a-01-32.pdf

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ANNOUNCEMENT AND REPORT
CONCERNING
ADVANCE PRICING AGREEMENTS
March 30, 2001
This Announcement is issued pursuant to § 521(b) of Pub. L. 106-170, the Ticket to Work and
Work Incentives Improvement Act of 1999, requiring that the Secretary of the Treasury annually
report to the public concerning Advance Pricing Agreements (APAs) and the APA Program.
The first report, in Announcement 2000-35, 2000-1 C.B. 922, covered calendar years 1991
through 1999. This second report describes the experience of the APA Program during calendar
year 2000 consistent with the mandate of § 521(b). This document does not provide general
guidance regarding the application of the arm’s length standard; rather, it reports on the structure
and activities of the APA program.
Sean F. Foley
Director, Advance Pricing Agreement Program
Background
IRC § 482 provides that the Secretary may distribute, apportion, or allocate gross income,
deductions, credits, or allowances between or among two or more commonly controlled
businesses if necessary to reflect clearly the income of such businesses. Under the regulations,
the standard to be applied in determining the true taxable income of a controlled business is that
of a business dealing at arm’s length with an unrelated business. The arm’s length standard also
has been adopted by the international community and is incorporated into the transfer pricing
guidelines issued by the Organization for Economic Cooperation and Development (OECD).
OECD, T
RANSFER PRICING GUIDELINES FOR MULTINATIONAL ENTERPRISES AND TAX
ADMINISTRATORS (1995). Transfer pricing issues by their nature are highly factual and have
traditionally been one of largest issues identified by the IRS in its audits of multinational
corporations. The Advance Pricing Agreement (APA) Program is designed to resolve actual or
potential transfer pricing disputes in a principled, cooperative manner, as an alternative to the
traditional adversarial process. An APA is a binding contract between the IRS and a taxpayer by
which the IRS agrees not to seek a transfer pricing adjustment under IRC § 482 for a covered
transaction if the taxpayer files its tax return for a covered year consistent with the agreed
transfer pricing method. In year 2000, the IRS and taxpayers executed 63 APAs.

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Since 1991, with the issuance of Rev. Proc. 91-22, 1991-1 C.B. 526, the IRS has offered
taxpayers through the APA Program the opportunity to reach an agreement in advance of filing a
tax return on the appropriate transfer pricing methodology (TPM) to be applied to related party
transactions. In 1996, the IRS issued internal procedures for processing APA requests. Chief
Counsel Directives Manual (CCDM), ¶¶ (42)(10)10 –(42)(10)(16)0 (November 15, 1996). Also
in 1996, the IRS updated Rev. Proc. 91-22 with the release of Rev. Proc. 96-53, 1996-2 C.B.
375. The APA Program continues to operate under the provisions of Rev. Proc. 96-53, which
provides taxpayers with instructions of how to apply for an APA, and what to expect in the
processing of the case. In an effort to encourage taxpayers to utilize the APA process, in 1997
the IRS instituted an Early Referral Program by which, in appropriate cases, field examination
teams may suggest to taxpayers that APAs be pursued before substantial time is spent examining
transfer pricing issues. In addition, in 1998, the IRS published Notice 98-65, 1998-2 C.B. 803,
which set forth streamlined APA procedures for Small Business Taxpayers (SBTs). That Notice
also expanded the availability of the lowest APA user fee in an effort to attract taxpayers who
may not have the resources to do the sophisticated economic studies normally required in APA
submissions.
Advance Pricing Agreements
An APA generally combines an agreement between a taxpayer and the IRS on an appropriate
transfer pricing methodology (TPM) for the transactions at issue (Covered Transactions) with an
agreement between the U.S. and one or more foreign tax authorities (under the authority of the
mutual agreement process of our income tax treaties) that the TPM is correct. With such a
“bilateral” APA, the taxpayer ordinarily is assured that the income associated with the Covered
Transactions will not be subject to double taxation by the IRS and the foreign tax authority. It is
the policy of the United States, as set forth in § 7 of Rev. Proc. 96-53 to encourage taxpayers that
enter the APA program to seek bilateral or multilateral APAs when competent authority
procedures are available with respect to the foreign country or countries involved. However, the
IRS may execute an APA with a taxpayer without reaching a competent authority agreement (a
“unilateral” APA).
A unilateral APA is an agreement between a taxpayer and the IRS establishing an approved
transfer pricing methodology for U.S. tax purposes. A unilateral APA binds the taxpayer and the
IRS, but obviously does not prevent foreign tax administrations from taking different positions
on the appropriate transfer pricing methodology for a transaction. As stated in Rev. Proc. 96-53,
should a transaction covered by a unilateral APA be subject to double taxation as the result of an
adjustment by a foreign tax administration, the taxpayer may seek relief by requesting that the
U.S. competent authority consider initiating a mutual agreement proceeding, provided there is an
applicable income tax treaty in force with the other country.
The APA Program
APAs are negotiated with the taxpayer by an IRS team headed by an APA team leader. As of
December 31, 2000, the APA program had 16 team leaders, of whom 14 were attorneys and 2

