Risk Transfer Valuation in Advance Pricing Agreements between Multinational Enterprises and Tax Authorities

Abstract:     
Advance pricing agreements are long-term contracts between multinational taxpayers and tax authority(ies), according to which the taxpayer consents to use the agreed upon transfer price for its related transactions for a fixed period of time. We argue that for such an agreement to be based on the principle of arm’s length, the specified transfer price(s) should include a premium that captures the risk transferred from one entity to another. When this risk is not accounted for, the long-term transfer pricing policy specified in the agreement (although supported by tax authorities) is not arm’s length. We present a pricing model that can be easily applied to value such risk and provide an example using real data from U.S. industry.

Number of Pages in PDF File: 26

Keywords: Transfer Pricing, Advance Pricing Agreement, Risk Valuation, Multinational Enterprise, Intercompany Transaction

JEL Classification: G38, K29, K34, M41, M42

working papers series