ADVANCE PRICING AGREEMENTS (APAs) DRAFT STATEMENT OF PRACTICE
(This draft is intended to be finalised around the date of Royal Assent and needs to be read as a statement of practice as from that date.)
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ADVANCE PRICING AGREEMENTS (APAs)
1. This Statement of Practice provides detailed guidance for taxpayers about how the Inland Revenue interprets sections [{j4501-4503}, FA 1999] which provide for Advance Pricing Agreements (APAs) and how it intends applying this legislation in practice. APAs offer a process for resolving complex transfer pricing issues on a prospective basis and for providing solutions in accordance with the Taxes Acts to situations where there is considerable difficulty or doubt in determining the method by which the arm’s length principle should be applied. In such cases, even though the process can be expected to absorb significant resources, an APA may prove more efficient than the retrospective examination of major transfer pricing issues and may allow the taxpayer to predict tax liabilities with greater certainty.
2. APAs made for the purposes of section [{j4501}, FA 1999] are written agreements between a taxpayer and the Board of Inland Revenue which determine a method for resolving transfer pricing issues in advance of a return being made. When the terms of the arrangement are complied with, they provide assurance that the treatment in accordance with the agreement of those transfer pricing issues will be accepted by both the Revenue and the taxpayer for the period of years covered by the agreement.
3. Sub-sections [{j4501}(2) and (4), FA 1999] set out the transfer pricing issues which can be the subject matter of an APA. These are the determination of:
a) the arm’s length provision for the purposes of Section 770A/Sch28AA, ICTA 1988;
b) the profits attributable to a branch or agency through which a trade is carried on in the UK; and
c) the amount of any income arising outside the UK and attributable to the overseas branch of a UK company.
4. APAs aim to assist
taxpayers in determining complex transfer pricing issues in accordance
with the arm’s length standard incorporated in domestic transfer
pricing legislation as well as in arrangements made with foreign governments
with a view to affording relief from double taxation (DTAs) and, where
relevant, in accordance with the Transfer Pricing Guidelines For
Multinational Enterprises And Tax Administrations (the "OECD
Transfer Pricing Guidelines") published by the Organisation for Economic
Co-operation and Development (OECD).
5. An APA may be comprised simply of a binding agreement between the UK taxpayer and the Inland Revenue in accordance with section [{j4501}, FA 1999]: referred to hereafter as a "unilateral APA". However, a unilateral APA can provide only a partial resolution of cross-border transfer pricing issues because, although it confirms the tax treatment in the UK, it does not determine how the issues are to be resolved in the other jurisdiction involved. Consequently, it does not eliminate the risk of double taxation in relation to the transfer pricing issues it addresses. In order to achieve that comprehensively in the case of cross-border transfer pricing issues where a DTA exists between the UK and the other jurisdiction containing a Mutual Agreement Procedure article, the Inland Revenue would have to reach agreement also with the tax administration of the related party: referred to hereafter as a "bilateral APA".
Unilateral or Bilateral Applications?
6. The Inland Revenue
encourages applications for bilateral APAs whenever this is possible in
relation to cross-border transfer pricing issues. Such bilateral arrangements
offer assurance that the method for dealing with the transfer pricing
issues covered in the APA will be accepted by the tax administrations
of both countries, thus avoiding potential double taxation. In accordance
with the obligation to endeavour to resolve difficulties or doubts as
to the interpretation or application of a DTA by mutual agreement whenever
the related parties involved in an APA application are residents of a
country with which the UK has a DTA containing a Mutual Agreement Procedure
article, the Inland Revenue will invite the treaty partner to participate
under that Procedure (and any relevant domestic arrangements governing
APAs that the treaty partner may itself have). If after a reasonable period
the treaty partner has not indicated a desire to participate, or despite
wishing to do so is unable to commit to proceeding within a reasonable
timescale, or for some other reason it is not possible to reach agreement
on a bilateral process, the Inland Revenue will be prepared to consider
a unilateral APA.
