Comments on Certain Technical Issues in the Draft APA Revenue Procedure

By Craig A. Sharon, Esq.

Ernst & Young LLP, Washington, D.C.

1

This is my second commentary on Notice 2013-79 (the Notice),2 the Advance
Pricing and Mutual Agreement (APMA) Program's draft update of the
current Advance Pricing Agreement (APA) revenue procedure (Rev.
Proc. 2006-9, 2006-2 I.R.B. 278, as modified by Rev. Proc. 2008-31,
2008-23 I.R.B. 1133) (hereinafter simply Rev. Proc. 2006-9). My
first commentary focused on the apparent shift in tone in the
Notice compared to earlier APA revenue procedures and questioned
whether or not that shift might signal an unexpected change in the
IRS' attitude about the APA process.3 On this issue,
we'll have to wait and see how the Notice is revised and how the
final revenue procedure (the Final Rev. Proc.) is actually
implemented.4

There are other broad themes in the Notice that deserve comment,
but I'm sure that many others will address those issues, e.g.,
APMA's elevated role in audits and IRS Appeals, the increased
standardization and expanded information requirements for APA
submissions, and the higher upfront investments likely to be
required under the Notice. This commentary will focus instead on a
small number of narrow technical issues.

APA Coverage

The Notice introduces a new term, "coverable issues," which
refers to the issues eligible for APA coverage.  The
definition of "coverable issues" expands the range of possible
APA-covered transactions in favorable ways, but some clarification
would be helpful, especially as it relates to the issues currently
covered by Rev. Proc. 2008-31, the revenue procedure that expanded
the APA program's jurisdiction to cover any issue that applies
transfer pricing principles. Specifically, the Notice includes
"ancillary issues" - another new term - among coverable
issues.  Ancillary issues include recurring secondary issues,
such as an election to treat a primary or correlative APA
adjustment as a payable or receivable under the principles of Rev.
Proc. 99-325 (i.e., newly
defined as an APA repatriation), interest on refunds and
deficiencies, penalties with respect to U.S.-initiated adjustments,
and the determination of whether a payment is compulsory for
foreign tax credit purposes.  Of these issues, all but an APA
repatriation are newly eligible for APA coverage, although it's
possible, in fact, likely, that some of these issues have been
covered in past APAs on an ad hoc basic.6 The Notice makes clear
that such issues are now generally eligible for coverage in all
APAs.  That's good because it allows a taxpayer to resolve
these secondary issues as part of the APA process, rather than
having to deal with them in a separate proceeding (e.g., as part of
a closing agreement with the IRS Exam function or administratively
with a foreign tax authority).

A few issues need clarification:

  •   The list of ancillary issues does not include
    characterization and related sourcing determinations (e.g., whether
    a payment is for services or a royalty). Sourcing is another
    recurring secondary issue, so it would be helpful, when the
    question arises, for the issue to be dealt with in the APA. Of
    course, that may require consultation with the technical branches
    within the Office of Associate Chief Counsel (International)
    (ACCI). Query, though, whether or not this issue could fall within
    APMA's new authority to resolve the compulsory nature of foreign
    tax credit issues, an issue that can turn on the characterization
    of a transaction in the foreign jurisdiction?
  •   The Notice would incorporate Rev. Proc. 2008-31, which
    amended Rev. Proc. 2006-9, into the Final Rev. Proc. That makes
    obvious sense.  The question, though, is whether the Notice
    goes beyond the issues covered by Rev. Proc. 2008-31. Specifically,
    Rev. Proc. 2008-31 extended APA coverage only to non-§482 issues
    for which "transfer pricing principles may be relevant." Until
    2011, when I left the APA program, we interpreted Rev. Proc.
    2008-31 narrowly, applying it, e.g., only to the few U.S. treaties
    (e.g., United Kingdom, Japan) that incorporated the Authorized OECD
    Approach (AOA) to determine the attribution of profits to a
    permanent establishment (PE) under Article 7 of U.S. treaties and
    only to certain (i.e., a few) determinations of effectively
    connected income (ECI), as decided by ACCI on a case-by-case basis.
    Although the Notice retains the language in 2008-31 allowing APA
    coverage for any issue that applies transfer pricing principles, it
    does so as a catch-all at the end of a string of other identified
    coverable issues, including issues involving PE attribution and
    determinations of ECI. The question is whether the proposed
    language would allow, as appears to be the case, APMA to cover: (1)
    PE attribution under any treaty, including U.S. treaties that don't
    incorporate the AOA (the vast majority of current U.S. treaties);
    and/or (2) any and all ECI determinations, not just the few
    instances determined by ACCI to apply transfer pricing principles
    (e.g., services within and without the United States, which is
    separately identified in the list of coverable issues).

