This Announcement is issued pursuant to § 521(b) of Pub. L. 106–170, the Ticket to Work and Work Incentives Improvement Act of 1999, which requires the Secretary of the Treasury to report annually to the public concerning advance pricing agreements (APAs) and the Advance Pricing and Mutual Agreement Program (APMA Program), formerly known as the Advance Pricing Agreement Program (APA Program). This nineteenth report describes the experience, structure, and activities of the APMA Program during calendar year 2017.

This notice sets forth updates on the corporate bond monthly yield curve, the corresponding spot segment rates for April 2018 used under § 417(e)(3)(D), the 24-month average segment rates applicable for April 2018, and the 30-year Treasury rates, as reflected by the application of § 430(h)(2)(C)(iv).

This notice provides guidance on the corporate bond monthly yield curve, the corresponding spot segment rates used under § 417(e)(3), and the 24-month average segment rates under § 430(h)(2) of the Internal Revenue Code. In addition, this notice provides guidance as to the interest rate on 30-year Treasury securities under § 417(e)(3)(A)(ii)(II) as in effect for plan years beginning before 2008 and the 30-year Treasury weighted average rate under § 431(c)(6)(E)(ii)(I).

Section 430 specifies the minimum funding requirements that apply to single-employer plans (except for CSEC plans under § 414(y)) pursuant to § 412. Section 430(h)(2) specifies the interest rates that must be used to determine a plan’s target normal cost and funding target. Under this provision, present value is generally determined using three 24-month average interest rates (“segment rates”), each of which applies to cash flows during specified periods. To the extent provided under § 430(h)(2)(C)(iv), these segment rates are adjusted by the applicable percentage of the 25-year average segment rates for the period ending September 30 of the year preceding the calendar year in which the plan year begins.^[1] However, an election may be made under § 430(h)(2)(D)(ii) to use the monthly yield curve in place of the segment rates.

Notice 2007–81, 2007–44 I.R.B. 899, provides guidelines for determining the monthly corporate bond yield curve, and the 24-month average corporate bond segment rates used to compute the target normal cost and the funding target. Consistent with the methodology specified in Notice 2007–81, the monthly corporate bond yield curve derived from March 2018 data is in Table 2018–3 at the end of this notice. The spot first, second, and third segment rates for the month of March 2018 are, respectively, 2.91, 3.99, and 4.43.

The 24-month average segment rates determined under § 430(h)(2)(C)(i) through (iii) must be adjusted pursuant to § 430(h)(2)(C)(iv) to be within the applicable minimum and maximum percentages of the corresponding 25-year average segment rates. For plan years beginning before 2021, the applicable minimum percentage is 90% and the applicable maximum percentage is 110%. The 25-year average segment rates for plan years beginning in 2016, 2017, and 2018 were published in Notice 2015–61, 2015–39 I.R.B. 408, Notice 2016–54, 2016–40 I.R.B. 429, and Notice 2017–50, 2017–41 I.R.B. 280, respectively.

The three 24-month average corporate bond segment rates applicable for April 2018 without adjustment for the 25-year average segment rate limits are as follows:

Based on § 430(h)(2)(C)(iv), the 24-month averages applicable for April 2018, adjusted to be within the applicable minimum and maximum percentages of the corresponding 25-year average segment rates, are as follows:

Section 431 specifies the minimum funding requirements that apply to multiemployer plans pursuant to § 412. Section 431(c)(6)(B) specifies a minimum amount for the full-funding limitation described in § 431(c)(6)(A), based on the plan’s current liability. Section 431(c)(6)(E)(ii)(I) provides that the interest rate used to calculate current liability for this purpose must be no more than 5 percent above and no more than 10 percent below the weighted average of the rates of interest on 30-year Treasury securities during the four-year period ending on the last day before the beginning of the plan year. Notice 88–73, 1988–2 C.B. 383, provides guidelines for determining the weighted average interest rate. The rate of interest on 30-year Treasury securities for March 2018 is 3.09 percent. The Service determined this rate as the average of the daily determinations of yield on the 30-year Treasury bond maturing in February 2048. For plan years beginning in April 2018, the weighted average of the rates of interest on 30-year Treasury securities and the permissible range of rates used to calculate current liability are as follows:

In general, the applicable interest rates under § 417(e)(3)(D) are segment rates computed without regard to a 24-month average. Notice 2007–81 provides guidelines for determining the minimum present value segment rates. Pursuant to that notice, the minimum present value segment rates determined for March 2018 are as follows:

The principal author of this notice is Tom Morgan of the Office of the Associate Chief Counsel (Tax Exempt and Government Entities). However, other personnel from the IRS participated in the development of this guidance. For further information regarding this notice, contact Mr. Morgan at 202-317-6700 or Tony Montanaro at 202-317-8698 (not toll-free numbers).