7. If, in the case of a finalised unilateral APA, a relevant treaty country takes action which results or will result in double taxation in respect of the transfer pricing issues addressed by the unilateral APA, the UK taxpayer may, as in any instance of taxation not in accordance with the treaty, request competent authority assistance to seek to eliminate the double taxation. As is made clear by section [{j4502}(3), FA 1999], the Inland Revenue’s ability to give effect to a mutual agreement reached with a treaty partner to eliminate double taxation under the terms of the treaty will not be restricted by the unilateral APA. In all cases, where a unilateral APA request involves foreign related parties resident in a country with which the UK has a DTA containing an Exchange of Information article, the Inland Revenue will notify the treaty partner of the request and will provide information relating to the request under that article.
8. Since one of the main purposes of the APA process is to eliminate the risk of double taxation by means of a mutual agreement with a treaty partner, the Inland Revenue’s International Division has responsibility for all applications except those involving oil taxation. Transfer pricing specialists and delegated competent authority caseworkers from International Division, assisted by the Inspector responsible for the taxpayer’s affairs, will be responsible for assessing APA requests. All expressions of interest in and applications for APAs (see paragraphs 20-28 below) should be made, in general, to the Assistant Director (APAs) at International Division, and, in cases involving oil taxation, to the Deputy Director (APAs) in the Oil Taxation Office. They will be responsible for all aspects of the process, including signature on behalf of the Board of Inland Revenue of any resulting agreements. Normally the person responsible for signing the agreement on behalf of the taxpayer should be the person responsible for signing the taxpayer’s tax return.
9. The addresses of the Assistant Director (APAs) in International Division and of the Deputy Director (APAs) in the Oil Taxation Office are shown at the end of this Statement.
10. An agreement can be made in relation to a chargeable period ending after the date on which the Finance Act [1999] receives Royal Assent (see section [{j4501}(8), FA 1999]).
11. An APA may be requested by
- any UK taxpayer, including a partnership, with transactions to which the provisions of Section 770A/Sch28AA, ICTA 1988 apply;
- any non-resident trading in the UK through a branch or agency;
- any UK resident trading through an overseas branch.
12. Potential applicants
need to bear in mind that the process is designed to offer assistance
in resolving complex transfer pricing issues. The Inland Revenue does
not regard entering into APAs on less complex matters as a sensible use
of resources in the absence of significant doubt as to the manner in which
the arm’s length principle should be applied. It may therefore decline
to accept applications that do not satisfy those criteria (see paragraph
39 for more details).
13. As a general
guide, where reliable market comparables can be established that enable
transfer pricing methods to be accurately employed in accordance with
the OECD Transfer Pricing Guidelines, then the application of the transfer
pricing legislation should not be complex and the clarification in accordance
with sub-sections [{j4501}(1) and (5), FA 1999] would not be necessary.
Where there is difficulty in establishing reliable market comparables
or doubt about how transfer pricing methods can be accurately employed
to determine arm’s length conditions, then the application of the
transfer pricing legislation becomes more complex. In such circumstances
a taxpayer may wish to evaluate the practical significance of the complexity
and to consider if clarification by way of an APA would, in the taxpayer’s
view, be beneficial.
14. Guidance about a potential application may be obtained from the Inland Revenue (see the discussion in paragraph 22 about the Expression of Interest stage in an application) and this Statement of Practice also indicates some circumstances in which an application is likely to be declined. The Inland Revenue recognises that complex transfer pricing issues can be encountered by smaller taxpayers as well as by large multinationals, and applications for APAs will not be declined solely by reference to the size of the transactions giving rise to the transfer pricing issues.
15. The potential scope of an APA is flexible. It may involve transfer pricing methods covering many different types of related party transactions and arrangements, including transfers of tangible or intangible property (in Scotland corporeal or incorporeal property) and the provision of services. The APA may relate to all of a taxpayer’s transfer pricing issues or be limited to one or more specific issues. The APA may apply to pre-existing issues and there is no requirement that the commencement of an APA should coincide with the commencement of the arrangements which it addresses.
16. An APA will be operative for a specified number of years from the date of entry into force as set out in the agreement. The taxpayer should propose an initial term for the APA taking into account the period over which it is reasonable to assume that the method for dealing with the relevant transfer pricing issues will remain appropriate in the circumstances. It is expected that the term is likely to be for a minimum of three, and a maximum of five, years. The formal submission of an APA request should normally be made no later than six months before the start of the first chargeable period to be covered by the APA.
