Legal Definitions - bilateral advance pricing agreement

A bilateral advance pricing agreement is a formal contract between a multinational company and the tax authorities of two different countries. This agreement establishes a specific method for determining the price of transactions (known as "transfer prices") between related entities within that company group across borders. The purpose is to ensure that these transactions are priced fairly, as if they were conducted between independent parties, thereby preventing disputes over taxation and avoiding the company being taxed twice on the same income in different countries. It provides certainty for the company regarding its tax obligations for future periods.

• Scenario: Cross-Border Manufacturing and Distribution

  A large electronics company, headquartered in Japan, manufactures specialized components through its subsidiary in Vietnam. These components are then sold to its parent company in Japan, which assembles them into final products for global distribution. To ensure fair pricing for the components transferred from Vietnam to Japan, the company seeks a bilateral advance pricing agreement.

  Illustration: This agreement would involve the Japanese tax authority and the Vietnamese tax authority. They would jointly review and approve a method for calculating the transfer price of the components. This prevents both countries from later claiming that the components were underpriced or overpriced, which could lead to double taxation for the company or disputes between the tax agencies.

• Scenario: Intra-Group Services and Intellectual Property

  A global pharmaceutical firm has its research and development (R&D) hub in Switzerland, where it develops new drug formulas. Its marketing and sales operations are primarily managed by a subsidiary in the United States, which also holds the licenses for distributing these drugs. The Swiss R&D entity charges the U.S. subsidiary for the use of its intellectual property and R&D services.

  Illustration: To avoid potential disagreements with tax authorities in both countries regarding the appropriate royalty rates for intellectual property and service fees, the pharmaceutical firm enters into a bilateral advance pricing agreement. This involves the Swiss Federal Tax Administration and the U.S. Internal Revenue Service (IRS) agreeing on a methodology to determine these charges, providing tax certainty for both the Swiss and U.S. operations.

• Scenario: Centralized IT Services

  An international banking group operates a centralized IT support center in India that provides services to all its branches and subsidiaries worldwide, including a significant operation in the United Kingdom. The Indian IT center charges its UK counterpart for these essential services.

  Illustration: To pre-empt any disputes over the arm's length (fair market) price for these IT services, the banking group pursues a bilateral advance pricing agreement. This agreement would involve the Indian tax authorities and His Majesty's Revenue and Customs (HMRC) in the UK. By establishing an agreed-upon pricing method, the bank ensures that both countries accept the charges, preventing double taxation and providing predictability for its tax planning.