Pawlicki - Final Final

195

ADVANCE PRICING AGREEMENTS: FAIR TO ALL

TAXPAYERS?

KATHRYN PAWLICKI†

I. INTRODUCTION .................................................................................. 195 II. BACKGROUND .................................................................................. 197

A. International Tax Generally ...................................................... 197 B. Origin of Transfer Pricing and the Advance Pricing Agreement

Program ................................................................................... 198 1. Transfer Pricing Generally .................................................. 198 2. Why Regulate Transfer Pricing? ......................................... 204 3. Emergence of the Advance Pricing Program ...................... 205

C. APAs Generally ......................................................................... 206 1. What is an APA? .................................................................. 206 2. Advantages and Disadvantages ........................................... 207

D. Formation, Administration and Enforcement of APAs .............. 209 III. ANALYSIS ........................................................................................ 210

A. Fairness in Tax Law................................................................... 211 B. Fairness in the Case of APAs ..................................................... 213

1. Cost to Participate ............................................................... 213 2. Specific Tax Result ............................................................... 214 3. Failure to Comply ................................................................ 216

C. Resolution .................................................................................. 216 IV. CONCLUSION ................................................................................... 220

I. INTRODUCTION

The IRS has printed over 13,350 publications, 1,500 forms, and 5,000

sets of instructions for U.S. business taxpayers operating abroad.1 Despite

the seemingly vast amount of resources, or perhaps as a result of these

† B.S., 2011, cum laude, Wayne State University; J.D., 2015, Wayne State University

Law School.

1. TAXPAYER ADVOCATE SERVICE, 2011 ANNUAL REPORT TO CONGRESS 133 (2011),

http://www.irs.gov/pub/tas/2011_arc_internationalmsps.pdf (“The IRS has 43 publications

pertaining to U.S. business taxpayers involved in economic activity abroad, totaling 1,212

pages. These publications refer to additional publications totaling 13,346 pages, 1,500

pages of forms, and another 5,018 pages of form instructions.”).

196 WAYNE LAW REVIEW [Vol. 61:1

resources, multinational corporations claim to face numerous difficulties

in complying with U.S. federal tax reporting requirements.2

One of the top, controversial compliance issues is transfer pricing.3

Transfer pricing refers, generally, to the price set by a taxpayer on goods

and services sold, purchased, and shared between two or more entities.4

This concept is particularly relevant in the case of multinational

corporations, where there are cross-border transactions between related

entities within the same corporate tax group.5 Here, an inappropriate

transfer price may allow the corporate group to lower its tax liability due.6

Taxing agencies are quick to address this form of tax avoidance.7

In the U.S., if a taxpayer fails to comply with IRS transfer reporting

requirements, the taxpayer may be subject to a substantial and unexpected

adjustment to its income tax liability, as well as large penalties.8 In an

attempt to address transfer pricing compliance difficulties, the IRS

designed the Advance Pricing Agreement Program (the “Program”).9 An

advance pricing agreement (an “APA”), in short, is an agreement between

the IRS and a taxpayer in which the parties agree to a transfer pricing

method to be applied for a set period of time.10

However, while the Program may be very beneficial to large

corporations, it has several flaws.11 Most significantly, the Program is

virtually unavailable to small businesses and individuals,12 which

2. Zeki Doğan et al., Factors Influencing the Selection of Methods and Determination

of Transfer Pricing in Multinational Companies: A Case Study of United Kingdom, 3 INT’L

J. ECON. & FIN. ISSUES 734, 734 (2013).

3. Id.; see also John McKinley, & John Owsley, Transfer Pricing and Its Effect on

Financial Reporting: Multinational Companies Face High-Risk Tax Accounting, J. ACCT.,

(Oct. 1, 2013), http://journalofaccountancy.com/issues/2013/oct/20137721.html.

4. BRIAN J. ARNOLD & MICHAEL J. MCINTYRE, INTERNATIONAL TAX PRIMER 55

(Kluwer Law International Ltd., 2d ed. 2002).

5. Jeffrey Trey & Kafui Asembri, International Tax Issues for Newly Multinational

Corporations: A Due-Diligence Perspective, 44 TAX ADVISER 215 (April 1, 2013),

http://www.aicpa.org/publications/taxadviser/2013/april/pages/clinic-story-04.aspx.

6. Yehonatan Givati, Resolving Legal Uncertainty: The Unfulfilled Promise of

Advance Tax Rules, 29 VA. TAX. REV. 137, 142 (2009).

7. See, e.g., Agnes W.Y. Lo & Raymond M.K. Wong, Tax Compliance and Audit

Adjustment – An Investigation of the Transfer Pricing Methodologies, 33 INT’L TAX J. 59,

(2007) (comparing transfer pricing in the U.S. and China); see also Kristin E. Hickman,

Comment, Should Advance Pricing Agreements be Published?, 19 NW. J. INT’L L. & BUS.

171, 179 (1998).

8. Givati, supra note 6, at 142.

9. JOSÉ MANUEL CALDERÓN, ADVANCED PRICING AGREEMENTS: A GLOBAL ANALYSIS

22 (1998).

10. 26 U.S.C.A. § 482 (West 2014).

11. See infra notes 115–119 and accompanying text.


2015] ADVANCE PRICING AGREEMENTS 197

represent a substantial portion of the U.S. income tax base.13 Limited

taxpayer access to the Program hinders the fairness of the U.S. taxing

system, which has long been recognized as “a fundamental and desirable

attribute of any tax system.”14 Given the Program’s lack of universal

availability and the importance of fairness, the IRS should modify the

APA Program requirements to make APAs more readily available to all

taxpayers.

II. BACKGROUND

A. International Tax Generally

Unlike its name suggests, “international tax” refers, more precisely, to

the international aspects of the national income tax laws of sovereign

states.15 In actuality, there are no tax laws that apply internationally to all

nations.16 Consequently, state taxing systems are largely a product of

national governments,17 which means each state will likely employ its own

varying rules and requirements, resulting in inconsistency and overlapping

across borders.18

The central problem of having several state taxing agencies attempting

to coexist, rather than a blanket international taxing agency, is overlapping

claims of taxing authority.19 This is commonly referred to as juridical

double taxation and occurs where various governments claim to have full

taxing authority on the same transaction.20 The generally accepted

resolution jurisdictionally limits a nation’s taxing authority by source,

residence, and citizenship.21 Under U.S. tax law, for example, income tax

13. See, e.g., infra note 116 and accompanying text.

14. Leo P. Martinez, The Trouble with Taxes: Fairness, Tax Policy, and the

Constitution, 31 HASTINGS CONST. L.Q. 413, 417 (2004) (“This requirement of fairness (or

at least the perception of fairness) has long been a veritable constant, and it is rare that

discourse on taxation does not emphasize fairness as a fundamental and desirable attribute

of any tax system.”).

15. ARNOLD & MCINTYRE, supra note 4, at 2.

16. Id. at 2–3. Exceptions exist in the case of tax treaties; however, tax treaties, by no

means, encompass all nations. RICHARD L. DOERNBERG, INTERNATIONAL TAXATION IN A

NUTSHELL 6 (7th ed. 2007).

17. Nancy H. Kaufman, Fairness and the Taxation of International Income, 29 LAW &

POL’Y INT’L BUS. 145, 167 (citing Alan G. Choate et al., Federal Tax Policy for Foreign

Income and Foreign Taxpayers: History, Analysis and Prospects, 44 TEMP. L.Q. 441, 441–

42 (1971)).

18. DOERNBERG, supra note 16, at 6.

19. Id. at 2.

20. Id. at 2–3.

21. Kaufman, supra note 17, at 148 (“Opinions differ about whether these established

jurisdictional bases rise to the level of customary international law. Nevertheless, it is


is imposed on a U.S. citizen’s total worldwide income.22 Therefore, a non-

U.S. citizen would not be taxed by the U.S. taxing authority.

