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Sadiq, Kerrie --- "The Taxing Effects of the Advance Pricing Arrangement Program: a Review of APAs and Their Impact on Stakeholders" [2007] JlATax 3; (2007) 10(1) Journal of Australian Taxation 104


By Dr Kerrie Sadiq[∗]

The current transfer pricing rules contained in Australia’s taxation regime are designed to counter the underpayment of tax by businesses engaged in international related-party dealings. Currently, these transactions must take place at an arm’s length price, a requirement which is becoming increasingly difficult to demonstrate. This results in an increased risk of an audit by the Australian Taxation Office. If a taxpayer wishes to avoid the risk of an audit, and any ensuing penalties, there is one option: an advance pricing arrangement (‘APA’). An APA is an agreement whereby the future transfer pricing methodology to be used to determine the arm’s length price is agreed to by the taxpayer and the relevant tax authority or authorities. This article investigates the use of APAs as a solution to the problem of transfer pricing and considers their impact on stakeholders. It is argued that while APAs provide a valuable practical tool for multinational entities facing the challenges of the taxation of global trading under the current regime, they may not be a practical long term solution.


Determining an arm’s length price for the purposes of the transfer pricing provisions of the Australian taxation regime is inherently problematic. Taxpayers are often faced with the daunting task of determining an arm’s length price where one may simply not exist, leaving them in the uncertain position of not knowing whether the requirements of the legislation have been complied with. This is particularly the case where the taxpayer is dealing in transfers of other than traditional goods and services as many of these transfers by their very nature are unique. The consequence is that these transfers may not actually have an arm’s length comparison for the purposes of determining an appropriate arm’s length transfer price. In the early 1990s, the Australian Taxation Office (‘the ATO’) responded to the inherent difficulties of determining an arm’s length price, with the resulting legislative uncertainty, by adopting a procedural mechanism known as the advance pricing arrangement (‘the APA’) program. In 1995, the ATO formalised the procedures for obtaining a bilateral or unilateral arrangement by issuing Taxation Ruling TR 95/23. Since the release of this ruling over a decade ago, the ATO has entered into numerous new arrangements as well as renegotiating many of the existing ones. To this extent, it may be argued that prima facie, the program successfully addresses many of the failures of the current transfer pricing regime. However, it needs to be asked whether the successful uptake of the program by affected taxpayers is a suitable measure of success.

The introduction of the APA program as an administrative response to the difficulties with current tax law has generally been viewed as a positive step towards solving the transfer pricing problem of determining an arm’s length price. However, the program is not without debate. Most recently, the controversy surrounding APAs, and in particular their confidential nature, has been highlighted in the United States through Internal Revenue Service litigation involving the pharmaceutical giant GlaxoSmithKline. This matter is one of the few transfer pricing cases to arise in recent times and highlighted the difficulty, first, in reaching a consensus on an appropriate transfer price, especially when dealing with intangibles and, secondly, the efficacy and fairness of the APA program.[1] Prior to this litigation, there had been little in the way of formal recognition of any disagreement as to the success or otherwise of the APA program. As one author, in the context of the GlaxoSmithKline litigation, states:

until 2004 the APA program enjoyed all the privileges of a spoiled child. Its mother — the IRS — nurtured it, watched it grow, and proudly displayed it for all to see. Its father — the tax community — watched it with a critical eye but was ultimately always supportive.’[2]

Disappointingly, this matter has now settled and therefore many of the questions asked have been left unanswered.[3] However, this case does demonstrate a need to review the APA program and question its utility within the broader tax regime.

The litigation involving GlaxoSmithKline occurred in the United States and to date there have been no similar proceedings in Australia. However, it is not possible to conclude from this fact that the Australian APA program is an unquestionable success. As such, this article examines the Australian APA program and, in the context of the effect on stakeholders, asks whether the program should be embraced as a long term solution to transfer pricing. The relative success of the program within the context of transfer pricing uncertainty is recognised. However, this article adopts a broader analysis of the APA program by using the benchmark criteria of equity, efficiency and simplicity to analyse its use long term. Prior to an analysis of the positive and negative effects on stakeholders, this article examines the role that APAs play in the current Australian tax regime.


It is a simple fact that tax rules differ between domestic taxing jurisdictions. It is also a fact that commercial entities seek to maximise their wealth. These two factors combine to create an incentive for the taxpayer to structure transactions in such a way as to ensure that profits are located in a jurisdiction with the most desirable tax consequences. When that taxpayer is truly multinational, the ability to shift profits from one jurisdiction to another is relatively simple. Splitting the wealth of the separate parts of the multinational entity does not affect the wealth of the entity as a whole. Therefore, when undertaking transfers between different parts of the one entity, the transaction (whether it is for the sale of goods, services or intellectual property) can be priced in such a way so as to move income from a high tax jurisdiction to a low tax jurisdiction.[4] This practice is known as transfer price manipulation.

The solution to transfer price manipulation, devised by the Organisation for Economic Co-operation and Development (‘the OECD’), is the concept of arm’s length pricing. Each part of the multinational entity is treated as a separate part of the economic entity (whether it is a branch or a subsidiary) and a price is substituted for taxation purposes that would have been used in the transaction had it been with an unrelated third party rather than a related-party within the same multinational entity. The OECD approach for many years has been seen as the solution to this manipulation. As a response to increased cross-border transactions and multinational enterprise operations, the OECD revised its international transfer pricing guidelines (‘the OECD Guidelines’) in 1995.[5] The current guidelines represent a consensus among 25 OECD member countries on the approach to international transfer pricing issues.

