Advance pricing agreements: A realistic option for transfer pricing

In the long run, an agreement with a taxing authority is often a wiser choice than traditional compliance and dispute resolution methods.
By Matthew Kramer, J.D., Ph.D., and Steven C. Wrappe, J.D., LL.M.

Transfer-pricing enforcement is on the rise globally. One reason is related to the COVID-19 pandemic: During the past two years, governments reduced transfer-pricing audits, and many governments are now increasing their audit activity to recoup lost tax revenue (see Shimizu, "Transfer Pricing Chat: Harumi Yamada of Grant Thornton Taiyo Tax," Daily Tax Report (Aug. 3, 2022); Transfer Pricing: A Year in Review, vol. 12, issue 1 (Bloomberg Tax, April 2021)). Another reason, related to the first, is increased enforcement funding. For example, in the United States, the Inflation Reduction Act, P.L. 117-169, enacted on Aug. 16, 2022, allocates nearly $80 billion in new funding to the IRS, of which more than $45 billion is for enforcement. With increased enforcement abroad, the IRS may need to allocate much of that funding to transfer-pricing enforcement, possibly encouraged by recent wins or partial wins in the U.S. Tax Court (The Coca-Cola Co., 155 T.C. 145 (2020); Medtronic, T.C. Memo. 2022-85). In this audit environment, advance pricing agreements (APAs) are a useful way to remain compliant and avoid transfer-pricing disputes.

Traditional transfer-pricing compliance can be difficult and expensive, at a minimum requiring annual documentation and preparation of uncertain tax positions (UTPs). The prominence of transfer-pricing UTPs demonstrates the uncertainty inherent in intercompany pricing. Even the most conscientious efforts to comply may not be sufficient to protect taxpayers from a proposed adjustment, and, as discussed below, that uncertainty is increasing. Moreover, the costs and resources associated with a transfer-pricing adjustment can be daunting. In addition to the cost of defending the adjustment in audit, appeals, and potentially in litigation, adjustments can also involve severe transfer-pricing penalties and significant interest and double taxation. Transfer-pricing adjustments require extensive resources to resolve the related disputes and further resources to amend federal, state, and foreign returns once resolution is reached.

Some governments offer mechanisms to obtain transfer-pricing certainty, including safe harbors for limited, normally low-risk types of intercompany transactions, and private letter rulings. In several circumstances, those mechanisms may be neither attractive nor effective. In some countries, the safe harbors may be excessively high relative to what one might consider an arm's-length result, and they may not be respected by tax authorities in the other country involved in the transaction. Some countries, such as Switzerland, may offer private rulings for intercompany pricing, but others, such as the United States, do not.

As an alternative to those mechanisms and the traditional transfer-pricing enforcement process, many countries, including the United States, offer APAs. An APA is a voluntary undertaking in which taxpayers negotiate a prospective agreement with one or more tax authorities to achieve certainty on their transfer pricing. Although pursuing an APA can involve significant expense and effort, for many multinationals those costs and efforts may be far lower than those required for traditional transfer-pricing compliance and defense.

Before discussing the potential advantages of the APA alternative, it will be helpful first to examine the challenges of traditional transfer-pricing compliance and dispute resolution.

Traditional transfer-pricing compliance and dispute resolution

To set the stage to explain the benefits of APAs, this section will describe the way that multinationals have handled transfer-pricing compliance and dispute resolution traditionally.


Focusing first on traditional compliance, the landscape appears to be changing. Traditional transfer-pricing compliance generally includes annual Sec. 6662 documentation studies and UTP. The primary purpose of Sec. 6662 documentation studies is to provide protection from transfer-pricing penalties. But, as will be discussed, recent changes in IRS practice suggest that under certain circumstances, penalty protection may not be available even with contemporaneous Sec. 6662 studies.

Changing expectations for transfer-pricing documentation studies: Stepping back briefly, transfer-pricing documentation studies prepared under Sec. 6662 are not, strictly speaking, required, but in most circumstances they are advisable. Their purpose is to provide protection against the transfer-pricing penalties that may otherwise be imposed in the absence of documentation. (The penalties can be significant. For corporations, they can be applied to adjustments above $10,000. Depending on the adjustment amount, the penalties can add 20% or 40% to alleged tax deficiencies. To illustrate, in DHL Corp., the IRS applied penalties of approximately $75 million on alleged deficiencies of approximately $195 million (DHL Corp., 285 F.3d 1210, 1216 (2002), rev'g T.C. Memo. 1998-461). Interest can also add a considerable amount to the expense. A payment by DHL to the IRS of approximately $114 million included approximately $55 million in interest.)