However, jurisdictional limits do not fully resolve the issues that arise

as a result of cross-border trade of goods, cross-border investments, and

cross-border services.23 In the case of each of these types of transactions,

the taxpayer is potentially subject to a tax in two jurisdictions.24

Keeping the international tax scheme in mind, this Note begins with a

discussion on the origin of transfer pricing,25 follows with a general

overview of APAs and the U.S. APA Program,26 and continues with more

specific detail as to the formation, administration, and enforcement of

APAs.27 The background sets the stage for an evaluation of whether or not

the APA Program is on par with standards of fairness28 and finishes with

a brief analysis of various proposals suggested to improve the current

Program.29

B. Origin of Transfer Pricing and the Advance Pricing Agreement

Program

1. Transfer Pricing Generally

Transfer pricing commonly arises in the case of large, multinational

corporations having U.S. parent-operations and smaller, foreign

subsidiaries.30 Transfer pricing is the value assigned to transactions for

reasonable to assert that source and residence taxation, if not also citizenship taxation, now

constitute customary norms.”); see also Suzanne M. Paquette, Discussion of “Who Benefits

from Inconsistent Multinational Tax Transfer-Pricing Rules?”, 23 CONTEMP. ACCT. RES.

133, 133 (2006) (“Governments are . . . encouraged to increase international cooperation

in transfer pricing to avoid double taxation.”).

22. INTERNAL REVENUE SERV., PUB. NO. 54, TAX GUIDE FOR U.S. CITIZENS & RESIDENT

ALIENS ABROAD 2 (Dec. 4, 2014), http://www.irs.gov/pub/irs-pdf/p54.pdf (“If you are a

U.S. citizen or a resident alien, your worldwide income generally is subject to U.S. income

tax, regardless of where you are living.”); see also INTERNAL REVENUE SERV., PUB. NO.

525, TAX GUIDE FOR U.S. CITIZENS & RESIDENT ALIENS ABROAD (Jan. 15, 2015),

http://www.irs.gov/pub/irs-pdf/p525.pdf; 26 U.S.C.A. § 61 (West 2014).


24. Id. This is commonly referred to as “double taxation.” “[D]ouble tax burdens can

become onerous and interfere substantially with international commerce. The necessity for

relief is clear on grounds of equity and economic policy.” Id. at 27.








goods and services that are shifted between related entities.31 Transfer

pricing may also refer to transactions of “intercompany commission

payments, loans, interest, royalties, or dividends flowing from one entity

to another.”32 The concept of transfer pricing is especially relevant where

there are corporate entities related by a similar parent entity.33

Problems occur when one entity within the corporation transfers goods

or services to another entity, failing to do so at an arm’s-length price or

failing to provide adequate support for the transfer price used.34 An arm’s-

length price, according to the IRS, is the price that would be used to reflect

the same transaction, under the same circumstances, between unrelated

taxpayers.35

Multinational corporations may be motivated to not report the

transaction at an arm’s-length price for tax purposes36 in order to avoid tax

liability.37 This manipulation occurs by shifting the income and expenses

of an intercompany transaction between jurisdictions using “artificially

high or low prices.”38 The taxpayer reports a majority of the income from

the transaction as income attributable to the entity located in the nation

31. Doğan, supra note 2, at 734 (citing MANFRED DAVIDMANN, COMMUNITY

ECONOMICS, MULTINATIONAL OPERATIONS: TRANSFER PRICING (1996); Gerald Aranoff,

Transfer Pricing With Technology Choice and Demand Fluctuations in a Simple

Manufacturing Model, QUARTERLY J. OF BUS. & ECON., Spring 2000, at 3, 3; Zeki Doğan,

Transfer Fiyatlama Politikalarının Belirlenmesinde Faaliyet Esasına Dayalı Maliyetleme

Yönteminin Önemi, 29 MUHASEBE VE FINANSMAN DERGISI 79, 80 (2003); Zeki Doğan, Çok

Uluslu Isletmelerde Transfer Fiyatlama Uygulama Nedenleri ve Verilerin Analizi, 22

MUHASEBE VE FINANSMAN DERGISI 71, 71 (2004); Jian Li, International Transfer Pricing

Practices in New Zealand, 7 UNIV. OF AUK. BUS. REV 59, 65 (2005)) (“Transfer pricing

can be used for goods and services transferred between units or profit centres within the

same firm, as well as for goods and services transferred between related companies located

in different countries. Transfer pricing, in general, is defined as a term used in order to

represent the value of transactions among the subsidiaries operating in different countries.

In other words, transfer pricing is defined as the price charged for transferring a

corporation’s tangible and intangible assets, goods or services, raw materials, know-how

and technology to its subsidiaries or branches.”).

32. Trey & Asembri, supra note 5, at 215.

33. Id.

34. Id. (“In many cases, multinational companies have substantial intercompany

transactions with transfer prices that do not reflect appropriate arm’s-length rates or lack

contemporaneous supporting documentation.”).

35. Treas. Reg. § 1.482-1 (2013).

36. Paquette, supra note 21, at 134 (“Firms have an incentive to shift part of their

income to the low-tax-rate country through transfer pricing.”).

37. ARNOLD & MCINTYRE, supra note 4, at 81. Transfer pricing manipulation is usually

classified as tax avoidance, rather than tax evasion, which is illegal and usually involves

either fraud or use of international scheme to conceal of income. Id.

38. Paquette, supra note 21, at 134; see also ARNOLD & MCINTYRE, supra note 4, at

82.


with a lower tax rate.39 Likewise, the taxpayer reports a majority of the

expense from that transaction as expense attributable to the entity located

in a nation with the higher tax rate.40 As a result, the gross income from

the transaction is taxed at a lower rate than if the transaction was recorded

at an arm’s-length price.41

For example, assume a parent taxpayer (“Parent”), with its

subsidiaries (collectively, the “Company”), operates internationally,

manufacturing and selling widgets.42 The cost to manufacture the widget

is $50, the widget typically wholesales between unrelated parties for $100,

and the widget retails for $200. Parent’s manufacturing facility, belonging

to Sub-M, is located in Country M, which has a very high tax rate of 90%.

Parent’s retail facility, belonging to Sub-R, is located in Country R, which

has a very low tax rate of 10%. In the absence of regulations, the Company

may manipulate the appropriate transfer price by failing to charge the full

wholesale price for the transfer of the widget from Sub-M to Sub-R.

Assume, for example, that Sub-M charges Sub-R only half the appropriate

wholesale price, $50, for one widget. This means Sub-M would recognize

$50 of expense and $50 of income, equaling $0 of gross income taxed at

90%.43 Sub-R would recognize $50 of expense and $200 of income,

equaling $150 of gross income taxed at 10%.44 The total tax liability for

Sub-M and Sub-R would be $15.45 Accordingly, Country M would receive

$0 of tax revenue, and Country R would receive $15 of tax revenue.

Now, assume the same facts, with the exception that the

manufacturing entity and retail entity, respectively M-Co. and R-Co., are

unrelated.46 As unrelated entities, not manipulating the tax system, both

M-Co. and R-Co. will recognize the full and appropriate price for the

wholesale and purchase of the widget, $100. In other words, for the

manufacture and wholesale of one widget to R-Co., M-Co. would

39. See Paquette, supra note 21, at 134.

40. See id.

41. See id. Less tax expense will be paid on an amount of income subject to a lower tax

rate, compared to the same amount of income subject to a higher tax rate, assuming all

other things are equal. See Givati, supra note 6, at 142.

42. Please note, this example is very elementary and considers no domestic tax laws or

other international factors, including treaties. Further, this example assumes both nations

follow basic U.S. tax laws and operate in U.S. currency.

43. 26 U.S.C.A. § 61 (West 2014). Gross income, at its most basic level, is income

reduced by business expenses. $50 − $50 = $0.

44. See supra note 43 and accompanying text. $200 − $50 = $150.

45. 26 U.S.C.A. § 11 (West 2014). The tax liability is, at its most basic level, gross

income multiplied by the tax rate. $0 × 0.90 = $0. $150 × 0.10 = $15. $0 + $15 = $15 total

tax.