Australia’s domestic income tax legislation and Double Tax Agreements (‘DTAs’) reflect the OECD approach to transfer pricing and both contain transfer pricing rules which are designed to counter the underpayment of tax by businesses engaged in international dealings between related parties. As with the OECD Guidelines, the current legislation and agreements require that related-party transactions take place at a value which reflects an arm’s length price, that is, a price which would be charged between unrelated parties. The issue, therefore, becomes one of application, which is not without difficulties.

Under the current regime as described, taxpayers are concerned with both the ability to demonstrate compliance with the arm’s length standard and the avoidance of double taxation arising through the over-taxation in one or both of the relevant jurisdictions. As to the first, it is increasingly difficult for multinational entities to demonstrate that they are transferring goods and services at a price which reflects the behaviour of independent parties, thereby making it difficult to demonstrate compliance with the relevant legislation. Taxpayers are required, through the compliance requirements, to demonstrate how they reached the transfer price and how that price is reflective of an arm’s length price. However, determining an arm’s length price where a taxpayer is dealing in transfers other than for goods or basic services can be problematic because by their very nature these transfers are usually unique and are only ever going to occur within the multinational entity. As to the second, where an Australian business undertakes cross-border related-party transactions there is the risk of an audit. The taxpayer is in a position where it must be able to satisfy the relevant revenue authorities that it has complied with the arm’s length requirement. Where a taxpayer fails to satisfy the relevant tax authority that it has met the arm’s length standard, one or both jurisdictions may undertake an adjustment to reflect what they believe to be the accurate arm’s length transfer price. Unless a correlative adjustment is made by the other revenue authority, which is by no means a certainty, double taxation can ensue.

Relevant revenue authorities also express legitimate concern in relation to transfer pricing. These authorities want to ensure that transfer price manipulation is not occurring, or that an incorrect transfer price is not being used, resulting in the underpayment of tax. In support of tax authority concern, both anecdotal and empirical evidence suggests that multinational entities are taking advantage of opportunities to reduce their tax burdens in high-tax countries by way of intra-firm transfer pricing. For example, empirical evidence suggests that transfer pricing manipulation is occurring in the financial sector of the market.[6] Again, this is an area where it is difficult for both the taxpayer and the tax authority to find comparable prices and as such the evidence may support an argument that financial institutions are taking advantage of this difficulty.

The foregoing suggests that the motivation of taxpayers and governments pull in opposite directions: taxpayers have the obvious interest in preventing double taxation, while governments are concerned with collecting revenue which may be missed through under-taxation.[7]

Both concerns are valid and must be reflected in the rules and procedures governing transfer pricing. However, these concerns have not been addressed in the substantive legislation. Rather, as a means of addressing both the concerns of the taxpayer and tax authorities, a procedural program involving mutual agreement between taxpayer and tax authority or authorities was devised. These agreements, or APAs, are an agreement whereby the future transfer pricing methodology to be used to determine the arm’s length price is agreed to by the taxpayer and the relevant tax authority or authorities. If a taxpayer wishes to avoid the risk of an audit, along with ensuing penalties, in relation to related-party transactions, entering into an APA is the only option.

The introduction of the APA program can be seen as a direct response to the continuing administrative problems associated with the current transfer pricing regime. Despite changes to the current regime, along with such efforts as the re-written OECD Guidelines, there was little improvement in the practical outcome resulting from the application of the procedures primarily spelt out in taxation rulings. Problems remained in terms of both the application of the rules and any dispute resolution where there was disagreement about that application.[8]

As such, it was deemed necessary to deal with the issue via a procedural mechanism.[9] This procedural mechanism, in the form of the APA program, was designed to resolve the uncertainty surrounding related-party dealings. By achieving this, the application of the rules was established thereby circumventing the need for any further dispute, or ex post controversies.[10]

In broad terms, an APA is an arrangement between a taxpayer and tax authorities. However, it is necessary to be much more precise in order to consider the role of the APA within the broader tax system. The OECD Guidelines define an APA as follows:

An advance pricing arrangement (‘APA’) is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria (e.g. method, comparables and appropriate adjustments thereto, critical assumptions as to future events) for the determination of the transfer pricing for those transactions over a fixed period of time. An APA is formally initiated by a taxpayer and requires negotiations between the taxpayer, one or more associated enterprises, and one or more tax administrations. APAs are intended to supplement the traditional administrative, judicial and treaty mechanisms for resolving transfer pricing issues.[11]

Within the Australian context, APAs have been described as ‘essentially a glorified private ruling’[12] that allows agreement to be reached between taxpayer and taxing authority about a suitable transfer pricing methodology. Yet, it can be argued that the APA process is much more complex than, and is in addition to, the private ruling regime. First, an application for and the entering into of an APA involves a different procedure to a private ruling. Second, the resulting APA has features that are not obtainable as part of the private ruling regime.

A private ruling is a written expression of opinion by the Commissioner of Taxation (‘the Commissioner’) about the way in which a tax law or tax laws would apply to a person (the rulee) in relation to an arrangement in respect of a specified year of income.[13] While it is possible to seek a private ruling on the way in which the Commissioner would exercise his discretion and, therefore, how he would exercise his discretion under the transfer pricing provisions, this is not what an APA does. An APA does not express the Commissioner’s opinion, but rather provides an agreement between taxpayer and taxing authority or authorities. Unlike an APA, a private ruling does not involve any negotiation by or agreement with the taxpayer. This principal difference is in part because of the legislative provisions enabling the agreements to be entered into. The private ruling system is contained in Part IVAA of the Tax Administration Act 1953 (Cth) with the process being part of the administrative regime of Australian taxation. Conversely, an APA, if unilateral, is concluded under the executive power of the Commonwealth conferred to the Commissioner.[14] Where the APA is concluded bilaterally, it will be through the Mutual Agreement Procedure Article under the relevant DTA.[15] The means by which the agreement is entered into results in the consequential difference between a private ruling and an APA being that the latter can be viewed as a contract. Again, this is consistent with the goal of an APA being an agreement or arrangement between the relevant stakeholders.