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were former international examiners. The team leader is responsible for organizing the IRS APA
team, arranging meetings with the taxpayer, securing whatever information is necessary from the
taxpayer to analyze the taxpayer’s related party transactions, analyzing the available facts under
the arm’s length standard of § 482 and the regulations, and negotiating with the taxpayer.
The APA team generally includes an economist, an international examiner and, in a bilateral
case, a competent authority analyst who leads the discussions with the treaty partner. The
economist may be from the APA Program or from the IRS field organization. The APA team
may include LMSB field counsel, other LMSB exam personnel, and an appeals officer.
The APA Process
The APA process is voluntary. Taxpayers submit an application for an APA, together with a
user fee as set forth in Rev. Proc. 96-53. The APA process can be broken into five phases: (1)
application; (2) due diligence; (3) analysis; (4) discussion and agreement; and (5) drafting and
execution.
(1)The APA Application
In many APA cases, the taxpayer’s application is preceded by a pre-file conference with the
APA staff in which the taxpayer can solicit the informal views of the APA Program. Pre-file
conferences can occur on an anonymous basis, although a taxpayer must disclose its identity
when it applies for an APA. The APA Program’s jurisdiction over a particular year is
established by the filing of the appropriate user fee on or before the due date of the tax return for
that year. Many taxpayers file a user fee first and then follow up with a full application later.
The procedures for pre-file conferences, user fees, and delayed applications can be found in Rev.
Proc. 96-53.
The APA application can be a relatively modest document for a small business taxpayer
consisting of about 30 to 50 pages. Notice 98-65 describes the special APA procedures for small
businesses. For most taxpayers, however, the APA application is a substantial document filling
several binders. The APA Program makes every effort to reach agreement on the basis of the
taxpayer's application. Two recent applications from two taxpayers in the same industry
illustrate this point. Each taxpayer has proposed differing algorithms, within the same transfer
pricing method, for valuing a service associated with the development of a product. The APA
Program believes that both algorithms, if applied correctly, should converge and provide an
accurate measure of the value of the service. As a consequence, the APA Program will work
with both algorithms proposed by the two taxpayers, and will not insist that taxpayers adopt one
algorithm over another.
The application is assigned to an APA team leader who will be responsible for the case. The
APA team leader’s first responsibility is to organize the APA team. This involves contacting the
appropriate LMSB International Territory manager to secure the assignment of an international

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examiner to the APA case and the LMSB Counsel’s office to secure a Division Counsel lawyer.
In a bilateral case, the U.S. Competent Authority will assign a competent authority analyst to the
team. In a large APA case, the international examiner may invite his or her manager and other
LMSB personnel familiar with the taxpayer to join the team. When the APA may affect taxable
years in Appeals, the appropriate appellate conferee will be invited to join the team. The APA
team leader will then distribute copies of the APA application to all team members and will set
up an opening conference with the taxpayer. The APA office strives to hold this opening
conference within 45 days of the receipt of the complete application. At the opening conference,
the APA team leader will propose a schedule designed to complete the recommended U.S.
negotiating position for a bilateral APA within 9 months from the date the full application was
filed and to complete a unilateral APA within 12 months from the application date.
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(2)Due Diligence
The APA team must satisfy itself that the relevant facts submitted by the taxpayer are complete
and accurate. This due diligence aspect of the APA is vital to the process. It is because of this
due diligence that the IRS can reach advance agreements with taxpayers in the highly factual
setting of transfer pricing. Due diligence can proceed in a number of ways, but in a large case
the taxpayer and the APA team typically will agree to a meeting, or more often to a series of
meetings on dates, established in the opening conference. In advance of the meeting, the APA
team leader will submit a list of questions to the taxpayer for discussion at the meeting. The
meeting may result in a second set of questions. These questions from the IRS are developed
jointly by the APA team leader and the IRS field. It is important to note that this due diligence is
not an audit and is focused only on the transfer pricing issues associated with the transactions in
the taxpayer’s application, or such other transactions that the taxpayer and the IRS may agree to
add.
(3) Analysis
A significant part of the analytical work associated with an APA is done typically by the APA or
IRS field economist assigned to the case. The analysis may result in the need for additional
information. Once the APA team has completed its due diligence and analysis, the APA team
leader will begin negotiations with the taxpayer over the various aspects of the APA including
the selection of comparable transactions, asset intensity and other adjustments, the transfer
pricing methodology, which transactions to cover, the appropriate critical assumptions, the APA
term, and other key issues. The APA team leader will discuss particularly difficult issues with
his or her managers, but in the main the APA team leader is empowered to negotiate the APA.
(4) Discussion and Agreement

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The average time for completing a negotiating position in year 2000 was 16.1 months for a new APA. Although
statistics regarding negotiating positions were not published for year 1999, 16.1 months, represents an improvement
and progress towards this goal compared to past years. A similar improvement was seen with unilateral APAs, with
an average processing time of 14.1 months for year 2000, as compared to 18.9 months for year 1999.