46. In other words, in this example there is no parent taxpayer and there is no collective

corporate group.


recognize $50 of expense and $100 of income, totaling $50 of gross

income taxed at 90%.47 For the purchase from M-Co. and retail-sale of one

widget, R-Co. would recognize $100 of expense and $200 of income,

totaling $100 of gross income taxed at 10%.48 The tax liability for M-Co.

and R-Co. would be $45 and $10, respectively.49 Accordingly, Country M

would receive $45 of tax revenue and Country R would receive $10 of tax

revenue. The total tax from this transaction, using an appropriate transfer

price, is $40 more than it was in our first example where the parties failed

to use an appropriate transfer price.50 From this scenario, it is evident that

when a corporation has the ability to shift its worldwide income without

restriction, the corporation can lessen its worldwide tax liability and has

significant fiscal incentive to do so.51

Given the obvious tax “savings,” multinational corporations may risk

engaging in a method of allocation where either no transfer price is

recognized or the transfer price used is less than arm’s-length.52 However,

if one or more of the taxing government agencies disagrees with the

chosen allocation, the corporation exposes itself to the possibility that each

governmental agency will disallow the taxpayer jurisdictional relief.53

That is to say, the corporation may be required to pay tax on the total

income earned from the transaction in both nations, which again results in

double taxation.54 The U.S. taxing authority is one that regulates the

method of allocation using the arm’s-length standard.

Section 482 of the Internal Revenue Code regulates transfer-pricing

rules in the United States.55 Its stated purpose “is to ensure that taxpayers

clearly reflect income attributable to controlled transactions and to prevent

the avoidance of taxes with respect to such transactions,” as exemplified

in the illustrations above.56 In order to affect its stated purpose, § 482

requires that intercompany transactions be made using an arm’s-length



49. See supra note 45 and accompanying text. $50 × 0.90 = $45. $100 × 0.10 = $10.

$45 + $10 = $55 total tax.

50. See also DOERNBERG, supra note 16, at 265. $55 − $15 = $40 tax difference.

51. Givati, supra note 6, at 142 (“By setting the transfer prices of international

transactions between related companies, income is shifted to the legal entity located in a

low tax rate jurisdiction, and tax payments are thereby reduced.”).

52. Paquette, supra note 21, at 134.

53. Id. (“[I]f either country audits, the countries may or may not agree on the transfer

price and, thus, on the income that should be taxed by a particular country. When countries

disagree because they apply transfer-pricing rules inconsistently, firms face the potential

for double taxation.”).

54. Id.

55. 26 U.S.C.A. § 482 (West 2014).

56. Treas. Reg. § 1.482-1(a) (2013).


standard.57 The arm’s-length standard, defined by the Internal Revenue

Code, requires a transfer price as if the parties to the transaction were

dealing with each other as independent or uncontrolled parties.58 In total,

there are six legally acceptable transfer-pricing methods for tangible and

intangible property.59 These methods include: (1) the comparable

uncontrolled price method,60 (2) the resale price method,61 (3) the cost-

plus method,62 (4) the comparable profits method,63 (5) the profits split

method,64 and (6) the comparable uncontrolled transactions method.65 The

Code of Federal Regulations provides that, “while there is no strict priority

of methods,” the method chosen should be that which “provides the most

reliable measure of an arm’s-length result.”66 A taxpayer should consider

legal factors, social and political factors, external economic factors, and

internal economic factors, in deciding the appropriate transfer pricing

57. INTERNATIONAL BUREAU OF FISCAL DOCUMENTATION, OECD TRANSFER PRICING

GUIDELINES FOR MULTINATIONAL ENTERPRISES & TAX ADMINISTRATIONS (2010 EDITION)

& TRANSFER PRICING FEATURES OF SELECTED COUNTRIES 730, 734 (Kamesh Susarla &

Antoine Glaize eds., 2012) (“Under § 482 of the IRC, tangible property, intangible

property, and services that are transferred (or where use is transferred) between related or

controlled parties must be priced on an ‘arm’s length’ basis.”).

58. Treas. Reg. § 1.482-1(b)(1) (2013).

59. Robert F. Reilly, Considerations in the Advanced Pricing Agreement Application

Process: Transfer Pricing Issues for Taxpayers, 81 CPA J. 22, 28 (2011).

60. Id. The comparable uncontrolled price method uses the transfer price of a

comparable product, from which the taxpayer can identify an arm’s-length price and make

appropriate, subsequent adjustments. Id. This method can only be used for tangible

property. Id.

61. Id. The resale price method uses the difference between the distributor resale price

to the distributor profit margin of a comparable product. Id. at 28–29. This method can

only be used for tangible property. Id.

62. Id. at 29. The cost-plus method uses the sum of the corporations’ cost to make the

product and an arm’s-length gross profit margin. Id. This method can only be used for

tangible property. Id. at 28.

63. Id. at 29. The comparable profits method uses “profit-level indicators” derived from

the transactions of similar, uncontrolled companies, applied to one or more profit margin

ratios. Id. This method can be used for both tangible and intangible property. Id. at 28.

64. Id. at 29. The profits split method allocates the gross profit or loss among the

controlled parties in a regulated fashion. Id. This method can be used for both tangible and

intangible property. Id. at 28.

65. Id. at 29. The comparable uncontrolled transaction method uses the transfer price

of comparable intellectual property, from which the taxpayer can identify an arm’s-length

licensing price and make subsequent, appropriate adjustments. Id. This method is used for

determining the arm’s-length price of intangible property only. Id. at 28.

66. Treas. Reg. § 1.482-1(a) (2013). At the same time, it has been suggested that the

Tax Court finds “discomfort with valuation methodologies that are heavy on finance theory

and light on taxpayer specific facts.” Paul M. Dau & John G. Ryan, The Tax Court Fires a

Shot Through the IRS’s Bow: Veritas Software Corp., INT’L TAX J., Mar. 2010, at 27, 27.


method.67 For example, in terms of legal factors, the taxpayer should

consider the shares of the local partnership;68 in terms of social and

political factors, the taxpayer should consider any religious or human

rights violations in the countries where the corporation operates;69 in terms

of external economic factors, the taxpayer should consider exchange rate

controls;70 and in terms of internal economic factors, the taxpayer should

consider the market shares of the corporation.71

Nevertheless, determining an arm’s-length price may be difficult,

especially for foreign entities.72 In the case of a foreign entity, there is often

important information missing to determine an appropriate arm’s-length

price, such as the best method for determining a transfer price.73 Further,

there is often little information to help foreign entities determine what

prices are normally charged by unrelated parties and to understand

industry-specific pricing standards.74 To make matters worse, even if

foreign entities fully understand third-party pricing, changes in such

pricing standards may require the foreign entity to implement similar

adjustments.75

If taxpayers fail to follow this requirement, § 482 authorizes the IRS

to “distribute, apportion, or allocate gross income, deductions, credits, or

allowances” between two or more organizations in order to prevent tax

evasion.76 And, if such failure results in an understatement of income tax,

the IRS may impose penalties totaling 20–40% of the misstated portion of

income.77 Such penalty may apply even if the taxpayer makes a good-faith

67. Doğan, supra note 2, at 737 (“The factors that affect determination of transfer

prices and selection methods in terms of parent corporations and subsidiaries are separated

into four groups; legal factors, political and social factors, external economic factors, [and]

internal economic factors.”).

68. Id.

69. Id.

70. Id.

71. Id. at 738.

72. Givati, supra note 6, at 142 (noting “the arm’s length principle is difficult to employ

in many cases due to the scarcity of comparable transactions, leading to frequent

controversy between taxpayers and tax authorities and significant uncertainty regarding a

corporation’s ultimate tax liabilities”); DOERNBERG, supra note 16, at 318.

73. Id.

74. Id.; see also ARNOLD & MCINTYRE, supra note 4, at 68 (“The difficulty arises in

part because unrelated corporations do not share comparable resources very often.”).