The process for formalising an APA results in the principal difference between an APA and any other taxpayer and tax office dealings being that the APA may be regarded essentially as a private contract negotiated and concluded between the taxpayer and the ATO. This contract is negotiated as to both ex ante and ex post issues in relation to the taxpayer’s transfer pricing transactions. That is, there is agreement about the arm’s length methodology to be used by the taxpayer as well as, where the agreed procedure is followed, the circumvention of a possible audit. As to the ex ante issues, one of the essential points to note about an APA is that it is unique in the sense that it does not establish a position for the taxpayer in terms of setting the transfer price, but rather, it allows for agreement on an acceptable methodology for determining transfer prices.[16] Despite the fact that the transfer pricing method agreed upon should reflect the arm’s length principle contained in the domestic legislation and DTA,[17] there is considerable scope for negotiation and variation. In this sense, APAs are an ‘unusual procedural device’ allowing the resolution of ‘substantive tax issues voluntarily, prior to the transactions occurring, and [the reaching of an] agreement on their tax treatment.’[18]

The consequence of the APA being considered a private contract is that once agreement is reached, the resulting APA may be regarded as a hybrid of the traditional ex ante and ex post administrative functions. This view is supported by the OECD definition of an APA where the OECD states that APAs are ‘intended to supplement the traditional administrative, judicial and treaty mechanisms for resolving transfer pricing issues’.[19]

APAs deal with both ‘ex ante functions (specifying rules applicable to taxpayers upfront)’ and ‘ex post functions (formalizing tax treatment, providing certainty to individual taxpayers and negotiating with foreign governments).’[20]

In fact, even before agreement is reached there are ex ante and ex post considerations at play. As Durst and Culbertson explain:

APAs take full advantage of the principle that ex ante manifestations of taxpayer intent can avoid the need for costly ex post controversies. Psychologically, as well, agreement in financial disputes often seems easier before rather than after the fact, since after-the-fact resolution often requires one or both of the parties to consider relinquishing benefits that, albeit perhaps temporarily, the party already possesses.[21]

This hybrid nature of the APA, and the consequent blurring of the distinction between rule-making and adjudication, means that it may be difficult to evaluate its success.[22]

However, if the conclusion is reached that an APA is a form of private contract, containing rule-making and adjudication provisions, an evaluation can be made of the nature of the APA itself. Within this context, this article now turns to an evaluation of the APA program by examining the effect on stakeholders.


APAs are generally viewed as a positive move towards resolving transfer pricing disputes. However, as already stated they are not without controversy. To this extent, their success may be measured by various means. Initially, success was measured in terms of the APA program’s response to the procedural problems associated with the current transfer pricing regime.[23] Generally, this meant considering whether taxpayers were utilising the APA program and thus viewing the extent of its use as a proxy for success, rather than as a response to the failure of the traditional regime. In this sense, the success of the APA program was only measured within the context of the specific transfer pricing requirements imposed on multinational entities rather than in the context of the broader income tax regime.

A relatively easy measure of success is the number of APAs entered into. Each year the ATO releases a report on the developments of the APA program. Contained in these documents are the statistics on the number of APAs entered into in a given financial year. The 2003–04,[24]

2004–05[25] and 2005–06[26] financial year figures indicate that there are currently over 100 APAs in operation as part of Australian tax administration.

While the statistics on the number of APAs entered into provide interesting information, and do add some value to an examination of the success of the APA program, they are not a measure of success per se. The number of APAs, and the growth in their use, is ambiguous as to both the reasons for taxpayers entering into APAs and how successfully they balance the interests of taxpayers and the ATO. For example, the growth in APAs being entered into may simply be indicative of the inherent failure in the traditional legislative regime. Or, they may be indicative of taxpayers negotiating out of future transfer pricing problems after already facing an ATO audit. The ATO states that ‘[w]e are encouraged by the very high level of APA renewals which indicates the acceptance and practical success of the process.’[27]

However, it is argued that this needs to be placed in the broader context of the overall numbers of taxpayers with transfer pricing issues as well as perhaps a ‘practical failure’ of the traditional process. For example, in the 2004–05 financial year nine APAs were entered into with small to medium entities.[28] In the same period the ATO completed 101 risk reviews of the same category of entities, with the highest 23 risk cases being faced with audits.

The above figures within the context of the overall tax regime are a salient reminder that the APA program, while unique in nature, is not isolated from the broader tax system. To measure the success of an administrative program it is necessary to consider the effect such a program has on the respective stakeholders within a broader framework of benchmark criteria for evaluating a tax system. The conventionally accepted and fundamental principles of equity, efficiency and simplicity may be used to evaluate the APA program.[29] There are further ancillary criteria which may also be considered, for example, the need to prevent tax avoidance and evasion, and the need to review government spending programs in the tax system.[30] In conducting an evaluation of the system within this framework, the benefits and detriments to the relevant stakeholders are considered.