Unilateral APAs

The Notice retains the IRS's preference stated in Rev. Proc.
2006-9 for bilateral APAs when a treaty partner is on the other
side of the covered transactions. Indeed, under the Notice,
taxpayers requesting a U.S. unilateral APA in such situations will
be required to submit a pre-filing memorandum before submitting a
formal APA request to give APMA an opportunity to consider the
issue in advance. In recent years, taxpayers have been allowed,
under Rev. Proc. 2006-9, to file for a unilateral APA, even though
a bilateral APA was possible, in certain fairly common
circumstances, such as when a covered transaction involved many
countries (e.g., headquarters allocations or licensing royalties)
or when the value of the covered transaction was small and the
likely time and cost to complete a bilateral APA disproportionately
large.

Under earlier APA revenue procedures, a taxpayer with a U.S.
unilateral APA involving a treaty country has been allowed to seek
Competent Authority relief in the event of a foreign-initiated
adjustment to a transaction covered by the APA. Not only would the
U.S. Competent Authority take the case, but it also was willing to
compromise the APA transfer pricing methodology to the extent
necessary to avoid double taxation. That posture contrasts with the
U.S. Competent Authority's unwillingness to compromise (as opposed
to negotiating correlative relief only) the results of a closing
agreement, Form 870-AD, or U.S. court decision covering the same
issue.

The Notice drops the express right to Competent Authority relief
contained in the earlier revenue procedures without comment or
substitute language. The draft update to the Competent Authority
revenue procedure, Notice 2013-78 (the MAP Notice),7 imposes new
limits on taxpayer access to a proceeding under the Mutual
Agreement Procedure article (a MAP), so it's possible that APMA is
intending to reverse its policy of taking foreign-initiated
adjustments relating to a unilateral APA to Competent Authority. Or
perhaps APMA will resolve the issue on a case-by-case basis as part
of the mandatory pre-filing process or during the unilateral APA
negotiations. Regardless, APMA should clarify its position in the
Final Rev. Proc.

Rollback Requests

No one should be surprised, following the LB&I
restructuring, the creation of the Office of Transfer Pricing
Operations (the TPO), and the merger of the APA program and the
U.S. Competent Authority double-tax staff, that the IRS would want
to integrate the new transfer pricing functions better. That makes
sense for various reasons, especially if it creates new case
processing efficiencies and streamlines issue resolution, but the
question is whether the Notice strikes the appropriate balance in
involving the APMA program: (1) more heavily in the issues to be
covered in an APA (i.e., years, countries, and transactions); and
(2) more centrally in resolving transfer pricing issues at audit
and working with IRS Appeals. Taxpayers have legitimate reasons to
be concerned whether an expanded/strengthened APMA role will work
as intended for the benefit of both the IRS and taxpayers, or
whether it will instead stretch APMA's resources, unnecessarily
reduce taxpayer control over what is supposed to be a voluntary APA
process, and/or complicate the settlement of transfer pricing
controversies involving treaty countries. Conceptually, I can
imagine the IRS approach working, but I have doubts in practice
because the Notice, increasingly blurs the lines of responsibility
and decision-making authority between and among the various
transfer pricing functions. This intentional IRS decision could
create significant implementation challenges.