17. While an APA
will normally operate prospectively in relation to chargeable periods
beginning after the time the application is made, it is possible that
a chargeable period to which the APA relates may have ended before agreement
is reached. Section [{j4502}(1), FA 1999] allows the APA to be effective
for that chargeable period and, in accordance with section [{j4502}(7),
FA 1999], the agreement may set out any adjustments to be made for tax
purposes as a consequence of the agreement.
18. In addition,
although a particular agreement does not relate to earlier periods, the
agreed transfer pricing methodology may be relevant to the resolution
of transfer pricing issues in those earlier periods if the particular
facts and circumstances surrounding those years are substantially the
same. Consequently, in such circumstances, the taxpayer may request that
the method for dealing with transfer pricing issues contained in the APA
should be considered for resolving any transfer pricing issues to which
it is relevant in earlier years. The Inland Revenue may itself also suggest
that the "roll-back" of the APA is an appropriate means of resolving
a transfer pricing issue in earlier years. Except where "roll-back"
is being considered, the request for an APA in respect of future years
will not in itself affect any transfer pricing enquiry into earlier years.
However, to the extent such an approach is appropriate and feasible, the
Inland Revenue will co-ordinate the APA request in respect of future years
with any transfer pricing enquiry in respect of prior years in order to
improve overall efficiency and reduce duplication of enquiries.
19. Information supplied by the taxpayer in relation to an APA request will be kept confidential in accordance with the confidentiality requirements of the Taxes Acts and the terms of any relevant DTA. However, such information will contribute to the pool of information held by the Revenue and no undertaking can be given that it will be taken into account only in relation to the APA. Thus, for example, where information is submitted under an APA which would appropriately enable the re-opening of earlier years under existing law, then the fact that the information was submitted under an APA would not in itself prevent reopening. To act otherwise could afford taxpayers seeking an APA an advantage over other taxpayers and may give rise to abuses. However, where any taxpayers are uncertain about a full commitment from the outset to the APA process, an initial approach on an anonymised basis (see paragraph 25 below) may provide taxpayers with an opportunity to explore the possibility of applying for an APA before disclosing their identity.
20. As provided by
section [{j4501}(1)(c), FA 1999] the APA process is initiated by the taxpayer
making an application for clarification by agreement of what the effect
would be of the application of the statutory provisions in question.
21. The APA process will typically comprise four stages: expression of interest, formal submission of application for clarification, evaluation, and agreement. However, the details of each stage may vary depending on the particular circumstances of the case.
22. A taxpayer interested in applying for an APA may wish to clarify in advance various aspects of the application, including its scope and term, and to discuss informally the proposed method for dealing with the transfer pricing issues to which it will relate, the presentation of the formal submission, the extent of the documentation requirements, and other matters. Generally, the Revenue would also wish to have the opportunity to discuss a potential application before detailed work in finalising it is undertaken by the taxpayer in order to ensure that the application is one which can be considered for an APA and that the submission will be focused on relevant issues. This should ensure that taxpayer resources are not wasted on the application process.
23. Written expressions of interest should contain such relevant information as:
a) the nature and value of the transfer pricing issues to be covered by the APA together with the identification and location of the parties involved;
b) a description of the business activities of the parties and how the transactions concerned relate to these business activities;
c) a description of the proposed transfer pricing method and an explanation of how it is intended to demonstrate that the method accords with the arm’s length standard;
d) an indication of the nature of any transfer pricing enquiries currently in progress for any of the parties involved in the transactions covered by the proposed APA; and
e) in the case of a cross-border transfer pricing issue, confirmation that a bilateral APA is required or reasons why the taxpayer considers that only a unilateral APA is possible in accordance with this Statement of Practice.
Four copies of the expression of interest should be submitted.
24. The Inland Revenue will consider the expression of interest, perhaps assisted by a preliminary discussion, and will indicate whether it is prepared to consider an application for an APA, bearing in mind such factors as those listed in paragraphs 12-13 and 39. It will discuss with the taxpayer the form of that application and the likely time frame for attempting to reach agreement.
