Legal Definitions - unilateral advance pricing agreement

A unilateral advance pricing agreement is a formal contract between a single taxpayer (a company) and a single tax authority (the government tax agency of one country). This agreement establishes a specific method for determining the prices of transactions between related entities within that company (e.g., a parent company and its subsidiary) for future tax periods. The primary goal is to provide certainty and prevent disputes regarding "transfer pricing," which is how profits are allocated between different parts of a multinational company operating in various countries.

The term "unilateral" signifies that only one country's tax authority is a party to the agreement. This means the agreement provides tax certainty for the company within that specific country, even if the transactions involve entities located in other nations. This type of agreement contrasts with bilateral or multilateral advance pricing agreements, which involve multiple tax authorities from different countries.

• Example 1: A large technology company based in the United States manufactures specialized components and sells them to its wholly-owned assembly plant in Vietnam. To avoid potential disputes with the U.S. Internal Revenue Service (IRS) regarding the pricing of these components, the U.S. parent company enters into a unilateral advance pricing agreement with the IRS. This agreement specifies the methodology for pricing the components sold to the Vietnamese subsidiary, ensuring the U.S. company's tax reporting for these transactions is accepted by the IRS for a set number of years.

  Explanation: This example illustrates a single company (the U.S. tech company) agreeing with a single tax authority (the IRS) on how to price its transactions with a foreign subsidiary. The agreement provides certainty for the U.S. company's tax obligations in the United States, without involving the Vietnamese tax authorities.

• Example 2: A German pharmaceutical company conducts extensive research and development (R&D) in Germany and then licenses the resulting intellectual property (IP) to its marketing and distribution subsidiary in Ireland. The German tax authority wants to ensure that the German R&D entity is adequately compensated for its contributions when the IP is transferred or licensed. The German parent company seeks a unilateral advance pricing agreement with the German tax authority to establish an acceptable method for valuing these IP transfers and royalty payments for German tax purposes.

  Explanation: Here, the German company and the German tax authority agree on a transfer pricing methodology for IP, providing clarity and preventing disputes solely from the German tax perspective. The Irish tax authority is not a party to this specific agreement.

• Example 3: A Japanese automotive parts manufacturer sources raw materials globally, processes them in Japan, and then sells the finished parts to its assembly plants located in various countries, including Mexico. The Japanese manufacturer wants to ensure that the profit margins it reports on sales to its Mexican plant are considered fair and arm's length by the National Tax Agency of Japan. It secures a unilateral advance pricing agreement with the Japanese tax authority to define the pricing method for these intercompany sales for future tax periods.

  Explanation: This scenario demonstrates a Japanese company and its domestic tax authority agreeing on the pricing of goods sold to a foreign subsidiary. The agreement focuses exclusively on the Japanese tax implications and provides certainty for the manufacturer within Japan's tax jurisdiction.