The stakeholders for the purposes of undertaking an evaluation within the framework of the broad tax system can be divided into two broad groups. First, there are the participants in the APA program: the taxpayers who are a party to an APA, and the relevant tax authority or authorities. Second, there are the non-participants in the APA program: those taxpayers with transfer pricing issues who do not enter into the program, and the community as a whole. The categories of stakeholders are therefore extensive and by considering the effects on the non-participants in the APA program it may be argued that complexity is added to the analysis.[31]

However, failure to do so may mean that it is not possible to get a true picture of the impact of the APA program as part of the broader tax system. In this context, it can be argued that the impact on taxpayers not electing to be part of the APA program can be just as important in terms of assessing the success of the program.[32] The discussion below, which considers the relative advantages and disadvantages to individual stakeholder groups, and questions the equity, efficiency and simplicity within those categories, then leads to a discussion of the equity, efficiency and simplicity of the APA program within the overall tax regime. It could be argued that only when these characteristics are present within the tax regime as a whole, balanced between all stakeholders, should the APA program be maintained. Each of the categories of stakeholders is examined.

3.1 The Participating Taxpayer

Claims of success for the APA program are generally supported by the perceived advantages to the participating taxpayer without resort to a consideration of other affected parties. The five main inter-related advantages generally listed for the participating taxpayer are: the resolution of uncertainty on a prospective basis, the prevention of double taxation, the avoidance of a possible audit (with penalties and litigation following), the ability to deal with real time issues, and a cooperative environment. The relative merits of each are considered in turn.

It is generally considered that the main advantage of the APA program is its ability to resolve uncertainty on a prospective basis. In this respect certainty can equate to efficiency. By entering into an APA the taxpayer (at least for a period of three to five years) is certain of the transfer pricing methodologies deemed acceptable by the relevant taxing authority or authorities. The ATO provides that by working with them to allow a better understanding of the industry, business as a whole and the relative contributions of parties. The certainty associated with an APA arises because an APA allows the taxpayer to plan its ‘activities and likely results over a number of years, secure in the knowledge that transfer pricing policies conform with internationally accepted practices.’[33]

A 1998 OECD discussion draft on The Taxation of Global Trading of Financial Instruments recognises that APAs provide a useful ‘safety valve’ in the absence of clear consensus on the concrete application of general principles.[34] Therefore, entering into an APA is a means of obtaining simplicity as contrasted to the complexity of an uncertain application of substantive provisions. The discussion draft, however, also recognises that many countries have little experience with APAs or fail to have domestic legislation allowing for such arrangements, and as such, fail to provide a complete solution.[35] Given the comprehensive nature of Australia’s APA program, this may not be as much of a concern for Australian taxpayers, except in so far as they wish to enter into bilateral APAs where the foreign jurisdiction is not as advanced with their program.

Where an APA is available to the parties, the 1998 OECD discussion draft suggests that it may help both the taxpayer and taxing authorities ‘save time and resources and provide the benefit of certainty in the otherwise difficult assessment of tax liability of global trading operations’.[36] This discussion draft, however, does recognise that while the benefits of entering into an APA may provide an incentive for taxpayers to request such agreements, the costs sometimes outweigh the benefits. In particular, it recognises that the opportunity costs of disclosure to the taxing authority may mean that the APA approach is insufficient to deal with global trading issues.[37]

Where a taxpayer does enter into an APA, the certainty provided to that taxpayer is in the form of an appropriate transfer pricing methodology, which the ATO believes ‘enhances the predictability of tax treatment of international transactions’.[38] A consequence of this certainty is a reduction in compliance costs (greater efficiency) along with a reduction in risk of an audit or penalties.[39]

It is this perceived certainty, along with the potential reduction in compliance costs and risk of audit, that the ATO sees as one of the key features of the program.[40] The taxpayer is also in a better position to predict costs associated with transfer pricing transactions and compliance, along with the ultimate tax liability.[41] To this extent, evidence suggests that a reduction in expected tax compliance costs is a necessary but not sufficient condition for a bilateral APA to occur.[42]

The level of certainty provided to the taxpayer is dependent on the type of APA entered into. Where the APA is bilateral (between the taxpayer, ATO and a foreign tax authority) there is the added certainty that the possibility of double taxation is eliminated.[43] Even where the APA is concluded unilaterally (between the taxpayer and the ATO) there is a substantial reduction in the possibility of double taxation and, at a minimum, domestic legal certainty.[44] To this extent, the ATO believes that the APA program may provide solutions to situations where there is no realistic alternate way of both avoiding double tax and of ensuring that all profits are correctly attributed and taxed.[45] The figures in Australia indicate that ‘over the life of the program, the number of bilateral and multilateral APAs have averaged approximately 43 percent of total APAs completed.’[46]

In 2003–04 bilateral APAs were completed with Canada, Japan, the Netherlands, New Zealand and the United States of America,[47]

while in 2004–05 Denmark and Korea were new APA partners.[48]

In 2005–06 bilateral APAs were completed with Japan, New Zealand, Switzerland and the United Kingdom, and for the first time, with Germany.[49]

An APA allows the taxpayer to address any transfer pricing issues on a prospective basis, thereby circumventing a possible audit. In turn, the possibility of protracted and expensive litigation is lessened.[50] The APA program may provide solutions to situations where there is no realistic alternative way of both avoiding double tax and of ensuring that all profits are correctly attributed and taxed. Further, it provides certainty on an appropriate transfer pricing methodology for the taxpayer. It is clear that APAs may circumvent administrative burdens, along with the risk of an audit.[51] However, APAs themselves add to the administrative burden together with high compliance costs. The fees that multinational entities must pay professionals for work on large transfer pricing tax issues can be enormous.[52]

Whether a taxpayer believes an APA provides for a simpler means of resolving transfer pricing issues is a matter for individual participants. However, given that there are costs associated with whether a taxpayer enters into an APA or not, it can be concluded that those who participate in the program believe there are complementary benefits of efficiency and simplicity at an individual level.