25. The Revenue considers that the expression of interest can best be evaluated where the identity of the taxpayer is known. However, if a taxpayer wishes to preserve anonymity until a decision in principle is made to proceed with the application, then the Revenue will be prepared to discuss an expression of interest on an anonymised basis providing all other relevant information is supplied.
Formal Submission of Application for Clarification
26. Where the taxpayer wishes to proceed with the APA proposal and the Revenue has not indicated that it is not able or willing to consider it, a formal written application for clarification incorporating a proposal as to the manner of clarification should then be submitted, normally no later than six months before the start of the first chargeable period to be covered by the APA. Four copies should be provided. The application must fulfil the requirements of section [{j4501}(5), FA 1999] and set out:
a) the taxpayer’s understanding of the effect of the relevant legislation including the effect of any DTA in relation to the transfer pricing issues under consideration;
b) the areas where, because of the complexity of the transfer pricing issues, clarification of that effect is required; and
c) a proposal
for clarifying the effect of the legislation in accordance with the
taxpayer’s understanding.
27. The centre-piece of the proposal will be a description of the method by which it is proposed to determine the transfer pricing issues in accordance with the arm’s length principle, and an analysis demonstrating how the application of that method satisfies the terms of the UK’s legislation and the OECD Transfer Pricing Guidelines. The nature of the detailed information supporting the proposal should be tailored to the specific features of the taxpayer and of the transfer pricing issues and should take into account discussions with the Inland Revenue during any expression of interest stage. However, it is anticipated that all proposals will need to be supported by most of the following information:
a) the identification of the parties and details of their historical financial data (the period may vary, but generally for the previous 5 years);
b) a description of the transfer pricing issues proposed to be covered in the APA and analysis of the functions and risks of the parties and projected financial data of the parties in relation to the issues;
c) a description of the world-wide organisational structure, ownership, and business operations of the group to which the taxpayer belongs, the place or places where such operations are conducted, and all the major transaction flows of the parties to whom the APA is intended to apply;
d) a description of the records which will be maintained to support the transfer pricing method proposed for adoption in the APA and the information which it is proposed will be supplied each year to demonstrate that the tax return conforms to the terms of the APA;
e) a description of any current tax enquiries or competent authority claims that are relevant to the issues covered by the proposed APA;
f) the chargeable periods to be covered by the APA;
g) the identification of assumptions made in developing the proposed transfer pricing method which are critical to the reliability of its application under the arm’s length standard; and
h) in the case of a cross-border transfer pricing issue, a request for a bilateral APA or confirmation that there is no objection to the exchanging of information relating to the APA with any relevant treaty partner where a bilateral APA is not being sought for reasons which the Revenue have indicated are acceptable in accordance with this Statement of Practice.
28. In the case of a bilateral APA the taxpayer will be asked to ensure that all information supplied to one tax administration is made available at the same time to the other tax administration involved.
29. As indicated in paragraph 27(g) above, the formal proposal should identify the assumptions made in proposing the method for dealing with the transfer pricing issues and which are critical to the reliability of that method. It is to be expected that the method will be sufficiently robust to accommodate some changes in the commercial and economic climate from that reasonably foreseeable when the proposals were made and still be capable of replicating an arm’s length outcome. However, the accuracy of the method is likely to be predicated on assumptions in respect of particular factors fundamental to its application, such as the effect of rival products or technology, or the nature of the functions performed. Any departure from the critical assumptions will result in a reconsideration of the agreement and may lead to its cancellation in accordance with section [{j4502}(2), FA 1999] and the terms of the agreement.
30. On receipt of an application the Inland Revenue will evaluate its contents and will seek clarification and further information from the taxpayer as necessary. The Inland Revenue believes the examination of the application needs to be a co-operative process through which the transfer pricing issues are discussed openly with the taxpayer and access to complete supporting information and documentation is made available. Lack of co-operation in these respects will result in the Revenue declining to give any further consideration to the application. Unless and until it becomes clear that a bilateral APA will not be feasible, the Inland Revenue will expect the taxpayer to continue to make all information available at the same time to each tax administration involved, and in turn will keep the treaty partner informed about the progress of its examination of the APA request and will discuss with the treaty partner the issues arising at an early stage.
