Advance Pricing Arrangement

As a special tax system arrangement, Advanced Pricing Agreement (APA) has been proved positive and innovative in dealing with transfer pricing issues by practices during past 20 years. APA focuses on cooperation between relevant parties to solve international tax disputes in a non-resisting way. It is definitely valuable both theoretically and practically to achieve long-term win-win situation for tax authority and taxpayers based on coordination and compromise.APA was generated due to difficulties in dealing with transfer pricing issues of multinationals. Based on current research and practices, this paper makes an in-depth analysis on APA from a point of view of rationality: it proves that APA is a mechanism in which balanced tax interests are achieved through gaming among multiple interest subjects, and it is also a new concept in international tax administration based on coordination and cooperation between taxpayers and tax authorities after appropriate compromise. This paper consists of six chapters: Introduction, multinationals and related transactions, APA and its theoretical basis, analysis on special issues and solution to international tax disputes through cooperation.Chapter 1 Introduction Transfer pricing mechanism has been introduced and improved in the past 30 years due to the rapid expansion of multinationals who own, control and dispatch production factors in the whole world through its subsidiaries or branches to maximize their profits. With their development, internal division of labor in these multinationals has been more and more sophisticated with business model being increasingly complicated and business scope being diversified, leaving vertical integration of the business. Multinationals lead the trend of internalization by saving transaction costs and avoiding incomplete middle products. Internalization is featured by internal control rather than market rules. Internal transaction pricing among the associated enterprises of a multinational is transfer pricing which has become an essential regulatory mechanism and a tool for multinationals to maximize their group interests through factitious control.Chapter 2 Multinationals and Related Transactions Transfer pricing is used by multinationals for the sake of their business strategy to expand market, allocate resources rationally, avoid foreign exchange risks and avoid tax, etc. Although it does not top the list, tax avoidance distorts taxation of relevant jurisdictions: on one hand, it reduced force of tax law since tax base is eroded by "control on price", leading to loss of tax interests and failure to implement tax law; on the other hand, transfer pricing causes imbalance of interests among different subjects. Normal taxation regulations and fair competition are breached by abuse of transfer pricing, therefore, tax mechanism on transfer pricing has been introduced in internal tax law by many countries.Arms-length principle is the core of tax mechanism on transfer pricing, namely, transactions between associated enterprises should be priced according to the arms-length transactions between independent enterprises, otherwise tax authorities are entitled to make adjustments.Two major means of TP (transfer pricing) adjustments are available: one targets to the price adjustments including comparable uncontrolled price method, resale price method and cost-plus method; the other focuses on comparable profits based on profit adjustments including comparable profit method, profit split method and transactional profit method. The former is very demanding on comparability and price information which is very difficult to obtain in reality due to lack of totally comparable enterprises and prices; by contrast, the later requires a reasonable range of price which is available from years of data and financial index of an enterprise, it is therefore used to target enterprises producing multiple products with complicate functions and extensive coverage of business. Being the most commonly used method by countries in making adjustment, profit method should not be abused to decide adjusted profit without careful consideration.TP adjustment is very demanding and time-consuming, requiring tax authorities and taxpayers to spend huge energy and auditing cost. It is possible to lead to double taxation, disputes of taxpayer, even tax disputes between countries. APA is therefore introduced as a supplementary mechanism for TP system.Chapter 3 APA and Its Theoretical Basis APA embodies a new and modern relationship between tax authority and taxpayer. Traditionally, tax authority imposes tax as an organization of power on behalf of a state, leaving legal rights of taxpayers neglected. APA is a mechanism to which taxpayer applies and provide information to negotiate and cooperate with tax authority for balanced interest and final agreement. It therefore contributes to equality between the two.APA means that taxpayers involved in associated transactions reach agreements with tax authorities before the controlled transactions in terms of pricing standards, including methods, comparability, suitable adjustments and key assumptions, aiming to decide the pricing method for associated transactions in a period of time in the future (usually 3-5 years). Three levels are introduced to interpret meaning of APA: at the primary level, APA is interpreted as a method of TP adjustment in