5
This phase differs for bilateral and unilateral cases. In a bilateral case, the discussions proceed in
two parts and involve two IRS offices -- the APA Program and the U.S. Competent Authority.
In the first part, the APA team will attempt to reach a consensus with the taxpayer regarding the
recommended position that the U.S. Competent Authority should take in negotiations with its
treaty partner. This recommended U.S. negotiating position is a paper drafted by the APA team
leader and signed by the Associate Chief Counsel (International) or his designee that provides
the APA Program’s view of the best transfer pricing methodology for the covered transaction,
taking into account the IRC, the Treasury regulations, the relevant tax treaty, and the U.S.
Competent Authority’s experience with the treaty partner.
The experience of the APA office and the U.S. Competent Authority is that APA negotiations
are likely to proceed more rapidly with a foreign competent authority if the taxpayer fully
supports the U.S. negotiating position. Consequently, the APA Office works together with the
taxpayer in developing the recommended U.S. position. On occasion, the APA team will agree
to disagree with a taxpayer. In these cases, the APA office will send a recommended U.S.
negotiating position to the U.S. Competent Authority that includes elements with which the
taxpayer does not agree. This disagreement is noted in the paper. The APA team leader also
solicits the views of the field members of the APA team, and, in the vast majority of APA cases,
the international examiner, LMSB field counsel, and other IRS field team members concur in the
position prepared by the APA team leader.
Once the APA Program completes the recommended U.S. negotiating position, the APA process
shifts from the APA Program to the U.S. Competent Authority. The U.S. Competent Authority
analyst assigned to the APA will take the recommended U.S. negotiating position and prepare
the final U.S. negotiating position which is then transmitted to the foreign competent authority.
The negotiations with the foreign competent authority are conducted by the U.S. Competent
Authority analyst, most often in face-to-face negotiating sessions conducted periodically
throughout the year. At the request of the U.S. Competent Authority analyst, the APA team
leader often will continue to assist the negotiations.
In unilateral APA cases, the discussions proceed solely between the APA Program and the
taxpayer. In a unilateral case, the taxpayer and the APA Program must reach agreement to
conclude an APA. Like the bilateral cases, the APA team leader almost always will achieve a
consensus with the IRS field personnel assigned to the APA team regarding the final APA. The
APA Program has a procedure in which the IRS field personnel are solicited formally for their
concurrence in the final APA. This concurrence, or any items in disagreement, are noted in a
cover memorandum prepared by the APA team leader that accompanies the final APA sent
forward for execution by the Associate Chief Counsel (International) or his designee.
(5)Drafting and Execution
Once the IRS and the taxpayer reach agreement, the drafting of the final APA generally takes
little time because the APA Program has developed standard language that is incorporated into
every APA. The current version of this language is found in Attachment A. As noted above,

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APAs are executed by the Associate Chief Counsel (International) or his designee for the IRS.
The APA is executed for the taxpayer by an appropriate corporate officer.
The Current APA Office Structure, Composition, and Operation
For the past three years, the APA Office has been structured into two branches, each staffed with
a mix of APA team leaders, economists, and support staff and headed by a branch chief. The
two branch chiefs report to the Director, APA. As of December 31, 2000, the APA staff was as
follows:
Director’s Office
1 Director
1 Secretary to the Director
Branch 1
1 Branch Chief (vacant)
1 Secretary
11 Team Leaders
1 Economist
Branch 2
1 Branch Chief
1 Secretary
5 Team Leaders
2 Economists
1 Paralegal
The APA staffing grew modestly in 2000, rising from 23 persons at the end of 1999 to 25 as of
December 31, 2000. The APA Office, however, had significant turnover in the past year. Of the
25 members of the APA staff, 9 were new to the program in 2000, replacing 7 people who left for
other positions. The number of team leaders grew from 14 to 16, while the number of economist
dropped from 4 to 3. Average caseloads per team leader remained essentially unchanged from
year-end to year-end at 13 APAs per team leader. The affect of the two additional team leaders
was mitigated by significantly higher total inventory. As set forth in Table 1 below, new APA
filings rose 32% to 91 as compared to 69 in the prior year.
In August 2000, the General Accounting Office published Tax Administration: IRS’ Advance
Pricing Agreement Program, GGD-00-168 The report found that the APA program was not
meeting consistently its goal of processing unilateral APA cases within 12 months and completing
recommended U.S. negotiating positions within 9 months. In his response to the GAO, which
was also published in the August report, the Commissioner of Internal Revenue stated:
The main reason APA cases take longer than the ideal to process is resource
constraints. In this way, the APA Program has been a victim of its own success.
As the Program’s reputation for reaching principled, even-handed, practical
solutions to some of the most difficult cases facing the IRS and taxpayers has
grown, demand for APAs has also grown. Even though we are processing APAs
at a record pace, this demand has outstripped the Program’s resources.