To provide penalty protection, transfer-pricing documentation studies must meet certain standards. Recently, the IRS put taxpayers on notice about the importance of these standards, stating in its Transfer Pricing Documentation Best Practices Frequently Asked Questions (FAQs) that low-quality documentation can invite extensive information requests from the auditor to clarify facts, transactions, and economic analyses, and may not provide penalty protection. The FAQs identify an extensive list of the areas in which documentation studies tend to fall short, based on a review of several actual studies. The areas include:

  • Lack of a clear connection between the functional and economic analyses;
  • Risk analyses that are inconsistent with intercompany agreements;
  • Lack of support for the selected transfer-pricing method;
  • No clear economic rationale supporting the profit-level indicator selected; and
  • No analysis on the impact of the differences in risks, or any other material differences, between the tested party and the comparables on the economic results.

The FAQs send a clear message: Many existing Sec. 6662 documentation studies are below expected standards and may not provide the penalty protection that many taxpayers might take for granted. Of course, these documentation studies have a single intended audience: the IRS.

FASB Accounting Standards Codification (ASC) Subtopic 740-10: Another challenging aspect of traditional transfer-pricing compliance is that, in addition to Sec. 6662 documentation, taxpayers have a financial reporting requirement to identify UTPs and potentially record reserves for UTPs in their financial statements, under ASC Subtopic 740-10 (formerly known as Financial Accounting Standards Board (FASB) Interpretation No. 48 (FIN48)). Beginning in 2010, certain corporations are also required to report these UTPs on Schedule UTP, Uncertain Tax Position Statement, if such positions would affect U.S. federal income tax liabilities. Schedule UTP requires a specified class of corporations to provide a concise description of each UTP for which the corporation or a related entity has recorded a reserve in its financial statements, or for which no reserve has been recorded, because of an expectation of litigation. Transfer-pricing determinations often form a significant part of UTP analyses and require time and resources to evaluate and quantify the positions.

Dispute resolution

Turning now to the issue of dispute resolution, transfer-pricing disputes can last years and require significant resource commitments in audit, administrative appeals, and litigation. Additional resources are often required to amend returns and adjust customs valuations. Brand-name companies often face a reputational risk when their tax disputes are reported in the media. These issues are discussed next.

Audits, appeals, mutual agreements, and litigation: As stated at the outset, transfer-pricing audits are increasing. The increase is attributable to the easing of pandemic-related restrictions, increased funding for transfer-pricing enforcement, and the need for government revenues. Transfer-pricing audits are often extremely resource-intensive, consuming a great deal of executive management's time, often over a period of two or more years, that could otherwise be committed to business pursuits. Once the audit is completed, taxpayers may contest the adjustment in administrative appeals or, if a foreign country audit, in the applicable dispute resolution forum in the local country. If the adjustment involves a transaction with a treaty country, taxpayers may seek to reduce or eliminate the double tax arising from the adjustment through the Mutual Agreement Procedure (MAP) process under the applicable treaty, potentially simultaneously with the IRS appeals process. Combined with an audit, taxpayers often face a commitment of resources lasting more than four years.

The resources required for the audit, appeals, and MAP process often pale in comparison to the resources required for litigation. In many cases, litigation is not completed until 10 or more years after the initial IRS audit adjustment. Companies sometimes must dedicate full-time resources to the litigation matter. A complex case can cost several million dollars in professional fees. (Information regarding the amounts companies may spend litigating a transfer-pricing case is not publicly available. However, the costs are generally recognized as significant. See Transfer Pricing: Litigation Strategy and Tactics (Portfolio 6932) (Bloomberg Tax), section II.A., Costs.)

Amended returns: The bulk of the resources expended in defending a transfer-pricing filing position are incurred during the audit, appeals, MAP, and litigation proceedings described above. Additional resources and costs are required post-resolution to amend federal, state, and foreign returns affected by the outcome, often over several years.