One of the most significant benefits to the taxpayer is that an APA can deal with difficult transfer pricing issues that may not have arisen previously. The ATO states that ‘APAs can provide significant benefits to a wide range of businesses because they can deal with real-time issues, including highly integrated operations and novel situations.’[53]

As multinational entities become more highly integrated and undertake transactions not previously contemplated, it will potentially become imperative that there is a procedural mechanism for dealing with these issues.

As a final benefit to the taxpayer, the ATO believes that the APA process is conducted in a cooperative and constructive environment,[54]

which helps the taxpayer. The ATO believes that the taxpayer is placed in ‘a better position to present its case and obtain an acceptable practical outcome’ because of this environment.[55] This environment allows the parties involved to ‘comprehensively deal with the matter based on appropriate and workable principles.’[56]

All of these benefits essentially fall within the ambit claim that an APA is a useful risk management tool.[57]

Overall, by entering into an APA reasonable certainty is provided and the likelihood of a transfer pricing investigation is substantially reduced. This is done via the mechanism of a private contract. The taxpayer is able to gain efficiency and certainty, thereby enhancing simplicity, by entering into a private contract with the ATO and agreeing to the factors which achieve this. As such, participating taxpayers are provided with greater efficiency and potentially greater simplicity by entering into an APA.

3.2 The ATO

While the APA program is generally not promoted on the basis of the benefits to the ATO, it may be argued that the program does benefit the ATO.[58]

These benefits may be divided into four broad interrelated categories: the APA program is a close fit with the ATO’s strategic direction, information obtained may be used in another forum, the APA program is a less costly path of dispute resolution, and the program potentially helps with future improvements. Again, the effect of these benefits is increased efficiency and the complementary effect of greater simplicity.

In terms of the fit with the ATO’s strategic direction, the ATO itself states that it aligns with ‘the cooperative compliance model in which a cooperative, self regulatory approach is the most desirable behaviour for us [the ATO] and for business.’[59]

This statement is consistent with the view that an APA is a private contract whereby the taxpayer decides whether to enter into one. However, contrary to this cooperative approach, and consistent with an argument that taxpayers are simply negotiating out of future transfer pricing problems after already facing an ATO audit, is the statement by the ATO which suggests that taxpayers enter into APAs not because of any desire to be cooperative, but rather the desire to avoid scrutiny. The ATO states in its 2003–04 report that

relatively fewer APA applications and expressions of interest were received this year. In part, this reflects the relative decline in the level of our transfer pricing risk assessment activity. We anticipate this will increase for 2004–2005 due to expanded fieldwork and more APAs becoming due for renewal.[60]

This is further supported in the 2004–05 report where the ATO states that it believes that the 2004–05 increase in completed APAs was due to three reasons: a determined attempt to complete delayed cases, a large number of renewals, and small to medium taxpayers using APAs to address concerns about the risk of a transfer pricing audit.[61]

When an APA is entered into, the ATO has the advantage of obtaining information which can be used in another forum. Generally, that forum would be the improvement of the transfer pricing regime and the interaction with other jurisdictions to resolve transfer pricing issues.[62]

There is no doubt that this use leads to greater efficiency and resulting simplicity within the transfer pricing regime. There is also no doubt that the ATO also uses APAs as a mechanism for solving transfer pricing problems,[63]

and this mechanism is likely to be less costly than traditional means. Therefore, it may be argued that the merits upon which the APA program is advocated on behalf of the ATO are complementary to an efficient and simple tax regime.

3.3 The Non-Participating Taxpayer

A non-participating taxpayer may be defined as a taxpayer which undertakes transactions subject to the transfer pricing regime but who elects not to participate in the APA program. There are limited benefits to these taxpayers, such as the addition of a procedural alternative to the mix of options[64]

and the potential for improved rules.[65] However, there are also several negatives associated with the APA program where a taxpayer does not participate. For instance, a taxpayer may not be able to participate because the ATO believes that they are not a suitable candidate,[66] or because they simply do not have the means. Of greatest significance however, is the potential for a rule difference between participants and non-participants. This resulting rule difference is the outcome of participants effectively entering into private contracts,[67]

with no way of comparing results due to the non-disclosure policy. APAs are a confidential process, and to date, there has been no disclosure of the details of any APAs entered into with the ATO.

The nature of an APA as both ex ante and ex post means that for the participating taxpayer, ex ante there are clear rules applicable to future transactions and, ex post, specified final treatment.[68] The non-participating taxpayer has the benefit of neither. Consequently, the non-participating taxpayer is in a position of not knowing whether they have complied with the transfer pricing requirements, or whether they will be subject to an investigation. The result, in essence, is that there may be different rules for participants and non-participants.[69] That is, there is the potential for an unequal application of the substantive transfer pricing requirements. However, there is no way to determine whether this is the case due to the non-disclosure rules for APAs. A disparity of tax treatment between participants and non-participants is clearly in conflict with the fundamental principle of equitable treatment of taxpayers. This violation of equity is addressed in further detail below.

3.4 The Community as a Whole

The APA program is part of the broader tax system. While its principle role is to facilitate the transfer pricing regime, it does not function as an independent program and, as such, must be analysed within the broader framework of the Australian tax system.[70] Consequently, the community as a whole may be viewed as a stakeholder in the APA program, as the community as a whole has a vested interest in the Australian tax system.

The principle benefit of the APA program to the community as a whole is reduced government administration and enforcement costs.[71] A reduction in these costs means more revenue to spend in other areas. However, there are several disadvantages which need to be considered. The three most significant negative consequences of the program are, first, the incremental effect on the performance of the transfer pricing system, second, the possibility of uneven application of substantive law and, third, the potential that taxpayers self select and utilise their relative bargaining power to take full advantage of the APA regime.