75. Alan Shapiro, Luis Coronado & Axel Nientimp, Post-Transaction Adjustments:

Managing Global Transfer Pricing While Reducing Ripple Effects, J. ACCT., May 2008, at

66, 66.

76. 26 U.S.C.A. § 482 (West 2014).

77. IBFD, supra note 57, at 746 (“In the case of a ‘substantial valuation misstatement,’

a penalty of 20% of the misstated portion is applied in addition to the adjustment by the


effort to comply with § 482.78 Moreover, even if a penalty is not imposed,

the taxpayer may still be required to forfeit millions in the case of a

settlement.79 For example, in 2006, GlaxoSmithKline Holdings

(Americas) Inc. paid $3.4 billion to settle a transfer-pricing dispute with

the IRS; the largest settlement in IRS history.80 Recently, companies like

Amazon, AOL, Adobe, Hewlett-Packard, and Microsoft have also made

headlines regarding transfer-pricing disputes with the IRS, concerning

sums “from tens of millions to upward of a billion dollars.”81

2. Why Regulate Transfer Pricing?

Nations regulate transfer pricing to address three primary concerns:

existing competition between taxing agencies, taxpayer manipulation of

the tax system, and equality among taxpayers.82 First, transfer pricing

“trigger[s] harmful competition at a global level among tax jurisdictions”

attempting to protect or increase their taxable revenue bases.83 Jose

Manuel Calderón labels this harmful competition a “global tax war.”84 He

argues that national taxing agencies have taken aggressive approaches to

protecting the tax bases from which they derive tax revenues.85 Such action

by one country harms the tax base of other countries and encourages

aggressive responses.86 If unregulated, transfer pricing is one mechanism

that contributes to this circular problem, building resentment among

nations.87

Second, transfer-pricing regulations aim to address improper taxpayer

manipulation.88 Such manipulation creates large tax gaps—estimated at

IRS. In the case of a ‘gross valuation misstatement,’ the penalty is increased to 40% of the

misstated portion in addition to the adjustment made by the IRS.”).

78. McKinley & Owsley, supra note 3, at 51.

79. See, e.g., id. at 52.

80. Id.

81. Id. at 51.

82. Eduardo Baistrocchi, Tax Disputes Under Institutional Instability: Theory and

Implications, 75 MOD. L. REV. 547, 552 (2012) (citing Harmful Tax Competition: An

Emerging Global Issue, OECD.ORG, http://www.oecd.org/dataoecd/33/0/1904176.pdf

(last visited 9 August 2011)). Taxpayer manipulation of the tax laws is often a means of

tax avoidance and, therefore, lessened tax revenue for the government. Id.

83. Id.

84. CALDERÓN, supra note 9, at 17–18.

85. Id.; see also, e.g., Lo & Wong, supra note 7, at 61 (“In summary, [in China] the

legislative framework for transfer pricing is continually being developed to resolve

ambiguous rule definitions, meet the government’s demand to collect adequate tax revenue,

and tackle tax evasion cases more effectively.”).


87. Id.

88. See Hickman, supra note 7, at 172–73.


$30 billion for the U.S. in 2001—for nations where the taxpayer is

allocating expenses, rather than income.89 For example, in 1990 the United

States reported that non-compliance with transfer pricing rules resulted in

lost government revenue of 100 billion U.S. dollars.90 Such revenues

would typically be used for both mandatory and discretionary government

spending, including Social Security, Medicaid, Medicare, and defense.91

Finally, transfer-pricing regulations aim to foster equality between

multinational taxpayers and solely domestic taxpayers, who cannot use

such tactics to avoid tax liability.92 Solely domestic taxpayers are unable

to shift income among entities located in countries with lower tax rates;

rather, the income earned by a solely domestic entity will be taxed fully at

the U.S. corporate rate.93

3. Emergence of the Advance Pricing Program

Early U.S. regulations attempted to address the problems with transfer

pricing; however, there proved to be glitches with the IRS’s traditional

means of enforcing related regulations.94 Critics have argued that pre-

existing statutes governing international tax were too complex, uncertain,

and ambiguous, resulting in wasted time and money for taxpayers and the

government.95

89. Jane Gravelle, The Corporate Income Tax: A Persistent Policy Challenge, 11 FLA.

TAX REV. 75, 89 (2011) (“The tax gap for corporations was estimated in 2001 at about $32

billion, or about fifteen percent of revenues at that time, but some authors estimate another

$30 billion of revenue was lost in international profit shifting.”).

90. CALDERÓN, supra note 9, at 19 (citing COMMITTEE ON WAYS AND MEANS, TAX

UNDERPAYMENTS BY U.S. SUBSIDIARIES OF FOREIGN COMPANIES, , H.R. REP. NO. 101-123,

pt. 3, at 10–12 (1990)).

91. Jonathan Schwabish & Courtney Griffith, The U.S. Federal Budget, CONG. BUDGET

OFF., http://www.cbo.gov/sites/default/files/cbofiles/attachments/budgetinfographic.pdf

(last visited March 31, 2014).

92. Baistrocchi, supra note 82, at 552 (noting “it provides a substantial advantage to

MNEs in comparison with non–multinational firms because only the former can use this

type of international tax planning strategy”).

93. Id.

94. CALDERÓN, supra note 9, at 21.

95. Id. at 20–21. “In the field of international tax, there has developed a national, and

even international consensus that traditional mechanisms for administering the law and

resolving disputes have virtually collapsed in the area of transfer pricing (which plays an

important role in allocating a taxpayer’s income among taxing jurisdictions).” Diane M.

Ring, On The Frontier of Procedural Innovation: Advance Pricing Agreements and the

Struggle to Allocate Income for Cross Border Taxation, 21 MICH. J. INT’L L. 143, 145

(2000) (citing U.S. GEN. ACCOUNTING OFFICE, GGD-95-101, INTERNATIONAL TAXATION:

TRANSFER PRICING AND INFORMATION ON NONPAYMENT OF TAX (April 1995),

http://www.gao.gov/assets/230/221228.pdf.


To address both issues with unregulated transfer pricing and

subsequent statutory confusion, the IRS established the APA Program in

March 1991.96 While the Program has grown substantially since its

inception, its purpose has remained the same.97 According to the IRS,

“[t]he APA Program’s central goal is the prompt, proper, and fair

resolution of APA requests and renewals consistent with the principles of

[a] sound tax administration.”98 Today, the APA Program is the most well-

known alternative dispute resolution procedure offered by the IRS.99

C. APAs Generally

1. What is an APA?

According to the APA Program website, an APA is an agreement

“between the IRS and a taxpayer by which the IRS agrees not to seek a

transfer pricing adjustment . . . for a covered transaction if the taxpayer

files its tax return for a covered year consistent with the agreed transfer

pricing method.”100 In other words, an APA is a private contract between

a taxpayer and the IRS, where the parties agree to the transfer price

assigned to the goods and services that move between entities within the

taxpayer’s corporate group. However, that is a simplified explanation; in

fact, there are several additional important characteristics of APAs that

taxpayers should understand.101 An APA is voluntary; although taxpayers

are always required to follow the provisions of § 482, they are not required

to participate in the APA Program.102 An APA may be unilateral, where

the only parties to the APA are the IRS and the taxpayer; bilateral, where

the parties to the APA are the IRS, the taxpayer, and a foreign taxing

authority; or multilateral, where the parties to the APA are the IRS, the

taxpayer, and two or more foreign taxing authorities.103 Finally, for 2013

the user fee for an APA request was $50,000 for large business

96. David J. Canale & Steven C. Wrappe, Advance Pricing Agreements – A Strategic

Tool in Global Transfer Pricing Management, 60 TAX EXECUTIVE 193, 193 (2008).

97. Id. at 205 (“In its seventeen years of existence, the APA Program has changed in

staff size, popularity, level of procedural formality, and experience. The basic opportunity

to achieve transfer pricing certainty in a non-adversarial forum, however, has not changed

substantially.”).

