When considering the consequences of non-compliance with terms and conditions of an existing APA, tax administrations should adopt a similar approach to situations where there is a failure to meet critical assumptions. For example, when determining their response, tax administrations should consider (i) the terms of the APA; (ii) any agreement between relevant tax administrations as to how to deal with non-compliance; and (iii) any applicable domestic law or procedural provisions.54 54 Paragraph 74 of Annex II to Chapter IV of the OECD TPG ...

Where the critical assumptions of an APA are breached, it is important that taxpayers collect and provide tax administrations with relevant supporting documentation. Depending on the particular critical assumption and other facts and circumstances, this could include, but may not be limited to: A description of the narrowest relevant taxpayer business segment tracked by management that encompasses the entities and covered transactions involved in the APA. Forecast and actual business segment profits for the financial years ending with or within financial years affected by COVID-19. Copies showing any proposed or implemented modifications to pre-existing agreements or of new intercompany contracts among the controlled parties affecting the covered transactions. A narrative explaining the anticipated effects of the current economic conditions on an agreed transfer pricing methodology during the financial years affected by COVID-19 including whether it caused restructuring of its operations and/or changes in its risks and responsibilities, and any mitigation of the impact of the current economic conditions on the tested party by government actions or other mechanisms such as business interruption insurance. The explanation must adequately demonstrate that the impact is attributable to the economic condition during the COVID- 19 pandemic, as a mere change in business results may be caused by other factors in a taxpayer’s business and accordingly may not constitute a breach of a critical assumption. A detailed profit and loss statement (“P&L”) with a breakdown of cost of goods sold (“COGS”) and selling, general and administrative expenses (“SG&A”) and other non-interest expenses for financial years affected by COVID-19 that include the covered transactions subject to the APA. The detailed P&L may include exceptional operating costs arising from COVID-19 or income from government assistance programme, including explanation on the accounting treatment of such costs or income. Information about third party behaviour ...

The timing for addressing the terms of APAs impacted by COVID-19 is important. Where material changes in economic conditions lead to the breach of one or more of the critical assumptions, taxpayers should notify the relevant tax administrations as soon as practicable after the change occurs, or the taxpayer becomes aware of the change. Early notification is encouraged in order to give the affected parties more time to try to reach agreement on revising the APA, thereby reducing the likelihood of cancellation ...

In the context of the COVID-19 pandemic, there are two situations which may lead to cancelling an APA when it is established that: in FY2020 (i) there is a material breach in an APA’s critical assumption as a result of a change in economic circumstances; or, (ii) the taxpayer failed to materially comply with any term or condition of the APA. Cancellation would not, however, be automatic and the tax administration may waive cancellation under certain circumstances.52 Cancellation would have the effect of ending an APA on an agreed date or from a particular tax year or accounting period (e.g. after FY2019). 52 Paragraph 81 Annex II to Chapter IV of the OECD TPG ...

In some situations, the APA agreement, domestic law or procedural provisions may prescribe procedures to follow, or describe the consequences that will arise, in situations where there is a failure to fulfil critical In these situations, tax administrations should follow the prescribed procedures.46 In other situations, tax administrations may have some discretion over their response.47 Also in the event that the effect of the breach is not material, (Paragraph 75 of the Annex II to Chapter IV of the OECD TPG), the taxpayer and tax administration may agree to continue to apply the APA In the case of bilateral or multilateral APAs, a common and helpful practice is for the tax administrations to consult before imposing any unilateral changes,48 and such consultation is mandated in some APAs.49 In the absence of other rules and procedures prescribed by domestic law, when the guidance in Chapter IV of the OECD TPG apply , a breach of critical assumption with the APA could have three potential outcomes as provided in section E.3 Annex II to Chapter IV of OECD TPG:50 Revision, which means that the taxpayer and tax administrations still have the benefit of the APA for the whole of the proposed period, albeit that different terms apply before and after the revision date. Cancellation, which means the APA is treated as being effective and in force but only up to the cancellation date and not for the whole of the proposed period. Revocation, which has the effect that the taxpayer is treated as if the APA had never been entered into. 46 Paragraph 74 of Annex II to Chapter IV of the OECD TPG. 47Paragraph 66 of Annex II to Chapter IV of the OECD TPG, item e) (breach of critical assumption would “trigger renegotiation of the agreement”). 48 Paragraph 75 of Annex II to Chapter IV of the OECD TPG (considering what “the tax administrations determine”). 49 Paragraph 66 of Annex II to Chapter IV of the OECD TPG, item e) (breach of critical assumption would “trigger renegotiation of the agreement”). 50 Paragraph 76 of Annex II to Chapter IV of the OECD TPG ...

