The Advantages and Disadvantages of Using an Advance Pricing Agreement: Lessons for the UK from the US and Austrarion Experience

The requirement in many OECD countries for "contemporaneous documentation" of a taxpayer's transfer pricing methodologies in order to avoid exposure to substantial penalties has led more taxpayers to consider entering into an Advance Pricing Agreement (APA). To these taxpayers, APAs represent an opportunity to remove the prospect of penalties and other areas of uncertainty related to transfer pricing enforcement. The latest transfer pricing survey by Ernst & Young revealed that "Fifty-seven per cent of U.K. subsidiary respondents that have not used APAs would consider using an APA as a controversy management tool in future." If penalties imposed on multinational enterprises (MNEs) for transfer pricing transgressions have been described as the "stick" to force taxpayers (generally companies) to get their transfer pricing procedures in order, then APAs might justifiably be described as the "carrot". It is significant to note that countries which have been updating and expanding their documentation and penalty rules (such as the United States (US), Australia, Canada, the United Kingdom (UK) and Mexico), have simultaneously expanded their APA programs to deal with the proliferation of transfer pricing controversies. Although the documentation requirements for APAs are onerous, increasingly a cost-benefit analysis is proving a decisive factor for entering into an APA. This is especially the case as countries enact more documentation legislation coupled with severe penalties for non-compliance. It is generally acknowledged that: "the concept of the APA as used by the OECD Fiscal Committee is very close to that provided by the IRS." As Australia and the UK also closely follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines), there are many similarities between UK, Australian and US APAs. This paper proposes to examine some of the advantages and disadvantages of APAs as seen by taxpayers and revenue authorities in the United States and in Australia, along, where relevant, with the views expressed in the OECD Guidelines, in order to discern whether these are applicable to APAs entered into in the UK.