advance; at the middle level, it is interpreted as an agreement between tax authority and taxpayer case by case, not applicable in other cases, but the procedure and nature of agreement is the same; at the high level, it is referred as a whole of regulations and arrangements, including legislation, law enforcement and jurisdiction. Strict law protection must be at place to realize the aim of APA. It is important to understand APA from the above-mentioned three levels because a legal foundation could be available to apply APA in a lower stage of law framework when laws concerning APA have not yet been sound in many countries.Introduction of punitive provision is the major reason for taxpayers to accept APA. Two major reasons that two parties accept APA have been established by the previous studies: for tax authority, TP problems could be solved more effectively, and for taxpayer, risks of being investigated and high cost in audit could be avoided. This paper stands that the most important driving force for taxpayers to accept APA is punitive provisions since all the countries do not include punitive measures prescribing tax avoidance as illegal in their tax law drafting, instead, it only requires taxpayer to pay the overdue tax. This means that multinationals do not have extra tax risks to avoid tax by TP: they will benefit from tax avoidance if tax authority does not audit and make adjustment, and they're only required to pay the overdue tax even after audit. As more strict measures against TP being taken by countries, taxpayers have higher risks in avoiding tax through TP because they must pay the overdue tax and be fined heavily. It is worth noticing that this kind of fine is not in its traditional means, rather it is default interest, namely, a fee for taking up tax. Different punitive measures have been made in different countries, and they became a direct driving force for taxpayer to choose APA.APA is classified into two types based on types of subjects: unilateral APA and bilateral (multilateral) APA. The former, having taxpayer and tax authority of one country as its subjects, is relatively easy to be accessed but cannot help taxpayers to avoid risks of double taxation. The later has its subjects as taxpayer and tax authorities from at least two contracting states of tax treaties, this is the prerequisite to initiate mutual agreement procedure and apply APA. Access to the bilateral (multilateral) APA is poor due to time consumed and procedure required. Advantages of APA are as follows: taxpayers can clearly know their future tax burden before arranging their business; bilateral (multilateral) APA can help taxpayer to avoid double taxation; information is transparent, saving tax authorities from collecting information on business of taxpayers and taxpayers from being audited; a mechanism of cooperation and negotiation is provided to solve tax issues. However, it is not yet a perfect system due to the following shortcomings: first, unilateral APA can not save taxpayer from double taxation; second, APA is still time-consuming and relatively inefficient thanks to its procedures; second, without powerful information sharing and exchanging system, APA will be a legal "mask" for corruption and tax law breach since information collection is a key stage in APA; finally, APA will cause reverse choice. But APA, bilateral (multilateral) APA in particular, is the second best choice before a best one is introduced in order to solve TP caused disputes and protect legal tax interest of relative countries.Chapter 4 Ruling of APA Following principles should be followed in APA negotiation: arms length principle, principle of voluntaries, principle of being pragmatic, principle of honest and credibility, principle of binding effects on two parties, principle of secrecy, etc. Reaching APA depends on information preparation to a large extent. Tax authority is obligated to keep secrecy of information offered by taxpayer to ensure legal interest of taxpayers.As far as its legal nature is concerned, unilateral APA has the nature of contract within the framework of internal law, adjusting relations between internal tax authority and taxpayers of a country. Bilateral (multilateral) APA belongs to international law to adjust relations of international taxation between contracting states.APA is consistent with basic taxation theory since it emphasizes on searching for a fair solution to TP issues based on cooperation and negotiation with principles being followed, maintaining the essential attribute of taxation of being gratuitous, fixed and mandatory. Taxpayer's obligation is not exempted due to APA, which only defines pricing methods for associated transactions. APA embodies the principles of neutrality, efficiency and equality.APA is featured by its procedure innovation. It is a special mechanism in taxation system to agree on TP method applied to associated transactions by taxpayers in advance and impose tax accordingly. Three stages are necessary to achieve APA including preparation, negotiation and implementation, and five steps are required during the last two stages, namely, preparatory meeting, formal application, investigation and assessment, negotiation and signature, and tracking management. Disputes in unilateral APA could be solved through administrative reviews or administrative proceedings, while bilateral (multilateral) APA disputes are solved through