US Tax Reform: Potential Role of the APA Program

US tax reform finally occurred in 2017 with what was formerly referred to as the Tax Cuts and Jobs Act of 2017 (the Act). The headline from a corporate standpoint is reduction in the maximum rate from 35 percent to 21 percent beginning in 2018. In the international context, the Act: (i) embraces a territorial system as exists with most of its trading partners; (ii) seeks to protect the US tax base from perceived cross-border erosion; and (iii) enacts an incentive for certain economic investments in the United States at a globally attractive effective tax rate (13.125 percent).

The purpose of this post is not to review the technical provisions of the Act, but to note that as each multinational enterprise (MNE) evaluates its impact on its effective tax rate strategy (both opportunities and hazards), an item to keep on the agenda may be “could a bilateral APA be of assistance?”

While there is no material reference to advanced pricing agreement (APA) procedures in the law, it is apparent that issues will inevitably arise in the future, framed in a simple illustration:

ILLUSTRATION: USCo (shareholders could be domestic or foreign) is in the business of developing, producing, and marketing Unique medical products. Its research and development (R&D) and manufacturing operations are conducted throughout the world, a result of a series of acquisitions dating back many years. USCo has an existing bilateral APA between the United States and United Kingdom, as well as a separate APA between the United States and Japan. The UK subsidiary is responsible for European operations, and the Japanese subsidiary is responsible for Japanese operations.

USCo recently completed its country-by-country (CbC) documentation and is current with all filings in all countries in which it has operations. The CbC documentation reflects the existence of significant non-USCo developed intangibles in the United Kingdom and Japanese subsidiaries.

In view of the Act’s international provisions, USCo is considering whether to renew its APAs. It has similar concerns about the UK Diverted Profits Tax.

The Illustration reflects a variety of issues that will confront all MNEs that believe they have intangibles located in various affiliates throughout the world. From a US standpoint, USCo may want to consider the following transfer pricing-related issues:

• Coordination with the existing Section 482 regulations, which have their own definitions of “intangibles” and related terms. There are a wealth of new terms that will require definition for regulatory purposes, as well as coordination with existing concepts. For example:
  • How do they coordinate with Section 482 regulation concepts?
  • The Act expands the definition of intangibles to include goodwill and related elements without any cross-reference to the new provisions.
  • It also amends Section 482 to authorize the IRS to utilize “aggregate” or “alternative ” intangible valuation methodologies, which is plainly intended to validate an IRS litigation strategy that has been rejected by the courts.
  • Coordination with other transfer pricing-related provisions, such as Section 367(d).
  • The “goodwill” and “aggregation” elements of the Act may be viewed by the IRS to suggest different intangible results than existed in the extant APAs.
• Will the IRS APA Program entertain renewals that address issues arising under the new provisions? The current APA revenue procedure was prepared prior to the completion of CbC packages or the Act.
  • In the absence of an APA, USCo is faced with a dilemma concerning the earnings of its non-US subsidiaries in the event they have net CFC tested income in excess of the deemed 10 percent return on tangible asset value in the pertinent new provisions.
    • The existing APAs may provide a profit split return to the respective parties.
    • Will this be respected in view of the Act’s provisions?
    • How will USCo and affiliates prepare transfer pricing and CbC documentation?
    • The Japanese and UK domestic law is likely to be in some tension with the requirements of the new provisions. How will USCo and affiliates file in each country to avoid double taxation?
    • The United Kingdom and Japanese tax authorities can certainly be anticipated to have a dim view of the fixed 10 percent return. (By the same token, the United States would counter that it is merely taxing a portion of the CFC’s return and is not contesting the overall transfer pricing model; thus, the United States would proffer that there is no economic double taxation, and the juridical double taxation is largely addressed by the new deduction and credit mechanisms. MNEs, of course, will at a minimum be concerned about the prospect of more tax leakage—whether economic or juridical.)
    • Are these issues subject to treaty dispute resolution mechanisms?
    • The same issues would exist with respect to the UK Diverted Profits Tax.
• Distinction between related and unrelated parties, including circumstances where sales or provision of services to related parties may qualify for the investment in the US incentive.
• In view of the new provisions, is the relevance of transfer pricing materially impacted with respect to US-related operations?
  • Does this render the details of outbound transfer pricing far less important than under prior law?
  • Not really. A US-based group could adopt the 10 percent minimum return as its global methodology, so that only the 10 percent return on tangible assets would remain in treaty countries.
    • Reaction of local countries?
    • What about local intangibles (via cost-sharing, local investment, acquisition, or otherwise)? The new provisions do not address these issues.
• In view of this initial range of questions in the USCo situation, a distinction may arise between transfer pricing issues for US and foreign purposes (following OECD or UN Guidelines). This can, inevitably, be assumed to lead to even greater levels of cross-border controversy in the future, in the face of already over-burdened dispute resolution processes throughout the world.