31. Any agreement
ultimately reached between the taxpayer and the Inland Revenue represents
a binding undertaking on the parties that the treatment for a specified
period of the transfer pricing issues covered by the agreement will be
determined in accordance with the agreement (provided that its terms are
observed and that none of the provisions leading to revocation, cancellation,
or competent authority over-ride as described below are triggered). In
the case of a bilateral APA the terms of the agreement between the Inland
Revenue and the taxpayer will also reflect the agreement reached between
the two tax administrations under the Mutual Agreement Procedure of the
relevant treaty in order to provide for the elimination of double taxation.
32. The agreement between the Inland Revenue and the taxpayer will be made subject to its terms being observed. The terms will include:
a) a commitment from the taxpayer to demonstrate adherence to the agreed method for dealing with the transfer pricing issues during the term of the APA in the form of a regular compliance report (see paragraph 34 below) and
b) the identification of critical assumptions bearing materially on the reliability of the method and which, if subject to change, would render the agreement invalid.
33. If agreement cannot be reached with the taxpayer, the Inland Revenue will issue a formal statement to the taxpayer recording the reasons for this. The Inland Revenue does not have any obligation to continue discussion beyond the point at which it has determined that agreement cannot be reached.
34. The APA will require the taxpayer to provide reports pursuant to section [{j4502}(4), FA 1999] that demonstrate continued adherence to the agreement during its term. The timing of the submission of the reports will be set out in the agreement. It is expected that the reports will be required annually and will coincide with the filing date for the taxpayer’s return. Failure to provide annual reports may lead the Inland Revenue to determine a penalty under section 98 TMA in respect of the failure, as provided for by section [{j4502}(9), FA 1999]. The particular requirements of each report will be set out in the finalised agreement, but, as a general guide, they are likely to include:
a) confirmation that the agreed method was applied during the year;
b) the financial results produced by the method;
c) where there was a mismatch between prices charged in relevant transactions during the period and those reflected in the results of applying the arm’s length standard under the agreed methodology, details of any compensating adjustments made to conform the operating results of the parties to the results of the method; and
d) an assessment
of whether the critical assumptions have proved to be sound and whether
they remain so.
35. The APA report is intended to provide the information required by the Inland Revenue to establish that the taxpayer has complied with the terms and conditions of the APA and to verify the accuracy of representations made in the APA.
36. In accordance with section [{j4502}(5), FA 1999], an APA may be nullified where it is discovered that the taxpayer has misrepresented or omitted facts in the APA application which have a material impact on the reliability of the APA to reflect arm’s length conditions. In accordance with section [{j4502}(2), FA 1999], an APA may be revoked or cancelled by the Revenue if the taxpayer does not comply with the terms and conditions of the agreement, or where the identified critical assumptions cease to be valid. When considering the revocation or cancellation of a bilateral APA the Revenue will consult with the competent authority of the treaty partner involved.
37. In some cases the APA may provide for modification of its terms in specific circumstances; for example, a particular agreement may provide that where there has been a change which makes the agreed methodology difficult to apply, but which does not go as far as to invalidate a critical assumption, the agreement may be modified with the consent of the parties to resolve that difficulty. In such cases the APA may be revised in accordance with [{j4502}(6), FA 1999] after consultations between the taxpayer and the Inland Revenue and, in the case of bilateral agreements, the competent authority of the other country involved.
38. The taxpayer may request renewal of an APA normally not later than 6 months before the expiry of its current term. The renewal application should expressly consider any changes or anticipated changes in facts and circumstances since the existing agreement was reached, whether any amendments are required to the agreement on renewal as a result, and should demonstrate how the proposed methodology accords with the arm’s length standard. The Revenue will conduct a review of the renewal application, taking into account whatever revisions to the existing APA are necessary and appropriate in the light of any changed facts and circumstances. Where it is agreed that the transfer pricing issues under consideration remain the same and the existing transfer pricing methodology can continue as before but with details updated to ensure continued adherence to the arm’s length principle, the agreement will simply be amended and extended for a further term. Where, however, the transfer pricing issues have changed, or a different method is being proposed, the taxpayer will be required to make a fresh APA application. In the case of a bilateral APA the taxpayer should ensure that the information contained in the renewal application is submitted at the same time to the other tax administration involved.