The principle benefit of reduced administration and enforcement costs must be considered in the context of the number of APAs entered into. The figures above indicate that only a small portion of entities with transfer pricing issues are participating in the APA program. Hence, it may be argued that the actual significance of the program is relatively minor.[72] Further, the APA program itself is not without cost as significant ATO resources are vested in the ongoing program.

Given the private nature of the APA program, there is the possibility of uneven application of substantive law, or in other words, a lack of equitable treatment of like taxpayers. This issue was raised in the context of the disadvantages to the non-participating taxpayer, but is also a cost borne by the community as a whole. The question that needs to be asked is whether the risks associated with the use of what are essentially private contracts are an acceptable part of the tax administration regime, with one of those risks being the possibility of the substantive law being inconsistently applied.[73] This is especially pertinent given the nature of an APA resolving both ex ante and ex post issues. The participating taxpayer need only demonstrate compliance with the APA to avoid an audit whereas the non-participating taxpayer must demonstrate compliance with the arm’s length standard required in the substantive law and then still faces the possibility of a risk assessment, resulting audit and consequential penalties.

Finally, impacting on the wider tax community is taxpayer behaviour. By virtue of the voluntary nature of the APA program, taxpayers have the option to self select. Whether to enter into an APA will depend on whether the taxpayer is risk averse. Only taxpayers wishing to seek certainty are likely to enter into an APA, with these taxpayers also likely to be in a low risk category for audit purposes. A taxpayer may also self select into the program where they believe they are in a position of relative bargaining strength.[74] Essentially, it may be argued that the program is open to ‘abuse and strategic behaviour. … By virtue of being a voluntary program for taxpayers, presumably participants and nonparticipants self select to be in the most individually favourable category.’[75]

Given the relative advantages and disadvantages of the APA program to stakeholder groups, the question needs to be asked whether it should be considered a long term solution to the issues of transfer pricing and whether it is desirable that such a program remain an integral part of our tax regime. This part of the article has considered the merits of the program to the relevant stakeholders, primarily measuring those merits against the benchmark criteria of equity, efficiency and simplicity. The next part of the article reconciles these criteria to draw conclusions as to the long term viability of the APA program.


To evaluate the long term viability of the APA program, it is necessary to consider the benchmark criteria as they apply to the program within the tax regime as a whole. At the crux of the analysis is the very nature of the APA, that is, an APA essentially being a private contract. It is within this context that the APA program is considered unique and, therefore, may pose different issues to other aspects of the current tax regime. Each of the criteria is considered in turn.

First, to the issue of equity, it must be asked whether, under a system which essentially allows taxpayers to enter into a private contract with tax authorities, there is equity. Arguably, the APA program allows for a distortion of horizontal equity, as well as vertical equity given the very nature of the agreement reached, coupled with the relative bargaining power of the taxpayers. It may be argued that ‘the creation of this alternative path pose[s] problems of fair and equitable treatment of taxpayers regardless of the method of dispute resolution selected’.[76] Horizontal equity may be distorted because it is likely that a non-participating taxpayer could view the regime as inequitable, believing that the participating taxpayer is at an advantage. And, this may in fact be the case given that a participating taxpayer has contracted to provide certainty as to the ex ante and ex post consequences of transfer pricing transactions. The non-participating taxpayer undertaking the exact same transaction has the certainty of neither, but instead must demonstrate that it has undertaken relevant transactions at an arm’s length price. Further, it is also difficult to see how vertical equity is achieved given the relative bargaining power and ability to enter into APAs of large as compared to smaller taxpayers.

Second, and conversely, it may be argued that the APA program does have a positive effect on efficiency. Taxpayers who enter the program circumvent many of the administrative burdens placed on both them and the tax authorities by the traditional regime. Cooperation replaces an adversarial system and agreement replaces uncertainty. However, again it must be asked whether the administrative costs, indirectly borne by the community as a whole, are appropriate given the low level of APA uptake. Would the costs associated with the APA program be better spent on other areas of the tax regime, one where there is greater benefit to a greater number of taxpayers? Arguably the answer is ‘yes’.

Third, while it may be argued that the APA program itself is relatively simple, any additional means of administration without addressing the underlying problems adds to the complexity of the current regime. Further, not all taxpayers would argue that the APA program is simple. It is time consuming, expensive and still bears substantial compliance costs. This question is one of context. The APA program may be simpler than demonstrating compliance with the substantive legislation requiring arm’s length pricing. However, it does not address the underlying complexity within the transfer pricing regime itself. Rather, the problems associated with the transfer pricing regime are masked by an administrative solution to a substantive problem.

The relative newness of the APA program, coupled with the low uptake, may mean that it is too early to conclusively decide the success or failure of the program. However, if it is concluded that the APA program is merely a procedural solution to a substantive problem, and one that may not produce a result considered optimal in our current regime, then it must be asked whether there is an alternate solution. Given that APAs may simply be an interim fix, it has been argued:

Advance pricing agreements are not the ultimate solution to the jurisdictional challenges facing the world’s taxing authorities. At best they are probably a temporary solution. However, for now, advance pricing agreements have proven to be an effective alternative to the litigation and uncertainty that preceded their development. And, to the extent that they have brought the world’s taxing authorities to the same table, perhaps they offer a starting point from which a true international reform effort can be established.[77]

It should not be forgotten that the APA program is a response to underlying flaws in the substantive rules of the traditional transfer pricing regime. As such, it is not a long term solution to the issues of transfer pricing. The question, therefore, that needs to be asked is ‘what form should this international reform take?’ It is not the purpose of this article to provide a legislative solution, but rather, to argue that APAs may not be a long term solution and to recognise the possibility of legislative reform. There is a spectrum of possible reform, ranging from a narrow to a wide view of changes. At one end, there could be minor substantive changes to the current legislative regime, with amendments merely clarifying compliance requirements. At the other end, a wide view would necessitate a wholesale legislative re-write to introduce a new source-based regime, possibly formulary apportionment. This is by no means a simple task. As Diane Ring explains:

Unfortunately, while the problem and the ‘solution’ may be relatively simple to describe, implementation of the statutory response has not been simple because of (1) the lack of information, (2) the multi jurisdictional element, and (3) unsettled questions about the validity of the arm’s length approach due to possible differences between integrated multinationals and companies that deal primarily with unrelated taxpayers.[78]

It is this very reason that the APA program emerged. Therefore, it is important to recognise that the APA program is somewhat of a success as it has provided taxpayers and tax authorities a resolution where one could not be found.