7
Recognizing these resource constraints, the Chief Counsel in June 2000 approved an initiative to
expand the APA program from two to four branches. These additional positions have been
announced and applications are now being processed.
Approximately 25% of the APA caseload comes from taxpayers located west of the Mississippi.
The majority of these cases (ranging between 50% and 75% depending on the year) are from
California. Servicing these Western cases involves significant travel by both APA staff and
taxpayers. The processing of Western cases from Washington, D.C. also is more difficult due to
time zone differences. To better service these Western cases, the APA Program plans to
establish a new branch four located in California. The California APA cases are divided almost
evenly between northern and southern California. As a consequence, the APA Program plans to
establish a split branch with two offices. One office would be located in Los Angeles and one
would be located in the San Francisco Bay area. The San Francisco office will open first, with
the Los Angeles office to follow as resources are available. Establishing a Western branch is
expected to have a number of benefits to the APA Program and taxpayers including more rapid
case processing, reduction in travel cost, and closer relations with Western taxpayers and
taxpayer organizations.
The planned APA Program structure, as memorialized in Chief Counsel Notice N(30)000-346,
Nov. 19, 2000, (Organization and Function of the Office of Associate Chief Counsel
(International)) is as follows:
Director
Branch 1Branch 2Branch 3Branch 4
Washington, DC
Office
San Francisco
Office
Los
Angeles
Office
The August GAO report also noted that the APA Program was not systematically tracking the
reasons why particular APA cases had required more time to process. In response, the APA
Program this past fall adopted a procedure by which APA team leaders periodically record
whether each APA case assigned to them is proceeding within the timeliness goals, and if not,
identifies the reason for the delay. This information is recorded in the central case processing
computer data base of the IRS Chief Counsel and will be available for analysis by management.

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Model APA at Attachment A
[§ 521(b)(2)(B)]
APA Program Statistical Data
[§ 521(b)(2)(C) and (E)]
The statistical information required under § 521(b)(2)(C) is contained in Tables 1 and 9 below;
the information required under § 521(b)(2)(E) is contained in Tables 2 and 3 below:
TABLE 1: APA APPLICATIONS, EXECUTED APAS, AND PENDING APAS
Unilater
al
Bilatera
l
Multilatera
l
Year
Total
Cumulative
Total
APA applications filed
during year 2000
246791492
APAs executed
• Year 2000
• 1991–1999
31
112
30
114
2
2
5
63
231
294
APA renewals
executed during year
2000
101012154
Revised or Amended
APAs executed during
year 2000
225
Pending requests for
APAs
45166211211
Pending requests for
renewal APAs
14455959
APAs revoked or
canceled
01
APAs withdrawn349

2
One 1996 APA involving a US Possession is counted as a bilateral APA.

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TABLE 2: MONTHS TO COMPLETE APAS
Months to Complete Advance Pricing Agreements in Year 2000
Combined Unilateral, Bilateral, Multilateral: Average24.0
Combined Unilateral, Bilateral, Multilateral: Median20.5
Unilateral NewUnilateral RenewalUnilateral Combined
Average16.3Average12.8Average15.2
Median11.0Median11.5Median11.0
Bilateral/Multilateral NewBilateral/Multilateral
Renewal
Bilateral/Multilateral
Combined
3
Average34.4Average27.4Average32.5
Median34.0Median24.0Median33.0

3
Although the time required to complete a negotiating position has substantially improved in the past year, the
average time required to conclude a bilateral or multilateral APA has historically been split roughly equally between
the APA and Competent Authority Offices.

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TABLE 3: APA COMPLETION TIME – MONTHS PER APA
MonthsNumber
of APAs
MonthsNumber
of APAs
MonthsNumber
of APAs
MonthsNumber
of APAs
1
1
16
1
31
0
46
0
2
3
17
1
32
1
47
2
3
1
18
2
33
2
48
2
4
0
19
0
34
4
49
0
5
4
20
2
35
0
50
0
6
1
21
1
36
0
51
1
7
0
22
2
37
0
52
0
8
1
23
2
38
0
53
0
9
2
24
2
39
0
54
0
10
3
25
2
40
0
55
2
11
3
26
0
41
0
56
0
12
4
27
1
42
2
57
1
13
0
28
0
43
2
58
1
14
0
29
0
44
0
59
0
15
4
30
2
45
1
60
0
TABLE 4: RECOMMENDED NEGOTIATING POSITIONS
Recommended Negotiating Positions Completed in Year 200036
TABLE 5: MONTHS TO COMPLETE RECOMMENDED NEGOTIATING POSITIONS
CombinedNewRenewal
Average14.9Average16.1Average11.9
Median15.0Median15.0Median12.5

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TABLE 6: RECOMMENDED NEGOTIATING POSITIONS COMPLETION TIME –
M
ONTHS PER APA
MonthsNumberMonthsNumberMonthsNumberMonthsNumber
1
1
11
2
21
1
31
0
2
0
12
2
22
0
32
0
3
0
13
2
23
2
33
0
4
0
14
3
24
0
34
1
5
0
15
2
25
0
35
0
6
2
16
0
26
1
36
1
7
2
17
2
27
0
37
0
8
1
18
3
28
4
38
0
9
2
19
1
29
0
39
0
10
0
20
0
30
0
40
1
TABLE 7: SMALL BUSINESS TAXPAYER APAS
4
Small Business Taxpayer APAs Completed in Year 2000
10
Renewals2
New8
Unilateral10
Bilateral0
TABLE 8: MONTHS TO COMPLETE SMALL BUSINESS TAXPAYER APAS
Months to Complete Small Business Taxpayer APAs in Year 2000
NewRenewalCombined
Average8.5Average6.5Average8.1
Median7.5Median6.5Median7.0

4
A " small business taxpayer" is a U.S. taxpayer with total gross income of $ 200 million or less, and the APA is processed
under the special procedures set forth in Notice 98-65.