Declining or Withdrawing an APA Request
39. At the expression of interest stage or at the stage where a formal proposal is submitted the Inland Revenue may exercise its discretion by declining the request for an APA. In that event, the Inland Revenue will advise the taxpayer of the reasons for doing so, and will allow the taxpayer the opportunity to make further representations. A request is likely to be declined if:
- sufficient information for proper and full consideration of the request is not provided;
- the proposal does not comply with the terms of the UK’s transfer pricing legislation or with the OECD Transfer Pricing Guidelines;
- the affected transactions are thought to be of a hypothetical nature or not seriously contemplated; or
- it appears to be an inefficient use of resources to pursue an APA (for instance because the relevant transactions are of a very limited nature such as not to warrant the time required to complete an APA or are of limited value relative to the value of the taxpayer’s other transactions, or because determination of the method by which the arm’s length standard can reliably be applied is not in material doubt).
40. Taxpayers may withdraw an APA request at any time before final agreement is reached.
41. The Revenue considers that APA information is subject to the same rules of confidentiality as any other information about taxpayers and that the unauthorised disclosure even of the existence of an APA will be a breach of confidentiality. Information exchanged with treaty partners–for instance, in the course of reaching agreement on bilateral APAs–is also protected from disclosure by the terms of the Exchange of Information Article in the relevant DTA.
42. Because an APA
is an agreement between the Revenue and the taxpayer which determines
how questions relating to the matters covered by the agreement will be
determined for the purposes of the Taxes Acts, a return made on any other
basis in relation to those matters during the currency of an APA will
constitute an incorrect return. Consequently, a tax-geared penalty will
be chargeable where the taxpayer has acted fraudulently or negligently
in making such an incorrect return and tax has been lost as a result.
Where a return is made in accordance with an APA, but it is discovered
that false or misleading information was submitted in the course of obtaining
the APA, the legislation provides at section [{j4502}(5), FA 1999] that
the agreement is treated as if it had never been made, with the result
that questions relating to the subject matter of the agreement are no
longer to be determined in accordance with the agreement. This may mean
that returns made in accordance with the nullified APA are incorrect with
the consequences for penalties described above.
43. In addition a penalty not exceeding £10,000 may be imposed where false or misleading information is supplied in connection with an application for an APA - section [{j4502}(8), FA 1999]. As indicated in paragraph 34 above, section 98 TMA 1970 will apply to information required as part of the process of monitoring an APA where there has been a failure to provide the information or where incorrect information has been fraudulently or negligently provided.
44. In accordance with existing appeal procedures, the taxpayer has the right to appeal against the amount of any additions to profits arising as a result of the revocation or cancellation of an APA.
45. When a UK taxpayer obtains an APA relating to provision made or imposed with another UK taxpayer, section [{j4503} FA 1999] removes any uncertainty about the tax position of that other taxpayer. Where there is a discrepancy between the provision agreed under the terms of the APA and the actual provision between the parties to the disadvantage of the other party, that other party may claim to have profits adjusted on the basis that the agreed provision was charged. However, the Revenue would seek to reduce the scope for such discrepancies by encouraging the taxpayer to agree wherever possible that the transfer pricing methodology will determine the commercial charge for the provision as well as the charge for tax purposes. Furthermore, where the parties agree, the Revenue will accept a joint application for an APA from both parties in order to reach consistent agreements as to the measure of each party's profits in relation to the transfer pricing issues. Where these measures are adopted, however, section [{j4503}] may still need to be invoked if the APA applies to chargeable periods ending before the making of the agreement.
46. The contact address for more information about APAs and for making an APA application in all cases except those involving oil taxation, is:
Assistant
Director (Advance Pricing Arrangements),
International Division,
Inland Revenue,
Melbourne House,
Aldwych, London WC2B 4LL.
Telephone: 0207-438 .......
Fax: 0207-438 ......... .
E-Mail ........
For APAs involving oil taxation, the contact address is:
Deputy Director
(APAs),
Oil
Taxation Office,
Melbourne
House,
Aldwych,
London WC2B 4LL.
Telephone 0207-438 ....
Fax 0207 438 ....
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