98. Rev. Proc. 2006-9, 2006-2 I.R.B. 482.

99. Nicholas Fiore, From the Tax Adviser: Alternative Dispute Resolution With the IRS,

J. ACCT., Feb. 1, 2000, at 92, 92.

100. INTERNAL REVENUE SERV., ANNOUNCEMENT AND REPORT CONCERNING PRICING

AGREEMENTS, (2008), http://www.irs.gov/pub/irs-drop/a-08-27.pdf.

101. See infra notes 102–106.

102. Reilly, supra note 59, at 29.

103. Canale & Wrappe, supra note 96, at 193.


taxpayers104 and $22,500 for small business taxpayers.105 Additional fees

are due in the case of amendment or renewal.106

2. Advantages and Disadvantages

Both the taxpayer and government seek several benefits from the APA

process. First, both parties aim to benefit from the reduced cost, which

comes in the form of time and money.107 Without the APA Program, each

party risks incurring more expensive costs related to audits and IRS

investigations, which may result in a traditional, adversarial transfer-

pricing dispute,108 itself taking over two years to close.109 Taxpayers may

also pursue an APA in order to gain certainty with the IRS’s position on a

given transaction and gain the purported guarantee from the risk of double

taxation—possibly saving hundreds of thousands, if not millions, of

dollars for the company.110 Moreover, if the taxpayer’s APA is approved,

this guarantees that the IRS will respect the transfer pricing method used

for tax reporting purposes.111 U.S. federal income tax certainty may extend

to certainty regarding the taxpayer’s SEC financial reporting

104. Rev. Proc. 2004-40, 2004-29 I.R.B. (noting a small business taxpayer “is any U.S.

taxpayer with total gross income of $200 million or less, as determined under section

4.12(1)(g)”).

105. Rev. Proc. 2006-9, 2006-2 I.R.B.

106. Id. The user fee for an APA renewal is $35,000. Id. Requests to amend a completed

APA require the taxpayer to submit an additional $10,000 user fee. Id.


108. Id. (“A major objective of the advance approval system is to reduce the high costs

that the taxpayers and the tax authorities typically incur in litigating disputes over transfer

prices.”); see also CALDERÓN, supra note 9, at 123 (“From an administration’s perspective,

the APA process reduces the use of government (and taxpayer) resources dedicated to

resolving transfer pricing issues.”); Canale & Wrappe, supra note 96, at 194–95

(Explaining that transfer pricing examinations require large amounts of both time and cost

from the taxpayer; however, the APA process typically results in both time and cost

savings).

109. James M. O’Brien & Mark A. Oates, Transfer Pricing: Why Is the Simultaneous

Appeals/Competent Authority Procedure So Unloved?, INT’L TAX J. 25, 26 (2011).

110. Canale & Wrappe, supra note 96, at 193 (“Historically, taxpayers have chosen to

pursue APAs to avoid transfer pricing uncertainty and freedom from exposure to double

tax and penalties.”).

111. Reilly, supra note 59, at 31 (“The APA application process can be demanding, but

it does provide substantial assurance that the IRS will respect the intercompany transfer

prices used by the taxpayer corporation.”); see also Rev. Proc. 2006-9, 2006-2 I.R.B..

(“The prospective nature of APAs lessens the burden of compliance by giving taxpayers

greater certainty regarding their transfer pricing methods.”). Note, however, that “[t]he case

[Veritas Software Corporation] is also interesting to the broader transfer-pricing

community in that it once again shows the Tax Court’s discomfort with valuation

methodologies that are heavy on finance theory and light on taxpayer specific facts.” Dau

& Ryan, supra note 66, at 27.


requirements.112 Finally, taxpayers enter into APAs because, by pursuing

an APA in the U.S., other nations may be more likely to respect the

outcome and give similar treatment to entities in their own foreign

jurisdictions.113 Other taxpayer objectives include simplicity of method,

specific tax result, and rehabilitation of the exam relationship with the

IRS.114

There are also disadvantages to APAs. For example, in the case of

many small multinational entities (“SMEs”) and individuals, the financial

resources required to pay APA fees and hire experts to help with the APA

process prohibits them from using the Program.115 To emphasize the effect

of this injunction, it is important to understand that SMEs comprise 97%

of all U.S. exports.116 Yet, as of 2010, SMEs having less than $200 million

dollars comprised only 10% of the IRS’s active APA cases.117

Additionally, in certain cases, the time to contract an APA can be over

four years,118 during which time the taxpayer may face lengthy

negotiations with the IRS, accrue substantial legal bills, and risk exposure

of previous years’ tax misstatements that result in additional undesirable

tax adjustments.119

112. Canale & Wrappe, supra note 96, at 193. However, while “intercompany

transactions are eliminated when consolidating the financial results of controlled foreign

corporations and their domestic parents, for tax purposes such entities are not consolidated

. . . , and the transactions are therefore not eliminated.” McKinley & Owsley, supra note

3, at 51.

113. Canale & Wrappe, supra note 96, at 193. (“[G]reatly increased global enforcement

efforts have encouraged both U.S.-based and non-U.S.-based MNCs to pursue APAs to

avoid examinations, or develop a representative arm’s-length outcome on a fact pattern

repeated in other countries.”).

114. Id. at 195–96. The APA process may help the taxpayer achieve certainty with a

simple transfer pricing method, which achieves an acceptable arm’s-length result, and

which the taxpayer can apply to other cross-border transactions. Id. Taxpayers may also

use the APA process to achieve a specific non-tax goal, such as compensation for

management. Id. at 196. Finally, the APA process may aid in restoring a positive

relationship between the taxpayer and IRS, especially where there exists previous, hostile

transfer-pricing disputes. Id.


116. Alistair M. Nevius, Advance Pricing Agreements for SMEs, J. ACCT., Oct. 1, 2010,

at 86, 86 (“In today’s global economy, small and medium-size enterprises (SMEs) compete

not only to make sales but to employ labor, consume raw materials, and obtain low-cost

capital. SMEs now comprise some 97% of all U.S. exporters and produce almost one-third

of all goods and services exported.”).

117. Id.

118. Lynnley Browning, The Tax break That Corporate America Wants Kept Secret,

FORTUNE, (July 22, 2013, 9:00 AM), http://finance.fortune.cnn.com/2013/07/22/irs-

corporate-tax-deal/.



D. Formation, Administration, and Enforcement of APAs

David J. Canale & Steven C. Wrappe divide the APA process into five

steps: (1) preparation and APA strategy; (2) pre-filing conference; (3)

preparing and filing the APA request; (4) evaluating, negotiating, and

drafting the APA; and (5) administration and renewal.120 The resulting

APA generally includes a description of “the controlled intercompany

transaction, the APA term, any analytical assumptions used, the taxpayer

records that must be maintained, and the taxpayer reporting

responsibilities.”121

Once the APA is approved, Revenue Procedure 2004-40 gives the IRS

discretion to enforce, revise, cancel, or revoke the APA if the taxpayer

fails to comply with any of its requirements.122 In the case that the IRS

audits the APA, the burden of proof falls on the taxpayer.123 The IRS also

has the administrative discretion to cancel an APA if it believes there to

be “misrepresentation, mistake as to a material fact, failure to state a

material fact, failure to file a timely annual report or lack of good faith

compliance.”124

In Eaton Corp. v. Commissioner of Internal Revenue, decided in June

2013, the United States Tax Court upheld the IRS’s administrative

discretion in cancellation of APAs.125 The IRS made an administrative

determination that Eaton had not complied with the terms of its APA.126

The IRS thereby canceled the APA and issued Eaton a notice, increasing

Eaton’s income allocation to the United States by over $350 million.127

The Tax Court held its only responsibility was to review the IRS’s decision

for abuse of discretion,128 while Eaton had the burden of showing that the

increased allocations were “arbitrary, capricious or without sound basis of

law or fact.”129 Absent a showing of abuse, the court found that the IRS

Commissioner had discretion to make an administrative determination to

cancel the APA, as reserved in the agreement and stated in applicable

revenue procedures.130 Finally, the court held that general contract



122. Rev. Proc. 2004-40, 2004-29 I.R.B. 482.

123. IBFD, supra note 57, at 744.

124. Id.

125. Eaton Corp. v. Comm’r of Internal Revenue, 140 T.C. 410 (2013).

126. Id.

127. Id.

128. Id. at 415. The IRS commissioner’s allocation under Section 482 must be sustained

absent a showing of abuse of discretion. Id.