While tax authorities are marketing APAs as a solution to difficult transfer pricing issues, it may not be the long term answer and to this extent we should not stop searching for a legislative solution. There is no doubt that the APA program is a procedural innovation in international tax.[79] It is an administrative approach, however, that attempts to prevent transfer pricing disputes from arising by being proactive in determining an agreed methodology[80] and avoiding costly disputes, rather than being a solution to the underlying theoretical and practical problems of the arm’s length pricing requirement. An APA is a practical solution,[81] but does not address the underlying failure of the arm’s length principle to easily allocate income to jurisdictions. While it has improved the administrative aspect of transfer pricing for participants,[82]

the APA program is merely a procedural solution to the transfer pricing dilemma.[83]


APAs provide a valuable practical tool for modern multinational entities facing the challenges of the taxation of transactions under the current transfer pricing regime.[84]

However, entering into an APA is not a long term solution to the problems facing multinational entities to determine transfer prices. Further, it may be argued that ‘the integrity of the system will be called into question if a “private law” track is permitted to develop.’[85] Despite this, the use of such an arrangement also aids the taxpayer to circumvent many of the administrative costs associated with the traditional regime. Consequently, it is likely that, until there are wholesale changes to the taxation of multinational entities, APAs will continue to play a role in the current tax regime.

It must be remembered that the APA program is not isolated from the broader tax regime. For this reason, we cannot assess the program as an isolated one. However, when an assessment is undertaken within the broader context, it may be found that the APA program does not appear as such an ideal solution to an ongoing problem.

[∗] Senior Lecturer, TC Beirne School of Law, The University of Queensland, St Lucia and Senior Research Fellow, Taxation Law and Policy Research Institute, Monash University.

[1] M Sullivan, ‘With Billions at Stake, Glaxo Puts US APA Program on Trial’ (2004) 34 Tax Notes International 456, 462.

[2] Ibid.

[3] United States Department of Treasury, ‘IRS Accepts Settlement Offer in Largest Transfer Pricing Dispute’, IR-2006-142 (11 September 2006).

[4] D Ring, ‘Advance Pricing Agreements and the Struggle to Allocate Income for Cross Border Taxation’ (2000) 21 Michigan Journal of International Law 143, 151.

[5] OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (1995). The revised guidelines, issued on 13 July 1995, replace those contained in the OECD’s 1979 report on transfer pricing.

[6] For empirical evidence of multinational banks undertaking transfer price manipulation, see A Demirguc-Kunt and H Huizinga, ‘The Taxation of Domestic and Foreign Banking’ (2001) 79 Journal of Public Economics 429. For evidence of transfer pricing generally, see D Wickham and C Kerester, ‘New Directions Needed for Solution of the Transfer Pricing Tax Puzzle’ (1992) 5 Tax Notes International 399; E Lester, ‘International Transfer Pricing Rules: Unconventional Wisdom’ (1995) 2 ILSA Journal of International and Comparative Law 283; J Wheeler, ‘An Academic Look at Transfer Pricing in a Global Economy’ (1988) 40 Tax Notes 87. See C Emmanuel, ‘Income Shifting and International Transfer Pricing: A Three-Country Example’ (1999) 35(3) Abacus 252 for a study of the empirical evidence indicating the existence of transfer price manipulation.

[7] Wickham and Kerester, above n 6, 401.

[8] Ring, above n 4, 169.

[9] Ibid 150.

[10] Taxation Ruling TR 95/23 [3].

[11] OECD, Transfer Pricing Guidelines, above n 5, IV-4.124.

[12] CCH, Australian Federal Tax Reporter 70-180.

[13] Taxation Ruling TR 93/1 [2].

[14] Taxation Ruling TR 95/23 [12]. The ATO states that unilateral APAs are concluded under the Commissioner’s power of general administration of the income tax legislation: ATO, Advance Pricing Arrangement Program: Report on Developments in 2003–2004 (2004) 3.

[15] Taxation Ruling TR 95/23 [12].

[16] A Sawyer, ‘Advance Pricing Agreements: A Primer and Summary of Developments in Australia and New Zealand’ (2004) 1(9) Bulletin for International Fiscal Documentation 556, 556.

[17] Taxation Ruling TR 95/23 [11].

[18] Ring, above n 4, 159.

[19] OECD, Transfer Pricing Guidelines, above n 5, IV-4.124.

[20] Ring, above n 4, 184.

[21] M Durst and R Culbertson, ‘Clearing Away the Sand: Retrospective Methods and Prospective Documentation in Transfer Pricing Today’ (2003) 57 Tax Law Review 37, 123.

[22] Ring, above n 4, 149.

[23] Ibid 190.

