timeline for resolving MAPs is approximately 2-3 years, and sometimes can reach 10 years! The processing time for APAs can be highly variable, from 2 to 5 years, depending on the scope and complexity of the cases and the involved tax authorities.
To conclude – it is difficult to consider MAPs or APAs as any replacement for good TP documentation (and, more generally, TP management systems). In most cases, TP documentation would still be required. APAs can help deal with the most material and complex transactions and elevate some TP documentation pain. Still, it only makes sense if the company proactively wants to secure the position and not solely for TP documentation avoidance purposes. Similarly, relying on MAPs to avoid TP documentation is a terrible option. The resources allocated to TP documentation would significantly reduce the need for MAP (or would improve starting position in MAP) – and MAPs are costly and long-lasting procedures.
Noticeably, there are also newly enacted multilateral TP risk management tools that MNEs can resort to in addition to APAs. For instance, MNEs with complex transfer pricing arrangements seeking proactive and resource-efficient remedies may be eligible to apply for the International Compliance Assurance Programme (“ICAP”) if certain premises are met. ICAP provides an open, transparent, and non-confrontation platform for MNEs to present and clarify their CbC reports and other relevant information to the participating tax authorities to facilitate and align the risk assessments assumed by the tax authorities. This way, tax authorities can collaborate and share opinions before reaching a mutual understanding of the level of tax risks assumed in each jurisdiction. Granted, ICAP does not entirely guarantee the complete avoidance of global tax risks as participating tax authorities may reconsider the decisions they made in ICAP and initiate tax audits, nor does it replace APAs or MAPs. But it can be deemed a supplement to APAs as it generally provides a faster track to assess the tax positions in bilateral or multi jurisdictions for MNEs. They have complex cross-border transactions that would otherwise be time-consuming if only APAs were applied. Compared with APAs, ICAP takes only 24-28 weeks to proceed (according to OECD). And the dissenting tax authorities of an ICAP would likely agree with the majority viewpoint concluded in the ICAP and make less material adjustments in the later MAP or domestic tax case, since as mentioned before, ICAP has provided an open, collaborative framework for all the material stakeholders to communicate and agree with each other on TP assessments already.
In some countries, there are also tax risk management programs that taxpayers can use to address TP issues efficiently (e.g., Louisiana Transfer Pricing Managed Audit Program) or to alleviate in-compliance penalties (e.g., Polish voluntary disclosure). However, there is no “one-size-fits-all” solution to eliminate international tax disputes, particularly regarding cross-border TP-related affairs involving multiple stakeholders. Therefore, MNEs must analyze the costs and benefits and consider their business strategies before using a tax assurance tool.
Moreover, good TP documentation is usually a requirement when joining any proactive tax risk management program (or applying for APA/MAP). Therefore, TP documentation continues to be the backbone of any TP management system, and no other program or instrument can replace it.
About the author:
Scott Chen works as a transfer pricing analyst at Aibidia. He assists clients in their journey of digitalizing transfer pricing documentation and provides ad-hoc support, including country-specific requirements. Scott previously worked as an M&A tax compliance specialist at PwC and a business development analyst at Neles. He holds a master’s degree in accounting from Aalto University.