Advanced Pricing Agreement Essay

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An advanced pricing agreement (APA) represents a binding agreement between a multinational corporation and a country’s tax authority as to the transfer price for a specified cross-border transaction known as the covered transaction. A typical APA will specify the covered transaction, the agreed transfer price, and an effective time period. Unlike transfer prices that are set in the normal course of business, transfer prices reached under an APA are not subject to further adjustment by either party and as a result avoid the risks of transfer pricing adjustments and associated penalties. In so doing, an APA provides pricing certainty to multinationals.

A transfer price is the price associated with related party transactions, i.e., transactions that take place within a corporation. As per many countries’ tax regulations, cross-border transfer prices must satisfy the arm’s length standard. This standard requires that related party transactions reflect the price that would have been charged if the parties were independent, i.e., separate companies, and trading at arm’s length. Tax legislation details the methods that may be used to determine appropriate transfer prices. Most of these methods rely on the existence of comparable transactions that serve as benchmarks for related party transactions.

Many internal transactions lack satisfactory third-party benchmarks. These internal transactions might be appropriate candidates for APAs. Additional criteria may include the underlying complexity and size of the transaction. One potential complexity is the inability to separate a single transaction into simpler transactions that may be more easily priced. Eligibility criteria for APAs often reflect the demands that they place on the resources of the relevant tax authorities, as every single APA requires review and approval by the tax authority, and the time commitment to a single APA can be significant. Consequently, not all internal transactions are appropriate candidates for APAs.

APAs may be unilateral, bilateral, or multilateral in scope. Unilateral APAs involve a single tax authority and the multinational corporation. Such APAs protect the multinational from transfer pricing penalties and adjustment in the jurisdiction in which it was negotiated, but confers no transfer pricing risk mitigation in the corresponding jurisdiction where the other end of the transaction takes place. Bilateral APAs involve two taxing authorities and are, by definition, more complex as they require the agreement of multiple taxing authorities with an inherent conflict as to how the associated income from a transaction should be shared between the two countries. Bilateral APAs, as do their unilateral counterparts, require review and approval by the tax authorities and consequently place significant demands on the resources of the relevant tax authorities. Bilateral APAs confer a further advantage to the multinational, however, as bilateral APAs provide transfer pricing certainty in both countries.

Whether unilateral, bilateral, or multilateral in scope, APAs are voluntary and are initiated at the request of taxpayers with a petition to the relevant tax authorities. Taxpayers may petition for an APA for any transaction that falls within the purview of the transfer pricing legislation. Approval for APAs is not always granted, and if they are, the petitioning firm must provide documentation that establishes the arm’s length standard of the proposed transactions. APAs are ideally suited to setting transfer prices in advance of transactions. They may also be used to set transfer prices on a concurrent basis.


  1. Internal Revenue Service, “Announcement and Reporting Concerning Advanced Pricing Agreements,” March 2008, (cited March 2009);
  2. Organization of Economic Cooperation and Development, “OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators” (OECD, 1995).

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