mutual agreement procedure.Provision of information and documents is essential in APA because it is the basis for consideration and analysis to determine a reasonable pricing range, and therefore taxpayers are required to cooperate by providing simultaneous documents timely and accurately concerning its business running and financial information, and even prove that their TP methods are consistent with Arms length principle if necessary.Different countries require differently concerning provision of simultaneous documents, but this basically falls into four types: (1) simultaneous documents and proof of registered accountants; (2) required simultaneous documents should be submitted along with annul tax returns or when tax authority requires; (3) tax authority encourages taxpayers to prepare documents; (4) limited simultaneous documents preparation should be submitted.Both tax authority and taxpayer are required to abide by their obligations and rights to ensure smooth implementation of APA. Rights of taxpayer in unilateral APA are: application, withdrawal from negotiation, proposal of holding preparatory meeting, demands on retroactivity, demands on renegotiation, proposal on reasonable adjustment, suggestion on drafts made, demands on secrecy, application for renewal, demands on dispute solution, demands for compensation, and right of enjoy the unilateral APA; taxpayers obligations are: disclosure of information, suggestion on drafts, cooperation in negotiation and signature, and implementation of other obligations defined in the unilateral APA. Tax authority has the following rights: accept or reject application (renewal) of APA, withdrawal from negotiation, audit and assessment of draft, negotiation on drafts, rescission, cancellation and adjustment, and other rights defined in APA; and tax authority has following obligations, including: keeping secrecy, holding preparatory meeting, accepting negotiation after application, negotiating on drafts and implementing other obligations defined in unilateral APA. In bilateral (multilateral) APA, tax authority is obligated to initiate mutual agreement procedure at the request of taxpayer and ensure consistency between bilateral (multilateral) APA entering into force and domestic law.Chapter 5 Analysis on Special Issues Countries with sound APA system have explicit regulations targeting common problems with implementation of APA. This paper introduces regulations on small-sized enterprises in the United States and makes comparison among countries in terms of critical assumptions, rollback, proof of burden, penalties and other detailed regulations.Chapter 6 Solution to International Tax Disputes Through Cooperation. APA embodies a concept of balanced interest as it is an arrangement and rule of adjustment concerning tax interest. This paper, for the first time, argues that the concept of balanced interest should be introduced in tax field. Tax system should be conducive to economic and social development particularly in a time of globalization when the boundary of tax jurisdiction is gradually vague: multinationals can easily adjust their income, cost and expenses through transfer pricing among countries, so how much taxable income should each of the relevant countries be entitled to? Both tax authority and taxpayers have their own views. It is therefore fair to say that administration on transfer pricing falls into embarrassment. However, APA is a mechanism containing a concept of balanced interest and asking multiple stakeholders to negotiate and compromise to realize balanced interest after cooperation and gaming. During this course, each tax stakeholder will make choice aiming to maximized interest while being counterbalanced by other stakeholders, hence a final reasonable balance between interest and realization of value of tax law in terms of attribution and a stable and fair tax system. APA reduces information asymmetry between tax authority and taxpayer and improves result of gaming. The course of gaming is to look for balance between tax law compliance and interest maximization. APA means cooperation and compromise to certain extent under combined constrains of both domestic tax law and tax treaty, it helps to achieve balance of tax interest based on taxpayers rights and public interest. Unilateral APA monitors distribution of tax income of relevant countries and bilateral (multilateral) APA is the achievement of cooperation between countries.Tax rights embody national sovereignty from tax perspective that one country has exclusive right to make tax regulations inside its boundary. However, economic globalization tends to harm tax sovereignty. Therefore one country cannot afford to neither focusing on tax sovereignty at the expense of economic development nor emphasizing on development while ignoring tax income. Tax authorities throughout the world should make efforts to achieve tax interest balance and stable, harmonious relations with taxpayers based on cooperation, mutual agreement, and extensive information exchange network and negotiations between relevant stakeholders. Only by so doing can the long-term win-win situation be possible by cracking down on tax avoidance while ensuring reasonable tax interest among relevant countries. We are the biggest developing country in the world, participating the international tax cooperation positively is our own needs and our social responsibility.