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TABLE 9: INDUSTRIES COVERED
Industry Involved
Number
5

Financial institutions and products10 - 13
Industrial and commercial machinery7 - 9
Food, beverages, and related products7 - 9
Transportation equipment7 - 9
Consumer electronics, not including computers4 - 6
Computer hardware, components, and related products, and computer
software
4 - 6
Photographic equipment and supplies1 - 3
Chemicals and related products (industrial, pharmaceutical, cosmetics)1 - 3
Transportation services1 - 3
Petroleum refining and related industries1 - 3
Hotel and related services1 - 3
Electrical equipment and components (excluding computers and
consumer electronics)
1 - 3
Information services1 - 3
Construction services; construction, ground moving, and mining
equipment
1 - 3
Mining1 - 3
Measuring, analyzing, and controlling instruments1 - 3
Jewelry, sporting equipment, and toys1 - 3
Printing, publishing, and related industries1 - 3
Metal industries and metal products (not machinery)1 - 3
Engineering, research, consulting, accounting, management, legal, real
estate, subscription, and related services
1 - 3
Telecommunications equipment, components, and services1 - 3
Trades or Businesses
[§ 521(b)(2)(D)(i)]
The nature of the relationship between the related organizations, trades, or businesses covered by
APAs executed in Year 2000 are set forth in Table 10 below:

5
Several APAs listed in this table covered more than one industry.

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TABLE 10: NATURE OF RELATIONSHIPS BETWEEN RELATED ENTITIES
RelationshipNumber of APAs
Foreign Parent — U.S. Subsidiary (-ies)39
U.S. Parent — Foreign Subsidiary (-ies)16
Foreign Company and U.S. Branch8
U.S. Company and Non-U.S. Branch0
Partnership0
U.S. Parent, U.S. Possessions subsidiary0
Covered Transactions
[§ 521(b)(2)(D)(ii)]
The controlled transactions covered by APAs executed in Year 2000 are set forth in Table 11 and
Table 12 below:
TABLE 11: TYPES OF COVERED TRANSACTIONS
Transaction TypeNumber
Sale of tangible property into the U.S.25
Use of intangible property by a U.S. entity16
Performance of services by a U.S. entity16
Performance of services by a Non- U.S. entity12
Use of intangible property by a Non- U.S. entity10
Sale of tangible property from the U.S.8
Financial products – U.S. branch of foreign company7
Financial products – U.S. parent company4
Financial products – Non- U.S. parent company3
Research & Development cost sharing – Non-U.S. parent company3

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TABLE 12: TYPES OF COVERED TRANSACTIONS – SERVICES
Intercompany Services Involved in the Covered TransactionsNumber
Marketing and/or Distribution12
Headquarters and Administrative Services10
Management Services5
Research and Development5
Technical and Product Support Services5
Warranty Services4
Product Assembly2
Communication Services1
Purchasing1
Other Services2
Business Functions Performed and Risks Assumed
[§ 521(b)(2)(D)(ii)]
The general descriptions of the business functions performed and risks assumed by the
organizations, trades, or businesses whose results are tested in the covered transactions in the
APAs executed in Year 2000 are set forth in Tables 13 and 14 below:
TABLE 13: FUNCTIONS PERFORMED BY THE TESTED PARTY
Functions PerformedNumber
Marketing and distribution functions38
Manufacturing23
Product assembly and/or packaging23
Licensing of intangibles23
Purchasing and materials management21
Product testing and quality control21
Research and development20
Transportation and warehousing19
Process engineering17
Managerial, legal, accounting, finance, personnel, and other support
services
17
Product design and engineering16
Trading and risk management of financial products15
Technical training and tech support for sales staff13
Product service (repairs, etc.)11
Consulting services7
Other services4

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TABLE 14: RISKS ASSUMED BY THE TESTED PARTY
Risks AssumedNumber
Market risks, including fluctuations in costs, demand, pricing, and
inventory
40
Financial risks, including interest rates and currency32
General business risks (e.g., related to ownership of Property, Plant, and
Equipment)
24
Credit and collection risks18
Product liability risks17
Research & Development risks16
Discussion
The vast majority of APAs have covered transactions that involve numerous business functions
and risks. For instance, with respect to functions, companies that manufacture products have
typically conducted research and development, engaged in product design and engineering,
manufactured the product, marketed and distributed the product, and performed support
functions such as legal, finance, and human resources services. Regarding risks, companies have
been subject to market risks, R&D risks, financial risks, credit and collection risks, product
liability risks, and general business risks. In the APA evaluation process a significant amount of
time and effort is devoted to understanding how the functions and risks are allocated amongst the
controlled group of companies that are party to the covered transactions.
In their APA proposals taxpayers are required to provide a functional analysis. The functional
analysis identifies the economic activities performed, the assets employed, the economic costs
incurred, and the risks assumed by each of the controlled parties. The importance of the
functional analysis derives from the fact that economic theory posits that there is a positive
relationship between risk and expected return and that different functions provide different value
and have different opportunity costs associated with them. It is important that the functional
analysis go beyond simply categorizing the tested party as, say, a distributor. It should provide
more specific information since, in the example of distributors, not all distributors undertake
similar functions and risks.
Thus, the functional analysis has been critical in determining the TPM (including the selection of
comparables). Although functional comparability has been an essential factor in evaluating the
reliability of the TPM (including the selection of comparables), the APA evaluation process has
also involved consideration of economic conditions such as the economic condition of the
particular industry.
In evaluating the functional analysis, the APA program has considered contractual terms
between the controlled parties and the consistency of the conduct of the parties with respect to