When considering the consequences of the failure to meet critical assumptions, tax administrations and taxpayers should consider the (i) terms of the APA; (ii) any agreement between relevant tax administrations as to how to deal with the failure; and (iii) any applicable domestic law or procedural provisions.45 This section follows the guidance in Chapter IV, Section F and Annex II to Chapter IV of the OECD TPG. 45 Paragraph 74 of Annex II to Chapter IV of the OECD TPG ...

Where tax administrations establish that the critical assumptions of an APA have not been breached, the existing APA, as agreed, must continue to be respected, maintained and upheld. If a taxpayer believes that the terms of the APA are no longer appropriate, it should not seek unilaterally to breach critical assumptions deliberately or fail to comply with the terms or conditions of the APA, and it should avoid making unreliable price adjustments or taking other actions that are not consistent with (or otherwise fail to comply with) the terms of the APA that it may view as not appropriate. Instead, where taxpayers have concerns, they should approach the relevant tax administration in a transparent way to discuss their concerns ...

Whether there has been a breach in a critical assumption should be analysed on a case-by-case basis, and it should take into account the individual circumstances of the taxpayer and commercial environment. The COVID-19 pandemic has not had the same impact on all enterprises. While many industries and business have experienced a drop in demand and revenues because of forced lockdowns, others have expanded their consumer-base or benefitted from new business opportunities. Whether a breach has occurred may also depend on the duration of the disruption. If a breach has occurred, in determining an appropriate response, a tax administration should carefully consider the extent of the divergence between the agreed parameters in the APA and the new parameters under the COVID-19 economic circumstances43; and, the ability of the agreed transfer pricing methodology to reliably reflect arm’s length pricing of a controlled transaction under the new situation.44 43 Paragraph 45 of Annex II to Chapter IV of the OECD TPG. 44 Paragraph 43 of Annex II to Chapter IV of the OECD TPG ...

Most APAs include critical assumptions about the operational and economic conditions that will affect the transactions covered by the APA. The COVID-19 pandemic and the response of governments have dramatically affected the economic and market conditions and are likely to qualify as a breach of the critical assumptions (para. 44 b) and c) of Annex II to Chapter IV of the OECD TPG). A mere change in business results during the period affected by the COVID-19 pandemic would not, however, result in a breach of a critical assumption (unless the particular APA had a critical assumption regarding changes in business results) ...

Generally, the APA itself will explicitly describe what constitutes a situation of non-compliance or failure to meet a critical assumption, as well as the consequences arising from it. Also, domestic law or procedural provisions may also impose consequences or obligations on the taxpayer and affected tax administrations. All this should be considered by taxpayers and tax administrations in determining the impact of the COVID-19 pandemic on existing APAs ...

Yes, existing APAs and their terms should be respected, maintained and upheld, unless a condition leading to the cancellation or revision of the APA (e.g. breach of critical assumptions) has occurred. Taxpayers and tax administrations cannot automatically disregard or alter the terms of existing APAs due to the change in economic circumstances. 42 In considering how to respond to the impact of COVID-19 on existing APAs, the guidance provided, in Annex II to Chapter IV of the OECD TPG: Guidelines for Conducting Advance Pricing Arrangements under the Mutual Agreement Procedure (MAP APAs) is relevant ...