This Announcement is issued pursuant to § 521(b) of Pub. L. 106–170, the Ticket to Work and Work Incentives Improvement Act of 1999, which requires the Secretary of the Treasury to report annually to the public concerning advance pricing agreements (APAs) and the Advance Pricing and Mutual Agreement Program (APMA Program), formerly known as the Advance Pricing Agreement Program (APA Program). The first report covered calendar years 1991 through 1999. Subsequent reports covered each calendar year 2000 through 2016 separately. This nineteenth report describes the experience, structure, and activities of the APMA Program during calendar year 2017. It does not provide guidance regarding the application of the arm’s length standard.

Part I of this report includes information on the structure, composition, and operation of the APMA Program; Part II presents statistical data; and Part III includes general descriptions of various elements of the APAs executed in 2017, including types of transactions covered, transfer pricing methods used, and completion time.

[Pub. L. 106–170 § 521(b)(2)(A)]

In February 2012, the former APA Program was moved from the Office of Chief Counsel to the Office of Transfer Pricing Operations^[2] within the Large Business and International Division of the IRS and combined with the U.S. Competent Authority staff responsible for transfer pricing cases, thereby forming the APMA Program.

As of December 29, 2017, the APMA Program included 55 team leaders, 17 economists, and 10 senior managers organized into 10 groups (7 team leader groups and 3 economist groups). The APMA Program’s main office is in Washington, DC, and it also has a significant presence in San Francisco and the Los Angeles area.

On August 31, 2015, new revenue procedures governing MAP and APA applications were published in 2015–35 I.R.B. on pages 236 and 263, respectively. Revenue Procedure (Rev. Proc.) 2015–41 provides guidance and instructions on filing APA requests as well as guidance and information on the administration of APAs. Rev. Proc. 2015–41 updates and supersedes Rev. Proc. 2006–9, 2006–1 C.B. 278, as modified by Rev. Proc. 2008–31, 2008–1 C.B. 1133, which is also superseded. Rev. Proc. 2015–40 provides procedures and guidance on requesting assistance from the U.S. Competent Authority where the taxpayer believes that the actions of the United States or a treaty country result or will result in the taxpayer being subject to taxation not in accordance with the applicable U.S. tax treaty. Rev. Proc. 2015–40 updates and supersedes Rev. Proc. 2006–54, 2006–2 C.B. 1035.

The 2009 model APA agreement appears in this report as Appendix 1. In the fall of 2017, APMA solicited comments on a proposed major revision. A list of primary APMA contacts is available at https://www.irs.gov/businesses/corporations/apma-contacts.

[Pub. L. 106–170 § 521(b)(2)(C)(i–viii)]

The table above illustrates the number of complete applications filed per year. As of December 31, 2017, APMA had also received 37 user fee filings that were not yet accompanied by substantially complete APA applications, in addition to the 101 complete APA applications.

Of the 116 agreements executed in 2017, 40 percent were new APAs (i.e., not a renewal of a prior APA). This is consistent with prior years.

As the chart above illustrates, nearly three quarters of the total number of bilateral APAs executed in 2017 involved the United States entering into mutual agreements with either Japan or Canada.

The number of pending APAs has continued to decline since 2015 with Japan, India, and Canada accounting for more than half of all pending bilateral APAs.

[Pub. L. 106–170 § 521(b)(2)(D) and (E)]

Nature of the Relationships

§ 521(b)(2)(D)(i)

 

As in prior years, more than half of the APAs executed in 2017 involved transactions between non-U.S. parents and U.S. subsidiaries.

§ 521(b)(2)(D)(ii–iii)

Although most of the transactions^[3] covered in APAs executed in 2017 involve the sale of tangible goods and the provision of services, over 20% covered the use of intangible property, which can be among the most challenging in APMA’s inventory. The IRS continues to seek opportunities to work with taxpayers and treaty partners to provide prospective certainty, wherever appropriate, for transactions involving the use of intangible property.

In the majority of APAs, the covered transactions involve numerous business functions and risks. For instance, with respect to functions, APAs involving manufactured products typically involve a controlled group that conducts research and development (R&D), engages in product design and engineering, manufactures the product, markets and distributes the product, and performs support functions such as legal, finance, and human resources services. Regarding risks, the controlled group may assume a variety of risks, including market risks, R&D risks, financial risks, credit and collection risks, product liability risks, and general business risks. In the APA evaluation process, a significant amount of time and effort is devoted to understanding how the functions and risks are allocated amongst the controlled group of companies that are party to the covered transactions. Generally, for methods requiring selection of a tested party, the tested party that is chosen will be the least complex of the controlled taxpayers.