Customs exposure: An additional, and often overlooked, expense associated with a transfer-pricing adjustment is customs exposure. Customs duties are assessed based upon the "dutiable value" of imported goods at the date of importation. Although customs rules contain a number of valuation methodologies, many companies use "transaction value" to value imported goods between related parties, which relies on the transfer price developed for tax purposes. In this situation, a downward adjustment in the price of products sold to a related party will increase the buyer's profit and decrease the buyer's potential duties in the importing country. An upward adjustment in the product price will decrease the buyer's profit and increase the buyer's potential duties in the importing country. A transfer-pricing adjustment can force taxpayers to report certain changes in values to customs and possibly pay additional duties plus interest.

Reputational risk: A final, unquantifiable, potential cost associated with a significant transfer-pricing adjustment is reputational risk. Multinational companies often face scrutiny and reporting of their tax practices by advocacy groups and the media, which sometimes has led to a diminution in brand and shareholder value, even when the reports were inaccurate or misleading.

The APA alternative

An APA is an alternative to traditional transfer-pricing compliance and dispute resolution that can help a company avoid the drawbacks described above. It is a prospective agreement between a taxpayer and a tax authority (or multiple tax authorities) regarding the intercompany transactions between related parties. The agreement sets out the prospective period covered by the APA, an appropriate transfer-pricing method, and an arm's-length range of results. In a typical APA, a taxpayer files an APA submission setting out the intercompany transactions proposed for coverage, factual background, economic analyses, and supporting documents. The tax authorities evaluate the proposal during a due-diligence period, often asking for additional information to supplement the facts or economic proposals, before reaching agreement on the appropriate transfer price. The APA process is intended to be a collaborative undertaking between the taxpayer and the APA team.

Many governments recognize the benefits of the APA process, and some governments are in the process of promoting, simplifying, and strengthening their APA programs. For instance, China is reportedly promoting the benefits of APAs and has recently piloted a simplified APA process, and APAs are a current priority for the French finance ministry (see Transfer Pricing: A Year in Review, vol. 12, issue 1 (Bloomberg Tax, April 2021), at footnote 1). In addition, the Organisation for Economic Co-operation and Development (OECD) recently released a manual setting out the details of the bilateral APA process and describing best practices (Bilateral Advance Pricing Arrangement Manual (OECD Forum on Tax Administration, 2022)). Governmental and organizational emphasis on APAs makes sense: The global inventory of MAP cases has grown significantly, from 3,328 cases in 2010 to 6,301 cases in 2021, and transfer-pricing MAP cases take an average of 32.3 months to resolve, compared to 20.7 months for MAP cases involving other issues (see OECD, 2021 Mutual Agreement Procedure Statistics). These statistics suggest that alternative, nontraditional forms of transfer-pricing dispute resolution are necessary to ease the growing controversy burden on tax administrations.

APAs provide benefits not just for governments but for taxpayers as well. The benefits to taxpayers derive not just from the transfer-pricing certainty that APAs provide but also from decreased compliance costs and burdens, reduced exposure on those transactions, reduced customs valuation and reputational risk, and general resource savings. The following factors contribute to the financial and business benefits of pursuing an APA:

Transfer-pricing documentation studies and UTP analyses no longer needed: After the taxpayer and the IRS negotiate an APA, the taxpayer is required only to provide the IRS with a relatively brief summary of facts and certain calculations to demonstrate compliance with the APA. Thus, an APA eliminates the need for annual updates to the taxpayer's transfer-pricing documentation. Taxpayers that have requested but not yet executed an APA generally do not prepare documentation for the proposed APA term; rather, the submission of a complete APA request, updated and supplemented in accordance with APA procedures, "will be a factor taken into account in determining whether the taxpayer has met the documentation requirements of Regs. Sec. 1.6662-6(d)(2)(iii) for the proposed APA years" (Rev. Proc. 2015-41, §3.07). Taxpayers previously covered by an APA can rely for penalty purposes on the agreed APA methodology for a few years afterward (Regs. Sec. 1.6662-6(d)(2)(ii)(A)(6)).

In addition, because taxpayers can achieve certainty after the resolution of an APA and some level of certainty after filing an APA request before the agreement is executed, the need for UTP reporting is eliminated.

Reduced exposure on covered transactions: As mentioned above, once a taxpayer enters into an APA, its obligations with respect to the covered transactions are generally limited to showing compliance with the APA terms and conditions. Accordingly, taxpayers are not exposed to an examination risk with respect to those transactions. In a bilateral or multilateral APA, the lack of exposure also applies to the other country or countries involved in the APA.