16
the allocation of risk. Per the § 482 regulations, the APA program also has given consideration to
the ability of controlled parties to fund losses that might be expected to occur as the result of the
assumption of a risk. Another relevant factor considered in evaluating the functional analysis is
the extent to which each controlled party exercises managerial or operational control over the
business activities that directly influence the amount of income or loss realized. The § 482
Regulations posit that parties at arm's length will ordinarily bear a greater share of those risks
over which they have relatively more control.
Related Organizations, Trades, or Businesses Whose Prices or Results are
Tested to Determine Compliance with APA Transfer Pricing Methods
[§ 521(b)(2)(D)(iii)]
The related organizations, trades, or businesses whose prices or results are tested to determine
compliance with TPMs prescribed in APAs executed in Year 2000 are set forth in Table 15
below:
TABLE 15: RELATED ORGANIZATIONS, TRADES, OR BUSINESSES WHOSE PRICES
OR
RESULTS ARE TESTED
Type of Organization
Number
6
U.S. Distributor26
U.S. Manufacturer14
Non-U.S. Manufacturer9
U.S. Provider of Services8
U.S. Licensee of Intangible Property8
Non-U.S. Distributor7
Non-U.S. Provider of Services7
U.S. Licensor of Intangible Property6
Non-U.S. Licensee of Intangible Property5
Non-U.S. Licensor of Intangible Property4
Non-U.S. Dealer in Financial Products3
U.S. Participant in Cost-Sharing Agreement2
U.S. Dealer in Financial Products2

6
For purposes of this report, both sides are counted as tested parties for transactions involving the use of the
Comparable Uncontrolled Price, Comparable Uncontrolled Transaction, and profit split methods, as well as for cost
sharing agreements. There was no “tested party” counted for purposes of interbranch allocations in financial
product cases (see Table 18).

17
Transfer Pricing Methods and the Circumstances Leading to the Use of Those
Methods
[§ 521(b)(2)(D)(iv)]
The TPMs used in APAs executed in Year 2000 are set forth in Tables 16–20 below:
TABLE 16: TRANSFER PRICING METHODS USED FOR TRANSFERS OF TANGIBLE
AND
INTANGIBLE PROPERTY
TPM usedNumber
7
Comparable Uncontrolled Price (CUP) (tangible property only) – based on
published market data
2
Comparable Uncontrolled Transaction (CUT) (intangible property only)6
Resale Price Method (tangible property only)3
Cost Plus Method (tangible property only)2
Comparable Profits Method (CPM): PLI is return on assets or capital
employed
4
Comparable Profits Method (CPM): PLI is operating margin22
Comparable Profits Method (CPM): PLI is gross margin1
Comparable Profits Method (CPM): PLI is Berry ratio2
Comparable Profits Method (CPM): PLI is a markup on total costs1
Comparable Profits Method (CPM) PLI is net margin1
Residual Profit Split5
Other Profit Split3
Royalty6

7
Profit Level Indicators (“PLIs”) used with the Comparable Profit Method of Treas. Reg. § 1.482-5, and as used in
these TPM tables, are as follows: (1) rate of return on assets or capital employed is the ratio of operating profit to
operating assets, (2) operating margin is the ratio of operating profit to sales, (3) gross margin is the ratio of gross
profit to sales, (4) Berry ratio is the ratio of gross profit to operating expenses, (5) markup on total costs is generally
a comparative markup on total costs involved, (6) SG&A to sales refers to the ratio of the costs of sales, general, and
administrative expenses to sales, and (7) net margin is the ratio of net (before tax) profit over sales.

18
TABLE 17: TRANSFER PRICING METHODS USED FOR SERVICES
TPM used
Number
8
Cost Plus Method9
Cost Method3
Comparable Profits Method: PLI is SG&A to Sales ratio2
Comparable Profits Method: PLI is return on assets or capital employed2
Comparable Profits Method: PLI is a markup on total costs1
Comparable Profits Method: PLI is operating margin1
Comparable Uncontrolled Transaction Method1
Other Method3
TABLE 18: TRANSFER PRICING METHODS USED FOR FINANCIAL PRODUCTS
TPM used
Number
9
Interbranch allocation (e.g., foreign exchange separate enterprise)8
Residual profit split5
Profit split under Notice 94-402
TABLE 19: TRANSFER PRICING METHODS USED FOR CONTRIBUTIONS TO COST
SHARING ARRANGEMENTS
TPM used
Number
10
Costs allocated based on sales3
Costs allocated based on total costs of R&D, manufacturing, and
distribution
1

8
Some of the service transactions were covered by the transfer pricing methods used in cost sharing arrangements
and tangible/intangible property transactions.
9
Some of the financial product APAs used more than one TPM.
10
One of the cost sharing APAs involved two TPMs.