129. Id. at 418 (citing Veritas Software Corp. & Subs. v. Comm’r, 133 T.C. 297, 318

(2009)).

130. Id. at 418–19.


principles did not apply to the Commissioner’s discretion to cancel

APAs.131 The result of Eaton demonstrates the potentially severe financial

impact a transfer-pricing dispute may have on a taxpayer, even after the

taxpayer has reached an agreement with the IRS.

III. ANALYSIS

Brian J. Arnold and Michael J. McIntyre specify four goals that are

important to a successful international tax system.132 For purposes of this

Note, I will address only the second goal—promotion of fairness. I find

fairness to be the most important goal in the case of APAs because, on its

face, the Program does not seem to promote equality among taxpayers.

Particularly interesting is the disparity the Program appears to create

between large, wealthy corporations and smaller, more financially-modest

corporations. Therefore, the question to be answered is whether the IRS’s

APA Program promotes fairness among taxpayers in the United States.133

A. Fairness in Tax Law

The United States Supreme Court has labeled the power to tax as an

inherent power of government.134 Like other powers of the U.S. federal

government, the ultimate authority of the IRS to tax is regulated by an

important constitutional norm: fairness.135 Fairness is, as a result, reflected

in several aspects of the tax system.136 For example, “[t]he decision to

adopt income as a tax base [in the United States] flows from a decision

about equity.”137 An income tax base is used because it is believed to

131. Id. at 419.

132. ARNOLD & MCINTYRE, supra note 4, at 4–5 (noting the four goals of international

tax rules include: (1) “getting its fair share of revenue from cross-border transactions,” (2)

“promoting fairness,” (3) “enhancing the competitiveness of the domestic economy,” and

(4) “capital-export and capital-import neutrality”).

133. Ring, supra note 95, at 189.

134. William B. Barker, The Three Faces of Equality: Constitutional Requirements in

Taxation, 57 CASE W. RES. L. REV. 1, 1 (2006) (citing Providence Bank v. Billings, 29 U.S.

(4 Pet.) 514, 563 (1830)).

135. Id. at 1–2 (“[T]he power to tax, like other government powers, is naturally

circumscribed by constitutional norms that define the relationship between government and

citizen. One such constitutional norm that is considered essential to a just system is

equality.”).

136. Or at least there is an attempt to achieve fairness in other areas of the U.S. taxation

system, such as state income tax and state property tax. See, e.g., Barker, supra note 134,

at 14, 18.

137. Kaufman, supra note 17, at 152.


distribute the tax burden in proportion with each taxpayer’s ability to

pay.138

On a more elementary level, fairness can be understood as important

to a tax system because it increases taxpayers’ morale and enhances

voluntary compliance.139 In an era of globalization, cross-border

transactions between businesses and individuals have become more

frequent, and competition among tax administration agencies for tax bases

and sources of revenue has increased.140 Because tax systems are widely

voluntarily, government revenue attributed to taxation significantly

depends “on taxpayers’ willingness and ability to comply.”141 Fairness is

recognized as an important goal of international tax rules because it serves

as a means of encouraging good-faith participation.142

138. Id.

139. Martinez, supra note 14, at 416 (citing Jonathan Skinner & Joel Slemrod, An

Economic Perspective on Tax Evasion, 38 NAT’L. TAX J. 345, 348–349 (1985); JOINT

COMM. ON TAXATION, 99TH CONG., GENERAL EXPLANATION ON THE TAX REFORM ACT OF

1986 7 (1986)); see also Barker, supra note 134, at 2 (“[E]quality might be perceived as a

logical outcome of a democratic order.”).

140. TAXPAYER ADVOCATE SERVICE, supra note 1, at 130 (citing U.S. Dept. of State,

Immigrant and Nonimmigrant Visas Issued at Foreign Service Posts FYs 2006 – 2010,

www.travel.state.gov/content/dam/visas/Statistics/FY10AnnualReport-Table1.pdf (last

visited MAY 24, 2015); Office of Immigration Statistics, Persons Obtaining Legal

Permanent Resident Status: FYs 1820 to 2010, DEPARTMENT OF HOMELAND SECURITY

(March 30, 2015), http://www.dhs.gov/files/statistics/immigration.shtm.) (“In fiscal year

2010 alone, approximately 6.4 million foreign individuals were issued nonimmigrant U.S.

visas, and 1.2 million aliens obtained legal permanent resident status.”). “An estimated five

million to seven million American citizens reside abroad.” Id. (citing Reaching Out to

Americans Abroad, IRS.GOV (Apr. 2009), http://www.irs.gov/Businesses/Reaching-Out-

to-Americans-Abroad; W&I RESEARCH STUDY REPORT, UNDERSTANDING THE

INTERNATIONAL TAXPAYER EXPERIENCE: SERVICE AWARENESS, USE, PREFERENCES, AND

FILING BEHAVIORS (2010)). “‘According to the Small Business Administration, from 2003

to 2010, U.S. small businesses’ exporting activity increased about 80 percent to account

for nearly $500 billion in annual sales and about 30 percent of America’s export

revenues.’” Id. (citing Karen Gordon Mills, Administrator of the U.S. Small Business

Administration (SBA), Taking Your Small Business Customers International, U.S. SMALL

BUSINESS ADMINISTRATION (Oct. 15, 2010), https://www.sba.gov/content/taking-your-

small-business-customers-international).

141. TAXPAYER ADVOCATE SERVICE, supra note 1, at 129.

142. ARNOLD & MCINTYRE, supra note 4, at 4; see also TAXPAYER ADVOCATE SERVICE,

supra note 1, at 178 (“Voluntary compliance also depends on the fairness of tax

administration, where service options are easily available and affordable for those making

a good faith effort to comply.”). Note that voluntary compliance refers to compliance even

if it indirectly results from enforcement mechanisms. Id.


For taxation purposes, fairness means an equal tax for taxpayers with

the same income.143 Where there is a multinational corporation, the

corporation’s worldwide, aggregate income should be taxed the same as a

similarly-situated, single-entity corporation.144 It would be unfair to other

taxpayers, for example, if multinational corporation A earned income in

both countries Y and Z, yet the total tax imposed by Y and Z amounted to

a tax on less than A’s total, worldwide income.145 Likewise, it would be

unfair to A if Y and Z each imposed a tax on A’s total, worldwide

income.146

While sometimes an unfair outcome is the direct result of tax imposed,

it may also result when taxpayers are not afforded equal administrative

resources, such as IRS services, to adequately comply with tax rules.147 In

the U.S., administrative resources can serve to mitigate the otherwise

complex and highly technical requirements and limitations of international

tax policies.148 Administrative inequality can mean either that the taxpayer

pays more tax than another taxpayer in a similar situation or the taxpayer

pays less tax and faces harsh penalty.149

B. Fairness in the Case of APAs

Despite the significance of fairness in the taxing system,

administrative restraints in the APA Program may jeopardize this

constitutional norm.

1. Cost to Participate

The cost to participate in the U.S. APA Program may prevent some

taxpayers from participating.150 As previously discussed, the initial APA

user fee ranges from $22,500151 to $50,000, depending on the size of the

143. ARNOLD & MCINTYRE, supra note 4, at 4–5 (“Fairness is achieved by imposing

equal tax burdens on taxpayers with equal income, without reference to the source of

income.”).