[24] Figures for the previous two years are as follows: as at 30 June 2004, there were 117 operating APAs, with 11 being renewed one or more times. In the 2004 financial year, there were 23 completed APAs. Of the 23 APAs completed, four were renewals of previously negotiated APAs. This exceeded the expectation of 20 APAs that the ATO forecast in the Tax Office Compliance Plan 2003–04. Seventeen were with companies with revenues in excess of $100 million. The participants were typically highly recognised, publicly-owned industrial companies who were leaders in their industry sector and involved in either the business-to-business sale of intermediate goods, the importation of finished goods or in retail or services sectors where product branding is important: ATO, Developments in 2003–2004, above n 14.

[25] As at 30 June 2005, there were 131 operating APAs, with 18 being renewed one or more times. The ATO completed 38 APAs in the 2005 financial year, including 12 renewals, exceeding the expectation of 32 forecast in the 2004–05 Compliance Program. Of the 38 APAs completed in 2004–05, 21 were dealings covering tangibles (import, export and manufacture), six were dealings covering intangibles and 11 were dealings covering services. The majority of APAs completed in 2004–05 were agreed with enterprises in the national client group (‘the NCG’) industry segment. That segment covers manufacturing, wholesaling, services, property and construction. Other segments represented were: multi-media and information technology (‘MMIT’), six (six in 2003–04); financial service industry group (‘FSIG’), one (two in 2003–04); energy and resources group (‘ENRG’), five (three in 2003–04); and nine for small to medium entities (‘SMEs’) (nil in 2003–04). See ATO, Advance Pricing Arrangement Program: Report on Developments in 2004–2005 (2005).

[26] As at 30 June 2006, there were 146 operating APAs with 25 being renewed one or more times. Of the 27 APAs completed in 2005–06, 14 were agreed with enterprises in the NCG industry segment. Other segments represented were FSIG (two), ENRG (three) and SMEs (eight): ATO, Advance Pricing Arrangement Program: Report on Developments in 2005–2006 (2006).

[27] ATO, Developments in 2003–2004, above n 14, 2.

[28] Small to medium entities are those entities with an annual turnover of between $2 million and $100 million.

[29] While there are many criteria by which a tax system may be judged, these three are generally accepted as the conventional criteria for evaluating a tax system. They are discussed in detail in Commonwealth, Reform of the Australian Tax System: Draft White Paper (1985) ch 1.

[30] Ibid.

[31] Ring, above n 4, 192.

[32] Ibid.

[33] ATO, International Transfer Pricing: Advance Pricing Arrangements (2005) 2.

[34] OECD, The Taxation of Global Trading of Financial Instruments (1998) 29(112). The 2003 updates do not comment on the use of advance pricing arrangements.

[35] Ibid.

[36] Ibid 30(113).

[37] Ibid 30(115).

[38] Taxation Ruling TR 95/23 [65].

[39] ATO, Developments in 2003–2004, above n 14, 2.

[40] Ibid.

[41] Taxation Ruling TR 95/23 [65].

[42] A Wagenaere, R Sansing and J Wielhouwer, ‘Using Bilateral Advance Pricing Agreements to Resolve Tax Transfer Pricing Disputes’ (Working Paper No 2005-24, Tuck School of Business, Tilburg University, 2005) 16.

[43] Taxation Ruling TR 95/23 [65].

[44] J Lagae, ‘Advance Pricing Agreements’ (1999) 1 EC Tax Review 8, 16.

[45] Taxation Ruling TR 95/23 [65].

[46] ATO, Developments in 2004–2005, above n 25, 5.

[47] ATO, Developments in 2003–2004, above n 14, 5.

[48] ATO, Developments in 2004–2005, above n 25, 5.

[49] ATO, Developments in 2005–2006, above n 26, 5.

[50] Taxation Ruling TR 95/23 [65].

[51] For the advantages and disadvantages of entering into an advanced pricing agreement by financial intermediaries, see A Snyder ‘Taxation of Global Trading Operations: Use of Advance Pricing Agreements and Profit-Split Methodology’ (1995) 48 The Tax Lawyer 1057.

[52] Wickham and Kerester, above n 6, 413.

[53] ATO, International Transfer Pricing, above n 33, 2.

[54] Lagae, above n 44, 16.

[55] Taxation Ruling TR 95/23 [64].

[56] Ibid.

[57] Sawyer, above n 16, 557.

[58] ATO, Developments in 2004–2005, above n 25, 2.

[59] ATO, Developments in 2003–2004, above n 14, 3.

[60] Ibid 5.

[61] ATO, Developments in 2004–2005, above n 25, 3.

[62] Ring, above n 4, 148.

[63] Sawyer, above n 16, 564.

[64] Ring, above n 4, 148.

[65] Ibid.

[66] Even if the ATO has accepted an APA application and commenced the APA process, it is not compelled to execute or conclude the APA: Taxation Ruling TR 95/23 [47]. The criteria for inclusion in the APA program are in para 70 of the ruling.

[67] Ring, above n 4, 198.

[68] Ibid.

[69] Ibid.

[70] Ibid 192.

[71] Ibid 148.

[72] Ibid 189.

[73] Ibid 148.

[74] Ibid 190.

[75] Ibid.

[76] Ibid 189.

[77] K Hickman, ‘Should Advance Pricing Agreements Be Published?’ (1998) 19 Northwestern Journal of International Law and Business 171, 194.

[78] Ring, above n 4, 153–4.

[79] Ibid 144.

[80] J Neighbour, ‘OECD Issues Guidance on Mutual Agreement APAs’ (1999) 19 Tax Notes International 1954, 1954.

[81] Y Reich, ‘US Federal Income Taxation of US Branches of Foreign Banks’ (1994) 2 Florida Tax Review 1, 25.

[82] Ring, above n 4, 232.

[83] Ibid 160.

[84] Reich, above n 81, 67.

[85] Ibid.

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