19
TABLE 20: TRANSFER PRICING METHODS USED FOR COST SHARING BUY-IN
PAYMENTS
TPM usedNumber
Capitalized R&D1
Other2
Discussion
The transfer pricing methods used in APAs completed during Year 2000 were based on those in
the § 482 Treasury Regulations. Under § 1.482-3, the arm’s length amount for controlled
transfers of tangible property are determined using the Comparable Uncontrolled Price (CUP)
method, the Resale Price Method, the Cost Plus Method, the Comparable Profits Method (CPM),
and the Profit Split method. Under § 1.482-4, the arm’s length amount for controlled transfers of
intangible property are determined using the Comparable Uncontrolled Transaction (CUT)
method, CPM, and the Profit Split Method. An “Unspecified Method” may be used for both
tangible and intangible property if it provides a more reliable result than the enumerated methods
under the best method rule of § 1.482-1(c). For transfers involving the provision of services, §
1.482-2(b) provides that services performed for the benefit of another member of a controlled
group should ordinarily bear an arm’s length charge, either deemed to be equal to the cost of
providing the services (when non-integral) or which should be an amount that would have been
charged between independent parties.
In addition, § 1.482-2(a) provides rules concerning the proper treatment of loans or advances,
and § 1.482-7 provides rules for qualified cost sharing arrangements under which the parties
agree to share the costs of development of intangibles in proportion to their shares of reasonably
anticipated benefits. APAs involving cost sharing arrangements generally address both the
method of allocating costs among the parties as well as determining the appropriate amount of
the “buy-in” payment due for the transfer of intangibles to the controlled participants.
In reviewing the TPMs applicable to transfers of tangible and intangible property reflected in
Table 16, it is clear that the majority of the APAs followed the specified methods. However,
there are several distinguishing points that should be made. The Regulations note that for
transfers of tangible property, the Comparable Uncontrolled Price (CUP) method will generally
be the most direct and reliable measure of an arm’s length price for the controlled transaction
when sufficiently reliable comparable transactions can be identified. § 1.482-3(b)(2)(ii)(A). It
was the experience of the APA Program in Year 2000 that in the cases that come into the APA
Program, sufficiently reliable CUP transactions are difficult to find. In APAs executed in Year
2000, there were only two APAs that used the CUP method, and they both looked to published
market data in setting the arm’s length price. See § 1.482-3(b)(5).
Similar to the CUP method, for transfers of intangible property, the CUT method will generally
provide the most reliable measure of an arm’s length result when sufficiently reliable

20
comparables may be found. § 1.482-4(c)(2)(ii). It has generally been difficult to identify
external comparables, and APAs using the CUT method tend to rely on internal transactions
between the taxpayer and unrelated parties. In Year 2000, there were six APAs that utilized the
CUT method, and four of those also used one or more other methods for different covered
transactions by the same taxpayer in the same APA.
Some cases in the past have utilized a "step royalty" arrangement to determine the proper transfer
price for use of a unique intangible. For example, taxpayers have argued that an intangible was
very valuable and therefore a high royalty rate was appropriate. Because there were no exact or
closely similar comparables, it was difficult to demonstrate objectively whether the taxpayer was
correct. A sliding scale, or step royalty, in conjunction with a CPM analysis, has been used to
resolve such cases. The premise of such APAs was that, if the intangible truly had great value,
the taxpayer would earn higher than normal return from its activities utilizing the intangible.
Conversely, as the value of the intangible decreased, the taxpayer's pre-royalty results would be
in the routine arm's-length range. Therefore, the royalty rate adopted in these APAs increases as
the licensee's profitability increases.
The Cost Plus Method and Resale Price Method were applied in Year 2000 in two and three
APAs respectively. See § 1.482-3(c), (d). The transactional nature of these methods
distinguishes them from the CPM method using either a gross margin PLI (as compared to the
Resale Price Method) or a markup on total costs PLI (as compared to the Cost Plus Method). A
strict transactional method focuses on prices for individual or narrow groups of transactions,
while a CPM looks at profits from broader groups of transactions or all of a company’s
transactions. In Year 2000, only one of the Resale Price Method APAs used only that method
alone. The four other APAs using these methods all were supplemented by a CPM.
The CPM is frequently applied in APAs. This is because reliable public data on comparable
business activities of independent companies may be more readily available than potential CUP
data, and comparability of resources employed, functions, risks, and other relevant
considerations is more likely to exist than comparability of product. The CPM also tends to be
less sensitive than other methods to differences in accounting practices between the tested party
and comparable companies, e.g. classification of expenses as cost of goods sold or operating
expenses. §1.482-3(c)(3)(iii)(B), and -3(d)(3)(iii)(B). In addition, the degree of functional
comparability required to obtain a reliable result under the CPM is generally less than required
under the resale price or cost plus methods, because differences in functions performed often are
reflected in operating expenses, and thus taxpayers performing different functions may have very
different gross profit margins but earn similar levels of operating profit. § 1.482-5(c)(2).
There were 31 APAs involving tangible or intangible property that used some form of the CPM
(with varying PLIs). The CPM was also used in some APAs concurrently with other methods.
For example, in the eight APAs involving the use of a profit split method, the CPM was used in
five of them to measure routine returns or other discreet parts of the covered transactions. The
CPM similarly was used with two out of the three APAs that used the resale price method,
including one of those three that used the resale price method, the cost plus method, and the
CPM. The CPM was used with two out of the six APAs that used the CUT method. Finally, in