Take the case of APA rollbacks as an example.  Under Rev.
Proc. 2006-9, taxpayers decide whether or not to request a
rollback, and the Exam team, which has jurisdiction over pre-APA
years, decides the question. The APMA program has jurisdiction only
over APA years. In practice, the two functions consult with each
other, but disagreements about the best approach to an APA
involving a rollback request are common (e.g., the Exam team may
want to deny a rollback and/or limit the covered transactions in
the APA). These disagreements may require higher-level review to be
resolved, but, in the end, one function or the other has the final
say (e.g., Exam on rollback years). The TPO, which stood up in the
last year, has complicated the jurisdictional issues, but the
existing framework remains essentially in place for now (i.e., the
TPO has not claimed issue jurisdiction over transfer pricing
audits).

The Notice obscures the existing jurisdictional lines further.
On rollback requests, the Notice provides that APMA will coordinate
and collaborate with other offices within the IRS and then inform
the taxpayer whether or not its rollback request has been accepted.
Perhaps it's implied, but it's not clear whether APMA is given
responsibility only for coordinating the decision-making process
and relaying the decision to the taxpayer or whether it has final
decision-making authority over the request and/or jurisdiction over
any accepted rollback.8 The same goes for
APMA's new right to condition acceptance of an APA request on the
taxpayer's acceptance of a rollback. As with rollback requests, the
Notice only reserves APMA the right to coordinate with the
applicable IRS offices and then inform the taxpayer of the final
decision. But is APMA the decision-maker or not? In my view, it
should be "the decider" at least on bilateral cases.

I understand that, under the new LB&I structure, all
transfer pricing issues ultimately funnel to the LB&I Deputy
Commissioner (International) (currently, Mike Danilack), but I
question whether or not it is realistic to expect one senior
executive, with a small personal staff, to resolve the
case-specific disagreements that will arise in the hundreds (and
growing) of transfer pricing audits and APAs underway at any one
time. I appreciate the notion of a "roundtable" of IRS
professionals making decisions on a consensus basis, but I was also
part of the 2010-11 Transfer Pricing Pilot that led to the creation
of the TPO, and I know firsthand the practical challenges of moving
cases forward on a timely basis when no one is officially in
charge, the IRS team is large, and resources are stretched.

Although the new rules of engagement are a work in progress, I
would encourage the IRS to draw clearer jurisdictional lines in the
Final Rev. Proc. Indeed, it doesn't have to look further than
§§9.01(4) and 9.02(1) of the MAP Notice to find potential
language.

There are a few other "rollback" issues that should be
addressed:

  •   What "clear interests" does the IRS have in mind in
    deciding whether or not to require a rollback as part of an APA
    request. Is this a new legal standard, different from the
    prevailing "in the interest of sound tax administration" standard
    in Rev. Proc. 2006-9? As with certain other provisions in the
    Notice (e.g., whether or not to impose an interest charge on APA
    repatriations and the legal effect of an APA on transfer pricing
    penalties), this change appears aimed at past cases perceived to be
    abusive, but the language is not so limiting or comforting. If the
    IRS wants to leave itself room, it could say that "a taxpayer's
    choice whether or not to request a rollback will generally be
    respected; however, in the interests of sound tax administration,
    APMA reserves the right in exceptional circumstances to … ."
    Similar softening language in the other "anti-abuse" provisions in
    the Notice would help reduce anxiety about the tone of the Notice
    without compromising IRS interests.
  •   The Notice gives taxpayers three months from an APA
    filing to decide whether or not to request a rollback, while the
    APMA program retains the right to decide "any time during the APA
    process" to require a rollback. Why the imbalance, and what happens
    if a taxpayer refuses an APMA demand made late in the process?
    Would the APA be terminated without consideration of the taxpayer's
    (likely significant) investment in the process?