144. Id. at 5.

145. Id. (“For domestic taxpayers operating abroad, fairness requires the full taxation of

both domestic and foreign-source income; moreover, foreign-source income must be taxed

whether the income is earned directly or through some foreign entity.”).

146. Id. The result would yield what is commonly known as “double taxation.” Id.

147. See Ring, supra note 95, at 196–97.


149. Id. at 129. Due to regulatory confusion, “[a] recent IRS study of taxpayer needs and

preferences showed that international taxpayers may have a greater current need for IRS

services that the general taxpayer population.” Id.


151. Rev. Proc. 2006-9, 2006-2 I.R.B.


corporation.152 While the IRS recognizes that “small business taxpayers

have lesser transfer pricing experience and resources,”153 this fee requires

all entities having zero to $200 million of income to pay $22,500.154 Such

a grouping essentially equates an international corporation grossing only

$100,000 of income, for example, to a corporation grossing $150 million

of income.155 Each must pay the same fee to receive access to the same

service.156 In some cases, these costs “can be significant enough to

discourage [taxpayer] participation.”157 The effect of these costs is evident

in data published by the IRS.158 Of the 1,155 APAs entered into since

1991, “[t]he biggest users are financial services companies with large

cross-border trade, and technology and pharmaceutical companies.”159 As

mentioned previously, note also that in 2010 only 10% of the IRS’s active

APA cases involved SMEs grossing income less than $200 million.160

2. Specific Tax Result

Still another concern regarding fairness is that participating taxpayers

may achieve a specific tax result by entering into an APA.161 Taxpayers

who can afford the cost of entering into an APA also have the unique

opportunity of receiving the IRS administration’s expertise and

negotiating the terms of the APA.162 Meanwhile, non-participating

152. Rev. Proc. 2004-40, 2004-29 I.R.B.

153. TAXPAYER ADVOCATE SERVICE, supra note 1, at 169. The IRS also recognizes that

the size of the corporation or dollar value of transactions does not necessarily dictate

complexity. Id.

154. Id. Note, this number excludes the cost of amendments and renewals, as well as

any internal costs accrued in connection with compliance.

155. Ring, supra note 95, at 194 (“[D]ifferential participation poses concerns for

horizontal equity to the extent that there seems no relevant distinction between larger and

smaller taxpayers.”).

156. Id.

157. Id. at 194–95 (“For example, if the conclusions reached in APA negotiations with

taxpayer A are not disclosed or are disclosed in a fairly limited form, then taxpayer B who

does not seek an APA may receive different treatment than taxpayer A through the process

of audit, appeal and litigation . . . . If taxpayer B could have sought an APA but simply

chose not to, the subsequent discrepancies might not imply unfairness. But, if we believe

that taxpayer B may have valid reasons for not pursuing an APA (e.g., cost, limited internal

resources, operations in a nontreaty country), then we may be particularly concerned about

different outcomes”).

158. Browning, supra note 118.

159. Id.

160. Nevius, supra note 116, at 86.


162. CALDERÓN, supra note 9, at 126; see also Ring, supra note 95, at 173 (“Moreover,

having the APA discussion in advance may enable a taxpayer to shape the transfer pricing

rules it faces. Where a current rule is very unclear, or in the extreme, prohibits a desired


taxpayers are forced to muddle through the tax rules with no one-on-one

guidance. This may produce uncertainty, and result in lengthy tax audits,

appeals, and litigation,163 which amount to large administrative and legal

expenses.164

The specific result afforded to taxpayers participating in the APA

Program can be viewed as allowing the taxpayer to “contract” the specific

terms of the taxpayer’s tax regime. For example, an attractive feature of

the APA Program is the opportunity of “roll-back,” which allows the

taxpayer to retroactively apply the transfer pricing method, affording them

the benefit of increased tax relief.165 For example, in 2013, Oracle,166 a

multinational corporation with $13.9 billion in pre-tax income, was taxed

at a 19% tax rate—16% below the standard 35% corporate tax rate.167 No

similar opportunity is afforded to non-participating taxpayers. In other

words, taxpayers unable to pay the user fee must pay the full 35% tax

imposed.168 The IRS argues, however, that “‘APAs won’t either increase

or reduce companies’ tax bills—instead, an APA will achieve the same

result that a company would have reached after audit and possible

litigation, but without all of the uncertainty and transaction costs.’”169

result, the taxpayer’s ability to discuss and negotiate on the point before it decides to engage

in the transaction is very much like negotiating with the Service for a particular rule to be

applied prospectively.”).

163. CALDERÓN, supra note 9, at 126 In the case of an adversarial transfer-pricing

dispute, if the taxpayer chooses to first protest to the IRS Appeals, the appeals process may

take two or more years to close. O’Brien & Oates, supra note 109, at 24. If the taxpayer

chooses to first litigate the dispute in the U.S. Tax Court, a final opinion may take three to

five years. Id. at 26. On the other hand, in 2007, the average time to reach a unilateral APA

and bilateral APA was 16 months and 17 months, respectively. Canale & Wrappe, supra

note 96, at 195.

164. Ring, supra note 95, at 171–72 (noting “substantial transaction costs in terms of

lawyer and accountant fees, internal resources, as well as the lost opportunity to modify or

change the transaction”).

165. CALDERÓN, supra note 9, at 66 (“APA roll-backs constitute one of the most

attractive opportunities provided by the APA procedure. This is true to the extent that some

taxpayers negotiate the APA mainly in order to obtain a roll-back. The Revenue Procedure

96-53 has recently enhanced the taxpayer’s possibilities of applying the APA [transfer

pricing method] to tax years prior to those covered by the APA roll-backs.”).

166. Oracle is a hardware and software company. Oracle Fact Sheet, ORACLE (Sept.

2014), http://www.oracle.com/us/corporate/oracle-fact-sheet-079219.pdf.

167. Browning, supra note 118.

168. Rev. Proc. 2006-9, 2006-2 I.R.B.

169. Browning, supra note 118 (quoting Michael Durst, former director of IRS APA

program).


Additionally, non-participating taxpayers are not given access to the

negotiations, terms, or analyses of issued APAs.170 Rather, APAs, and the

provisions therein, are not published due to taxpayer confidentiality

laws.171 This will almost definitely result in different tax treatment for

taxpayers in similar situations.172 For instance, non-participating taxpayers

will be unable to predict any leniency the IRS gives APA users when

interpreting the Internal Revenue Code, and as a result, non-participating

taxpayers will be forced take more conservative approaches when

calculating their own tax liability.173 Alternatively, small non-participating

taxpayers may be forced to shell-out large sums of money to employee

professionals to properly interpret and advise on information that,

arguably, “should be freely available to everyone.”174

3. Failure to Comply

Lastly, the fairness issue is also illustrated by the penalties imposed

on taxpayers who fail to comply with international tax policies. This issue

was recently highlighted in the 2011 Annual Report to Congress175

published by the Taxpayer Advocate Service (the “TAS”), an independent

organization within the IRS, responsible for ensuring that fairness is

afforded to all taxpayers.176 One of the most serious problems noted by the

TAS was that “the IRS’s international tax administration strategy has

focused on stepped-up enforcement without adequate coordination or a

corresponding increase in service to international taxpayers.”177 Such lack

of coordination has created trouble for U.S. taxpayers who—intentionally,

or, more importantly, unintentionally—fail to comply with complex

information reporting requirements. These taxpayers may be forced to pay

170. Hickman, supra note 7, at 190 (citing Peter J. Meadows & William A. Dobrovir,

Who Killed Guidance?, 96 TAX NOTES TODAY 201, 245 (1996)); see also Browning, supra

note 118.

171. 26 U.S.C.A. § 6103 (West 2014) (“Returns and return information shall be

confidential[.]”).

