Healthy US 2023 APA Statistics: benefits of tax certainty

Positive UK implications from the latest IRS APA statistics showing a record number of APAs executed by the IRS. UK in the top five partners

Positive UK implications from the latest IRS APA statistics showing a record number

On 26 March 2024, the US Internal Revenue Service (IRS) Advance Pricing and Mutual Agreement (APMA) Program issued its latest annual report for the 2023 calendar year providing insights on advance transfer pricing agreements (APAs). Headlines include that 167 new APA applications were filed in 2023 with (in a very positive sign) a record 156 executed APAs, of which 130 were bilateral (also a record number) and two multilateral. Whilst this record number appears to include some post-Covid bounce-back effect, this latest report has positive implications for those interested in applying for a UK/US APA. The US is by far the UK’s largest trading partner in terms of exports and imports of goods and services and in our view, this treaty partner APA relationship has the potential to go from strength to strength in the coming years with an increased number of UK/US bilateral APAs (BAPAs) and multilateral APAs expected.

The IRS APA program is very long-established and a lot of continuity and stability can be seen in many aspects of the APMA statistical reporting, with Japan being consistently the main IRS APA counterparty. Closer to home though, the IRS statistics reinforce our view that the UK is likely to be an ideal European counterparty to select for a BAPA with the US. This is because there is no arbitration available under the UK/US double tax treaty and our experience is that APA processes between the UK and US generally work well and reliably deliver the certainty sought. Italy is the other counterparty where the recent signs are encouraging based on the number of executed US/Italy BAPAs reported.

Whilst the 43.7 month average (a small decrease on the 2022 figure) time taken to complete bilateral APAs may reduce the appeal of bilateral APAs for some, we have seen APAs agreed significantly quicker than this. It is also important to look at the time taken in the context of the complexity of the issues that APAs are addressing and the cost and time taken for audits followed by litigation and/or mutual agreement procedures. The IRS statistics show that the IRS often agrees to extend APAs beyond five years to ensure a reasonable amount of prospectivity in the APA term and we see this from HMRC too. The average term for US APAs executed in 2023 was six years, but 47 APAs had a term of seven years or greater.

What’s more, we expect the time taken for bilateral APAs to come down as the impact of delays from the Covid pandemic dissipate and the publishing by the OECD of APA statistics by the Inclusive Framework from 2024 onwards has a positive effect.

Another encouraging indicator from the US APA statistics is the significant number of renewals which implies a positive experience from the returners to the process.  45 percent of the bilateral APAs executed in 2023 were renewals. The IRS has also been strengthening its APMA team by increasing the number of experienced managers and economists in the team.

Within the IRS report is also a model APA (found in Appendix 1) and guidance on approaches to some of the issues and features of the businesses involved. This is well worth a read for anyone considering applying.

Why do we expect demand for UK/US APAs to grow?

Essentially this boils down to:

  1. Changes in the international tax landscape;
  2. Greater tax authority enforcement activity and associated audit risks; and
  3. Established APA programs in the US and UK that have proven effective in delivering tax certainty.

We have expanded on areas 1 and 2 below. 

Changes in international tax landscape: BEPS 2.0

Pillar Two will put an even greater premium on tax certainty because it raises the stakes considerably on getting transfer pricing right in the accounts the first time.  In this regard, the established willingness of the IRS and HMRC to agree APAs with a term test, that is testing the outcome over the whole APA term rather than year-by-year, could be very attractive in light of BEPS 2.0, particularly for cyclical industries and those where the timing of investments and pay-offs varies.

The scope and practical application of Amount B looks increasingly like it will be very narrow, missing many key industrial growth areas (e.g. digital goods and services), and under delivering on hoped for improvements in tax certainty and administrative burden for those potentially in scope.

Heightened US audit risk

The IRS has been investing in its TP resources and use of technology. With this investment we expect a more assertive IRS – a recent example being the nudge campaign targeted at 180 inbound distributors.

It is also the case that the pendulum swing on the IRS enforcement of TP penalties increases the value of getting certainty up-front.

Heighted UK audit risk and other developments in HMRC’s approach

HMRC’s interpretation of the OECD Transfer Pricing Guidelines risk control and DEMPE frameworks poses risks for US multinationals with senior leaders in the UK rewarded on a cost plus basis. As explained in our previous article, new HMRC guidance published earlier this year has reinforced their stance and we are seeing more UK audits on this area building upon a key focal point of HMRC’s Profit Diversion Compliance Facility.

HMRC is upping the ante on UK TP compliance with new mandatory documentation requirements now in force and expected to be followed by a detailed set of practical guidelines for compliance, whilst a Summary Audit Trail requirement remains under consideration. 

As we reported last year, updated HMRC APA guidance made it important to apply for an APA before a UK audit starts if it may be warranted (a UK audit now prevents an APA application). This reinforces the importance of businesses developing a proactive strategy for managing transfer pricing risks including the role of APAs within it.

There is also clear growth potential with most large UK businesses not yet having certainty on transfer pricing for their US transactions. Of circa 1,000 businesses whose tax affairs are handled by HMRC’s Large Business Directorate, we estimate no more than five percent have UK/US APAs at this point.

If you would like to learn more about our experience with UK/US APAs, or to discuss APAs or Transfer Pricing audit readiness options more generally, please reach out to one of the authors or your usual KPMG in the UK contact.