I'm not sure any time limit for taxpayer rollback requests is
necessary (up to the final agreement), since APMA can always deny a
late request. But if a time limit is to be imposed, it should
extend well past three months, given that the APA process rarely
starts so soon after a submission. At a minimum, a later cutoff
date should be provided (e.g., after the First Meeting or after
APMA presents its preliminary economic analysis).

  •   Both the Notice and the MAP Notice provide that the APMA
    program will "share" jurisdiction with the Treaty Assistance and
    Interpretation Team (TAIT), the other arm of the U.S. Competent
    Authority, on PE issues. Neither notice delineates the nature of
    that sharing, but I would think it means that TAIT will decide
    whether or not a PE exists and that APMA will decide the profit
    attribution issue (perhaps limited, as noted above, to U.S.
    treaties incorporating the AOA). I'm not concerned about this
    division of labor, given that APMA and TAIT are part of the same
    office, but I'm uncertain whether and how a taxpayer would get an
    advance ruling on a PE determination. Currently, PE determinations
    are made as part of the pre-filing agreement (PFA) process (a Field
    function) and are not generally covered by an APA. Is this changing
    and, if so, how?

Anonymous Pre-Filings

The Notice prohibits anonymous pre-filings for the enumerated
mandatory pre-filing topics (e.g., unilateral requests when a
bilateral is available, cost-sharing cases, global dealing, etc.).
I understand the thinking that full transparency is needed on
subjects that the IRS deems to be sensitive or complex, but a
hard-and-fast prohibition on anonymity may hurt the IRS and
taxpayers alike, because such conferences allow APMA to learn about
new and emerging issues early on and to potentially steer them
toward the more cooperative APA environment. The APMA program
should want these cases. At a minimum, I'd hope that APMA will make
clear that it remains open to informal anonymous consultations.

Contents of Pre-Filing Memoranda

The Notice provides that mandatory pre-filing memoranda "must
have a length and content appropriate to the size and complexity"
of the covered issues, while pre-filing memoranda for optional
pre-filing issues "must have a length and content appropriate to
the substantive or procedural issues the taxpayer wishes to raise"
with APMA. Are these different standards?

APA User Fee

Rev. Proc. 2006-9 adopted the current rule that taxpayers need
pay only one APA user fee for all APA submissions filed by a
taxpayer within any 60-day period. This "60-day" rule replaced the
rule in Rev. Proc. 2004-40,9 the predecessor
to Rev. Proc. 2006-9, that required a separate APA fee for each APA
request. The Notice drops the 60-day rule and goes back to Rev.
Proc. 2004-40. From an IRS perspective, the revived "per-APA" fee
structure may seem reasonable given the size of most APA taxpayers,
but I can say - somewhat to my surprise since leaving the APA
program - that an APA fee can represent a sizable portion of a
taxpayer's investment in submitting an APA request. Even under the
60-day rule, the fees are high enough to reduce taxpayer interest
in the program. The new fee structure will only increase the
disincentive, and it's also not cost-free to APMA. Eliminating the
current rule may raise a small amount of revenue for the
government, but it will also reintroduce the recurring pre-2006
debates about whether or not a taxpayer's APA submission involves
one or more requests. At least Rev. Proc. 2004-40 included a
definition of "separate APA request."10 The Notice does
not, but should. Better yet, the Final Rev. Proc. should retain the
current rule.

Abbreviated APA Requests

The Notice provides for newly named "abbreviated APA requests"
in three named circumstances: simple renewals, small case requests,
and requested extensions of a MAP agreement into an APA. I commend
the concept, but Rev. Proc. 2006-09 already provides for expedited
processing for the first two cases; however, it rarely occurs,
mostly because there aren't many simple renewals or small business
taxpayers willing to accept rough-justice results. I hope that APMA
is prepared to do better going forward, but it will require a
serious commitment (and pushy taxpayers) to make it work.