172. Hickman, supra note 7, at 190. Further, it is likely that this secrecy is breeding

grounds for suspicion, public distrust, and corruption. Joseph J. Thorndike, Historical

Perspective: APA Program Highlights IRS Struggle to Balance Privacy and Secrecy, TAX

ANALYSTS (Feb. 3, 2004),

http://www.taxhistory.org/thp/readings.nsf/ArtWeb/A3E959D0325F3CDF85256E43007

3ABF7?OpenDocument.

173. See, e.g., Hickman, supra note 7, at 190.

174. Thorndike, supra note 172.

175. TAXPAYER ADVOCATE SERVICE, supra note 1.

176. Taxpayer Advocate Service, INTERNAL REVENUE SERVICE,

http://www.irs.gov/Advocate (last visited March 31, 2014).



large penalties that are disproportionate to the actual tax liability due.178

TAS highlighted further that “lack of efficient IRS-wide coordination of

international taxpayer service may undermine international enforcement

initiatives and discourage future compliance by taxpayers . . . .”179 In

response to the report, the IRS recognized that it needed to increase

administrative coordination for international taxpayer services and

contends it is working with W&I Research & Analysis to identify specific

problems.180

C. Resolution

Due to the ongoing “tax war,” globalization “can have an adverse

impact on [governments’] sovereign power to impose fair and efficient

taxes.”181 Some scholars suggest tackling the “global tax war” head-on by

creating a completely new institution for dealing with transfer pricing on

an international level: “an informal forum for coordination between

countries sharing similar interest.”182 This type of international forum

presents several potential advantages including: suppression of

undesirable aims by taxpayers and nations, existing countermeasure

against domestic political pressures, and promotion of efficient and

effective policy choices.183 However, while this new institution may

address competition among nations and foster a uniform tax system, it

does not guarantee equal domestic treatment of all taxpayers. Moreover,

because complete fairness cannot be achieved without the combined effort

of worldwide taxing agencies,184 this solution may not be easily feasible.

To address the problem now, the U.S. can begin to create a fair system

by taking effective countermeasures,185 such as promoting fairness within

its own domestic policies.186 Here, the APA Program can advance the

178. Id. at 191.

179. Id. at 176.

180. Id. at 183–84.


182. H. David Rosenbloom, Noam Noked & Mohamed S. Helal, The Unruly World of

Tax: Proposal for an International Tax Cooperation Forum, 15 FLA. TAX REV. 57, 58

(2014).

183. Id. at 84.

184. ARNOLD & MCINTYRE, supra note 4, at 143 (“In the global economy, a wholly

unilateral approach to tax policy is obsolete, counterproductive, and ineffective.”); see also

id. at 6 (“The fairness and efficiency of income taxation ultimately depends not on the

income tax laws of any one country but on the cumulative effects of the income tax laws

of all countries.”).

185. Id. at 143.

186. Id. at 142. (“[Cooperation may be achieved by] contributing to the development of

fair and appropriate international tax standards, by imposing tax burdens that are consistent


fairness objective by addressing the disparity between large, wealthy

corporations, and small, financially-modest corporations and individuals.

As the TAS suggests, it may be beneficial to modify the APA Program

to provide similar consulting services, subject to reduced user fees, for

taxpayers with assets of $10 million or less.187 The IRS may consider

assessing user fees in direct proportion with the taxpayer’s gross income.

Such an approach will mirror the fairness objective of the ability-to-pay

approach taken with the U.S. federal income tax.188

The IRS may also consider publishing all issued APAs after rescinding

all potentially sensitive information. This was the argument made by the

Bureau of National Affairs (BNA) in a previous suit against the IRS.189

The BNA argued that APAs constitute written determinations and

therefore are governed under § 6110, rather than § 6103.190 Publication of

APAs would benefit taxpayers who cannot participate in the Program due

to high user fees, by giving them access to the IRS’s analyses and methods

used and alleviating the potentially considerable expense of their

compliance.191 Congress has since enacted legislation that classifies the

APA return information under § 6103,192 thereby enforcing the practice of

not publishing APAs due to confidentiality laws. Yet, the potential

benefits to publishing APAs remain valid, and it has been suggested that

Congress and the IRS should reconsider their position.193

Regardless of the solution adopted by the IRS, most critics still

recommend that all taxpayers—or at least most SMEs operating in the

global market—make an effort to informally participate in the APA

application process.194 This will provide at least some level of assurance

that the taxpayer has complied with U.S. and foreign tax laws and

with these standards, and by otherwise cooperating with foreign countries in the assessment

and collection of tax on their residents and nationals.”).


188. Offer in Compromise, INTERNAL REVENUE SERV.,

http://www.irs.gov/Individuals/Offer-in-Compromise-1 (last updated Apr. 2, 2015).

189. Hickman, supra note 7, at 174 (citing BNA Complaint Demanding APAs, 96 TAX

NOTES TODAY 42–33 (1996) (publishing BNA’s original complaint under IRC § 6110);

IRS Issues Final Denial of Tax Analysts’ FOIA Request for APAs, 12 TAX NOTES INT’L

1929, 1929 (1996) (reporting BNA’s amendment to its complaint adding a claim for release

of the information under FOIA)).

190. Id.

191. Id.

192. John L. Abramic, Advance Pricing Agreements: Confidential Return Information

or Written Determinations Subject to Release?, 76 CHI.-KENT L. REV. 1823, 1824 (2001)

(citing Tax Relief Extension Act of 1999, Pub. L. No 106-170, § 521, 113 Stat. 1860, 1925–

27).

193. See generally id.

194. Nevius, supra note 116, at 86.


potentially limit the taxpayer’s tax exposure.195 Further, this process will

provide taxpayers with greater certainty as to the appropriateness of their

transfer price, mitigating the risk of audit and potential for litigation.196 If

this extent of due diligence is not feasible, even taking the preliminary

steps to consider obtaining an APA may be helpful to taxpayers unable to

fully participate in the Program.197

IV. CONCLUSION

Because international income shifting has previously resulted in

upwards of $30 billion of lost revenue for the U.S. government,198 it is

understandable that the IRS wants to protect its revenue base by

encouraging taxpayers to voluntarily enter into agreements that regulate

transfer prices. APAs seem to do just that.199 However, an analysis of the

APA Program reveals that it has some flaws, particularly in regard to

equity.

Equity or fairness is a rudimentary objective that should not be

forgotten at the international level.200 As discussed, fairness means not

only a fair tax imposed,201 but also fair administration.202 In other words,

for fair administration, all taxpayers should be given access to the same

resources so they can better abide by the tax laws.203 As a result of this

objective, taxpayers are more willing to voluntarily comply with tax laws,

resulting in an increase of voluntarily-forfeited tax revenue for the U.S.

government.204

For the aforementioned reasons, the U.S. government should consider

structuring the APA Program so it is available to all taxpayers.

Specifically, the IRS should focus efforts on making the Program more

affordable for SMEs and individuals,205 publishing specific tax results

195. Id.

196. Marianne Burge, Marylouise Dionne & Kenneth Kral, IRS Agreement on Transfer

Pricing Now Possible, 171 J. ACCT. 23, 23 (1991).

197. James G. Collins, Small and Medium Enterprises Should Consider Making

Advance Pricing Agreements, 41 TAX ADVISER 679, 680 (2010).

198. See supra note 89 and accompanying text.

199. See supra notes 100–114.

200. Kaufman, supra note 17, at 182 (“Whether it is equitable for a particular country

to impose its tax on the worldwide incomes of its taxpayers and to determine the identities

of those taxpayers by its own domestic standards is a matter of international significance.”).

201. See supra notes 143–146 and accompanying text.


203. Id.




reached by the APAs of participating taxpayers,206 and lessening the

penalties imposed on taxpayers who make a good-faith effort but fail to

comply with existing transfer pricing regulation.207 Several solutions exist

to address these areas of focus.208 Regardless of which solution the IRS

pursues, it is important that APAs be made more readily accessible,

thereby increasing fairness afforded by the current APA Program. If the

IRS focuses on making the APA Program fair in this respect, not only will

it benefit the U.S. taxpayers, but it will also serve as a means for fighting

the “global tax war.”209





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