Over three quarters of the tested parties in 2017^[4] were U.S. distributors, U.S. manufacturers, or U.S. service providers.

§ 521(b)(2)(D)(iv)

Consistent with prior years, in 2017, the primary transfer pricing method (TPM) used for both the sale of tangible property and the use of intangible property was the comparable profits method/transactional net margin method (CPM/TNMM). The CPM/TNMM was used for 87 percent of transfers of tangible and intangible property while all other methods combined accounted for the other 13 percent of such transactions.

For covered transfers of tangible and intangible property that used the CPM/TNMM, the operating margin (OM) continues to be the most common profit level indicator (PLI) used to benchmark results. It was used 85 percent of the time. Other PLIs, such as the Berry Ratio and return on assets or capital employed, made up the other 15 percent. As used here, OM means the ratio of operating profits to sales,^[5] and “Berry Ratio” means the ratio of gross profit to operating expenses.^[6] Most services transactions (86 percent) also used the CPM/TNMM, and the OM was also the most common PLI (used 62 percent of the time).^[7]

§ 521(b)(2)(D)(v–vii)

For the APAs executed in 2017 that used external comparable data in the analysis, the most widely used data source for comparables was Standard and Poor’s Compustat/Capital IQ database. Other sources were also used in appropriate cases (e.g., where the tested party was not the U.S. entity or where transaction-based methods were applied). The other more commonly used databases are listed in the table below.

In making comparability adjustments, the standard balance sheet adjustments identified in Treas. Reg. § 1.482–1(d) and § 1.482–5(c), including adjustments for differing amounts of payables, receivables, and inventory, were made in the majority of cases. Where appropriate, adjustments for different accounting practices were made to convert from LIFO to FIFO inventory accounting, and a small number of cases also involved the accounting reclassification of expenses, e.g., from COGS to operating expenses.

§ 521(b)(2)(D)(viii–ix)

Most transactions covered in APAs target an interquartile range as described in Treas. Reg. § 1.482–1(e)(2)(iii)(C). Where the transaction involves a royalty payment for the use of intangible property, both specific royalty rates and ranges have been used. Where the covered transaction is the payment of a royalty based solely on external royalty agreements, a secondary method, e.g., a test of the post-royalty operating margin or cost-plus mark-up, has been used. The testing periods of the APAs executed in 2017 were either: (1) a single year, (2) the term of the APA only, or (3) the term of the APA plus rollback years.

APAs executed in 2017 included several mechanisms for making adjustments to tested party results when the results fall outside the range or do not match the point required by the APA. The following are examples of the mechanisms used: an adjustment bringing the tested party’s results to the closest edge of the range applied to the results of a single year; an adjustment to the closer edge of the range applied to the results over the APA term; an adjustment to the specified point or royalty rate; or an adjustment to the median of the range for a single year.

§ 521(b)(2)(D)(v)

The model APA used by the IRS (included as Appendix 1 of this report) includes a standard critical assumption that there will be no material changes to the taxpayer’s business or to its tax or financial accounting practices during the APA term. A few bilateral cases have also included critical assumptions tied either to the taxpayer’s profitability in a certain year or over the term of the APA, or to the amount of non-covered transactions as a percentage of the taxpayer’s revenue. Pursuant to § 7.06(3) of Rev. Proc. 2015–41, 2015 I.R.B. 263, APMA will cancel an APA in the event of a failure of a critical assumption unless the parties agree to revise the APA.

§ 521(b)(2)(D)(x)

As described in § 3.03(1) of Rev. Proc. 2015–41, taxpayers should request an APA term that would cover at least five prospective years and may also request that the APA be “rolled back” to cover one or more earlier taxable years, although the appropriate APA term is decided on a case-by-case basis. Of the APAs executed in 2017, 22 percent included rollback years. A substantial number of those APAs with terms of greater than five years were submitted as a request for a five-year term, and the additional years were agreed to between the taxpayer and the IRS (or, in the case of a bilateral APA, between the IRS and the foreign government upon the taxpayer’s request) to ensure a reasonable amount of prospectivity in the APA term.

§ 521(b)(2)(E)

The median time required to complete an APA in 2017 increased slightly (32.8 months in 2016 versus 33.8 in 2017).

§ 521(b)(2)(F)

As described in § 7.02(1) of Rev. Proc. 2015–41, taxpayers are required to file annual reports to demonstrate compliance with the terms and conditions of their APA. The filing and review of these annual reports are critical parts of the APA process. Through annual report review, the APMA Program monitors taxpayer compliance with APAs on a contemporaneous basis. Annual report review also provides current information on the success or problems associated with the various TPMs adopted in the APA process.