Some companies with executed APAs have been able to use them to reduce their exposure on similar transactions in countries that are not involved in the APA-covered transactions. The executed APAs can sometimes provide persuasive evidence to a tax administration of what the arm's-length result on those transactions should be.

Rollback to resolve prior years: Although APAs are intended to provide resolution of transfer-pricing issues prospectively, a rollback of the transfer-pricing method developed in an APA to tax years prior to the prospective APA term can be an effective way to address unresolved transfer-pricing issues. This approach can add substantially to the attractiveness of an APA solution since it provides transfer-pricing certainty over an extended period.

APA renewal: A taxpayer may request a renewal APA using updated information. In the United States, the APA user fee for a straightforward renewal is $62,000 rather than $113,500 for an initial APA, and taxpayers may request an abbreviated APA request for a renewal. If the intercompany transactions, functions, and risks remain the same as in the original APA, a renewal APA should take less time and require fewer resources than the original APA. However, the IRS's Advance Pricing and Mutual Agreement Program might scrutinize the renewal request if the taxpayer's results during the term of the original APA were to fall consistently at the edge of the agreed-upon arm's-length range.

Reduced customs valuation and reputational risk: By avoiding transfer-pricing adjustments, an APA can also eliminate the need for the administrative burden of correcting the customs valuation. In addition, an APA can be an effective tool to minimize reputational risk associated with transfer pricing. Governments treat APAs as highly confidential, so the likelihood of public disclosure is small. Even if the transactions were disclosed, an APA would provide a government imprimatur on the transactions, suggesting that the taxpayer's transfer-pricing practices comply with international norms.

Resources: In addition to potential cost benefits of an APA over traditional transfer-pricing compliance and defense, an APA can have significant benefits for company managers, allowing them to focus more on business needs than on transfer-pricing compliance and exposure. In addition, a typical audit covers only three years of tax filings, leaving open the possibility that the IRS will conduct audits in a future cycle. By contrast, an APA can cover several years forward and back and can be renewed, generally at lower cost than the original APA. Moreover, compared to a transfer-pricing audit, where a tax authority may control the process and draw conclusions without significant input from the taxpayer, an APA generally provides the taxpayer with a greater degree of ownership and control over the facts, the process, and the overall transfer-pricing narrative. That ownership and control can be critical in helping to facilitate an outcome consistent with the taxpayer's objectives.

In addition, with few exceptions, APAs are completed far more quickly than the traditional dispute resolution process. Relatively simple cases can be completed within a year or two under that framework. Very complex cases can take two years for the due-diligence phase and an additional two years for competent authority negotiations. Even in the latter group of cases, the completion time frame is generally shorter than in the traditional enforcement process.

Establishing some certainty with APAs

Transfer pricing is often the top tax concern for multinational companies. Their concern has several sources, including the uncertainty inherent in pricing intercompany transactions, differences in the approaches taken by tax administrations, and, in recent years, the potential impact of the pandemic. In addition, tax administrations globally appear to be gearing up to focus more on transfer-pricing audits in the coming years. Traditional transfer-pricing compliance has drawbacks because it can require significant resources and may not provide sufficient protection against an audit.

For many companies, an APA may be a realistic alternative to navigate those headwinds. An APA can provide transfer-pricing certainty over a period of several years and require far lower resource and cost commitments than traditional compliance and dispute resolution. An APA can significantly reduce not only a company's transfer-pricing exposure, but also potential customs valuation issues and reputational risk, and may provide evidence of arm's-length approaches for similar transactions not covered by the APA.

Matthew Kramer, J.D., Ph.D., is managing director, transfer pricing at Grant Thornton in San Francisco, and Steven C. Wrappe, J.D., LL.M., is national technical leader, transfer pricing at Grant Thornton in Washington, D.C. To comment on this article or to suggest an idea for another article, contact Dave Strausfeld at

Tax Insider Articles


Business meal deductions after the TCJA

This article discusses the history of the deduction of business meal expenses and the new rules under the TCJA and the regulations and provides a framework for documenting and substantiating the deduction.


Quirks spurred by COVID-19 tax relief

This article discusses some procedural and administrative quirks that have emerged with the new tax legislative, regulatory, and procedural guidance related to COVID-19.