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Simple English definitions for legal terms
advance pricing agreement
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A quick definition of advance pricing agreement:
An advance pricing agreement is a deal made between a big company that operates in different countries and the tax authorities of those countries. The agreement decides how the company will calculate the prices of goods or services that it transfers between its different branches in different countries. The purpose of the agreement is to avoid double taxation, which means paying taxes twice on the same income. There are different types of advance pricing agreements, depending on how many tax authorities are involved. However, if a tax authority is not part of the agreement, it can still decide to tax the company differently.
A more thorough explanation:
An advance pricing agreement (APA) is a binding arrangement made between a multinational company and one or more national tax authorities. The purpose of this agreement is to determine the method that the company will use to calculate transfer prices, with the aim of reducing or eliminating double taxation.
There are three types of APAs:
- Unilateral APA: An agreement made between a company and one tax authority.
- Bilateral APA: An agreement made between a company and two tax authorities.
- Multilateral APA: An agreement made between a company and more than two tax authorities.
It's important to note that a tax authority that is not a party to the agreement is not bound by the transfer-pricing method specified in the agreement.
Let's say a multinational company has subsidiaries in two countries, Country A and Country B. The company wants to ensure that it doesn't pay taxes on the same income twice, so it enters into a bilateral APA with the tax authorities in both countries. The APA specifies the transfer-pricing method that the company will use to calculate the prices at which it transfers goods or services between its subsidiaries in Country A and Country B.
Another example could be a company that operates in multiple countries and wants to avoid disputes with tax authorities over transfer pricing. The company could enter into a multilateral APA with the tax authorities in all the countries where it operates. The APA would specify the transfer-pricing method that the company will use to calculate the prices at which it transfers goods or services between its subsidiaries in different countries.
These examples illustrate how APAs can help multinational companies avoid double taxation and reduce the risk of disputes with tax authorities over transfer pricing.