Shedding Light on Advance Pricing Agreements

U.S. multinationals, or at least some of them, aren't paying that much tax. Their marginal tax rates are falling, and lawmakers and the public are starting to notice. In May, Apple's CEO was dragged before the Senate Homeland Security and Governmental Affairs Permanent Subcommittee for Investigations and forced to defend the company's aggressive transfer pricing and income-shifting practices. Even the OECD, a traditional defender of multinationals, is starting to get serious about eroding corporate tax bases. This isn't the first time the Senate has tried to get to the bottom of aggressive transfer pricing practices. In 2005 the Finance Committee put together a draft report on the IRS advance pricing agreement program that showed that APAs were being heavily abused. The report was ultimately scuttled, but the APA problem might have grown worse since then.

Lynnley Browning of Fortune calls APAs "the tax break that corporate America wants kept secret," in an article detailing how Oracle had used a series of agreements starting in 2003 to cut its corporate tax bill almost in half. In 2003 Oracle paid an effective tax rate of 32 percent. By 2013, that rate had fallen to 19 percent. Oracle had consolidated hundreds of subsidiaries into six core affiliates in Ireland, Browning writes. That allowed the software company to take advantage of the much lower corporate rate to begin slicing into its U.S. tax bill, she argues. Browning describes how APAs could be used to obtain the IRS's inadvertent blessing of aggressive tax maneuvering. The Service seems to be interested in simplifying its enforcement burden by obtaining certainty, but the cost seems to be a hampering of audit efforts, she writes.

APAs aren't as obscure as Browning implies in her article. In fact, they have caught Congress's attention before. In 2005 a major report was drafted that criticized the APA program.The report detailed IRS incompetence in negotiating the agreements and discussed how the agency wasn't even tracking how much revenue was being lost because of APAs. It recommended that the IRS begin to develop a way to track revenue losses and also change the way in which APAs were negotiated. The goal was to stop the revenue leakage. The report did not recommend the one change that many were calling for: publication of APA terms. That's right -- APAs are completely secret. The IRS is not required to reveal their terms, and companies frequently don't even admit that the agreements exist.

The APA report could have been a significant step in stopping transfer pricing revenue leakage, but the Senate killed it before it could be finalized. The reasons have never been clear, but the effects have been a proliferation of APAs and a dramatic decrease in the tax rates paid by multinationals, particularly those with intangible assets.

The IRS is fighting back against the perception that it is giving away the store in APAs. Last year it canceled two APAs that it had negotiated with Eaton Corp. The IRS says that Eaton did not abide by the terms, and it is seeking to collect additional taxes and penalties. Eaton is fighting the cancellations in the Tax Court, which has allowed the case to proceed.

If the Tax Court holds that the IRS can't cancel the APAs, the Service might find that it's bound to honor deals that heavily favor corporate taxpayers, causing serious harm to the fisc and the federal financial outlook. But just how much sympathy should we have for the government, considering that it made the deals in the first place, insists on keeping them secret from the public, and continues to send mixed messages about whether it will seriously try to rein in rampant transfer pricing abuses by U.S. companies?

Jeremy Scott is editor of Tax Analysts' Tax Notes. He also blogs at