"Appendix 1" Full APA Submissions and Covered Issue
Diagrams

Surely, there will be a full array of comments on Appendix 1 in
the Notice (e.g., pros and cons of increased standardization, how
much information is enough, will the new requirements streamline or
complicate the process, etc.). I'll let others offer their views on
the general topic. Here, I'll ask one specific question:

  •   The Notice asks for taxpayers to prepare "covered issue
    diagrams" (i.e., diagrams, charts, or similar representations)
    similar to the issue diagrams presented in a report prepared by the
    Joint Committee on Taxation in 2010 (the JCT Report).11 The language
    suggests that APMA is looking for diagrams only, without the
    narrative included in the JCT Report.  However, the opening
    line in Appendix 1, §3.4, requires a taxpayer to "provide a
    detailed discussion of each proposed covered issue… ." Does APMA
    want a narrative or not?

Extension of Statute of Limitations

Taxpayers have always been required to extend the statute of
limitations for years covered by an APA request, including rollback
years. Virtually all taxpayers are willing to do so, but most would
prefer to sign a restricted consent, which keeps the statute open
only for the APA-covered transactions (and ancillary issues),
rather than a general consent, which keeps open all issues in the
affected years. Whether or not a taxpayer is allowed to sign a
restricted consent is generally within the purview of IRS district
counsel, and the policy in most district counsel offices, typically
with the support of the IRS Field, has been to require general
consents. The Notice suggests a softening of the current practice
by providing that taxpayers will be instructed as to the type of
consent to execute, "viz., general or restricted." A more liberal
use of restricted consents would be desirable and defensible,
especially for rollback years when the IRS has had reasonable time
and opportunity to complete an audit for an older year (as is often
the case, given how long it typically takes to complete an
APA).

This commentary also will appear in the April 2014 issue of
the
 Tax Management International Journal.  For
more information, in the Tax Management Portfolios, see Levey,
Carmichael, van Herksen, Patton, Levi, Krupsky and Kellar, 890
T.M.
, Transfer Pricing: Alternative Practical Strategies
(Chapter 8, "Advance Pricing Agreements"),  and in Tax
Practice Series, see ¶3600, Section 482 - Allocations of Income and
Deductions Between Related Taxpayers.


  1 The views expressed herein are those of the
author and do not necessarily reflect those of Ernst & Young
LLP or any other member of Ernst & Young Global Limited. 
Moreover, they should be viewed in the context of the time they
were expressed. Ernst & Young Global Limited, a U.K. company
limited by guarantee, does not provide services to clients. Ernst
& Young LLP is a client-serving member firm of Ernst &
Young Global Limited operating in the United States. EY refers to
the global organization, and may refer to one or more of the member
firms of Ernst & Young Global Limited, each of which is a
separate legal entity.

  2 2013-50 I.R.B. 653.

  3 See Sharon, "Notice 2013-79: A Change in
Attitude?" 43 Tax Mgmt. Int'l J. 122 (2/14/14).

  4 The IRS asked for comments on the Notice by Mar.
10, 2014, and is expected to issue the Final Rev. Proc. by year
end.

  5 1992-2 C.B. 296.

  6 The U.S. Model Treaty and a dozen or so U.S.
treaties (e.g., with the U.K. and Denmark) expressly allow for
interest and penalties to be resolved in a mutual agreement. 
However, such issues have not generally been dealt with in mutual
agreements.

  7 2013-50 I.R.B. 633.

  8 Adding to the uncertainty, the Notice also states
that "[a]lthough APMA will coordinate within the IRS to minimize
duplicative requests in conducting its due diligence, the taxpayer
remains obligated to respond to information document requests
issues, and according to deadlines set, by other IRS offices in any
examination or enforcement proceedings."

  9 2004-29 I.R.B. 50.

  10 "A separate APA request concerns a specific
[transfer pricing methodology (TPM)] and distinct facts, such that
a review of the facts will determine the suitability of the TPM and
all other methodologies under consideration." Rev. Proc. 2004-40,
§4.12(1)(b).

  11 Joint Committee on Taxation, "Present Law and
Background Related to Possible Income Shifting and Transfer
Pricing," JCX-37-10 (7/20/10), available at www.jct.gov.