§ 521(b)(2)(D)(xi)

APAs require taxpayers to file timely and complete annual reports describing their operations and demonstrating compliance with the APA’s terms and conditions. Not every annual report will include each of the items listed in the following table^[8]; they are required where the facts demonstrate a need for such documentation.

§ 521(b)(2)(D)(xii)

In appropriate cases, APAs may provide specific approaches for dealing with risks, including currency risk, such as adjustment mechanisms and/or critical assumptions.

[§ 521(b)(2)(B)]

between

[Insert Taxpayer’s Name]

and

THE INTERNAL REVENUE SERVICE

The Parties to this Advance Pricing Agreement (APA) are the Internal Revenue Service (IRS) and [Insert Taxpayer’s Name], EIN ________.

[Insert Taxpayer Name] is the common parent of an affiliated group filing consolidated U.S. tax returns (collectively referred to as “Taxpayer”), and is entering into this APA on behalf of itself and other members of its consolidated group.

Taxpayer’s principal place of business is [City, State]. [Insert general description of taxpayer and other relevant parties].

This APA contains the Parties’ agreement on the best method for determining arm’s-length prices of the Covered Transactions under I.R.C. section 482, the Treasury Regulations thereunder, and any applicable tax treaties.

{If renewal, add} [Taxpayer and IRS previously entered into an APA covering taxable years ending _____ to ______, executed on ________.]

The Parties agree as follows:

The Parties have executed this APA on the dates below.

[Taxpayer Name in all caps]

By: ___________________________ Date: ___________________, 201___

Jane Doe

Sr. Vice President (Taxes)

IRS

By: ___________________________ Date: ___________________, 201___

John C. C. Hughes

Director, Advance Pricing and Mutual Agreement Program

COVERED TRANSACTIONS AND TRANSFER PRICING METHOD (TPM)

For any APA Year, if the results of Taxpayer’s actual transactions produce a [price per unit, royalty rate for the Covered Transactions] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] within the Arm’s Length Range, then the amounts reported on Taxpayer’s U.S. Return must clearly reflect such results.

For any APA year, if the results of Taxpayer’s actual transactions produce a [price per unit, royalty rate] [or] [Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin for the Tested Party] outside the Arm’s Length Range, then amounts reported on Taxpayer’s U.S. Return must clearly reflect an adjustment that brings the [price per unit, royalty rate] [or] [Tested Party’s Gross Margin, Cost Plus Markup, Berry Ratio, Operating Margin, Three-Year Rolling Average Operating Margin] to the Median.

For purposes of this Appendix A, the “results of Taxpayer’s actual transactions” means the results reflected in Taxpayer’s and Tested Party’s books and records as computed under U.S. GAAP [insert another relevant accounting standard if applicable], with the following adjustments:

(a) [The fair value of stock-based compensation as disclosed in the Tested Party’s audited financial statements shall be treated as an operating expense]; and

(b) To the extent that the results in any prior APA Year are relevant (for example, to compute a multi-year average), such results shall be adjusted to reflect the amount of any adjustment made for that prior APA Year under this Appendix A.

5. APA Revenue Procedure Treatment

If Taxpayer makes an adjustment under paragraph 4 of this Appendix A (a “primary adjustment”), Taxpayer and its related foreign entity may elect APA Revenue Procedure Treatment in accordance with section 11.02(3) of Revenue Procedure 2006–9 and avoid the possible adverse tax consequences of a secondary adjustment that would otherwise follow the primary adjustment.

[Insert additional provisions as needed.]

CRITICAL ASSUMPTIONS

This APA’s critical assumptions are:

1. The business activities, functions performed, risks assumed, assets employed, and financial and tax accounting methods and classifications [and methods of estimation] of Taxpayer in relation to the Covered Transactions will remain materially the same as described or used in Taxpayer’s APA Request. A mere change in business results will not be a material change.

[Insert additional provisions as needed.]

APA RECORDS AND ANNUAL REPORT

The APA Records will consist of all documents listed below for inclusion in the Annual Report, as well as all documents, notes, work papers, records, or other writings that support the information provided in such documents.

The Annual Report (and each of the four copies required by paragraph 5(e) of this APA) will include:

DEFINITIONS

The following definitions control for all purposes of this APA. The definitions appear alphabetically below:

The APA Annual Report Summary on the next page is a required APA Record. The APA Team Leader supplies some of the information requested on the form. Taxpayer is to supply the remaining information requested by the form and submit the form as part of its Annual Report.