An advance price agreement (APA) is a type of agreement between a taxpayer and tax authority regarding transfer pricing. Transfer pricing refers to the pricing of goods and services that are exchanged between related parties, such as a parent company and its subsidiary.
When transfer pricing is not done at arm`s length, it can lead to tax evasion or avoidance. An APA allows the taxpayer to mitigate these risks by agreeing on an appropriate transfer pricing methodology with the tax authority in advance.
Under an APA, the taxpayer and tax authority agree on the transfer pricing methodology to be used for a specified period of time (usually three to five years). This agreement is binding and provides certainty for the taxpayer in terms of their tax obligations.
There are three types of APAs: unilateral, bilateral, and multilateral. Unilateral APAs involve only the taxpayer and the tax authority of the country where the taxpayer is located. Bilateral APAs involve the taxpayer, the tax authority of the country where the taxpayer is located, and the tax authority of another country where the related party is located. Multilateral APAs involve the taxpayer, multiple tax authorities, and related parties located in various countries.
To apply for an APA, the taxpayer must provide a detailed description of the proposed transfer pricing methodology and supporting documentation. The tax authority will review the application and may request additional information or negotiations before reaching a final agreement.
Overall, an APA provides several benefits for the taxpayer, including reduced risk of double taxation, certainty in tax obligations, and the ability to focus on business operations rather than transfer pricing compliance.