21
two APAs the royalty payments were tested according to a CPM with an operating margin PLI,
and were subject to adjustment based on the taxpayer’s results compared to the CPM range.
The CPM has proven to be versatile in part because of the various PLIs that can be used in
connection with the method. Reaching agreement on the appropriate PLI has been the subject of
much discussion in many of the cases, and it depends heavily on the facts and circumstances.
Some APAs have called for different PLIs to apply to different parts of the covered transactions
or with one PLI used as a check against the primary PLI. In three APAs, an operating margin
PLI was used in conjunction with other PLIs (rate of return on assets or capital employed in two
and a gross margin in one). In one APA, a Berry ratio
11
was used to measure the distribution
function, while a markup on total costs was used for the manufacturing function. There was one
APA that used a gross margin PLI, but also employed an operating margin PLI in a critical
assumption.
The CPM also was used regularly with services as the covered transactions in APAs executed in
Year 2000. There were a total of six service APAs using the CPM method with various PLIs
according to the specific facts of the taxpayers involved. Two APAs used a SG&A to sales PLI,
and did not combine these methods with any others (services being the only covered
transactions). Both of these also allocated various overhead expenses based on a percentage of
worldwide sales by geographic region. In addition, and similar to the overlap of PLIs with
tangible and intangible property, one APA involving services used separate PLIs for different
U.S. subsidiaries of the foreign parent (return on assets or capital employed and operating
margin). Table 17 reflects the methods used to determine the arm’s length results for APAs
involving services transactions.
In Year 2000, there were eight APAs involving tangible or intangible property that used some
form of a profit split, primarily the Residual Profit Split, § 1.482-6(c)(3), in which routine
contributions by the controlled parties are allocated routine market returns, and the residual
income is allocated among the controlled taxpayers based upon the relative value of their
contributions of intangible property to the relevant business activity. Profit splits are generally
considered in cases in which the parties to the controlled transaction own valuable, non-routine,
intangible property. Of the eight profit split APAs, none of them involved the use of the
Comparable Profit Split under § 1.482-6(c)(2). Five APAs made use of a Residual Profit Split
method. One APA used an unspecified method profit split based on the proportion of each
country’s total manufacturing, research and development, and distribution costs. See § 1.482-
4(d) (unspecified methods for transfers of intangible property). Another APA used a profit split
in which only the U.S. taxpayer’s income was split at a ratio of 25% to the U.S. subsidiary and
75% to the foreign parent (the APA also used a CPM with an operating margin PLI, and
involved royalty payments by the U.S. taxpayer). Lastly, one APA used a profit split based on a
range developed with the use of a CPM with an operating margin PLI. This APA also required
the taxpayer to annually update the data set of comparable companies.

11
Named after Professor Charles Berry, who used the Berry ratio when serving as an expert witness in E.I. DuPont
de Nemours & Co. v. United States, 608 F.2d 445 (Ct. Cl. 1979).

22
Profit splits have also been used in a number of financial product APAs in which the primary
income-producing functions are performed in more than one jurisdiction. Two APAs executed
in Year 2000 applied a profit split as described in Notice 94-40. Five APAs applied Residual
Profit Splits as described in Prop. Reg. § 1.482-8(e)(6).
There were eight financial product APAs involving interbranch allocations. These involve a
single taxpayer with branches that act autonomously with respect to the covered transactions,
generally involving foreign currency exchanges. These particular APAs determine the
appropriate amount of profits attributable to each branch from the activity by reference to the
branches’ internal accounting methods. The results take into account all trades, and test the arms
length results using statistical tests to ensure that all controlled trades are priced the same as
uncontrolled trades.
There were three cost sharing APAs during Year 2000. Cost sharing APAs under § 1.482-7
generally address the methods used for determining each participant’s share of costs (consistent
with the reasonably anticipated benefits) for the development of intangibles. When there is also
the transfer of existing intangibles, the APA will also generally address the appropriate buy-in
amount. Tables 19 and 20 reflect the methods applied in cost sharing APAs executed in Year
2000.
Critical Assumptions
[§ 521(b)(2)(D)(v)]
Critical Assumptions used in APAs executed in Year 2000 are described in Table 21 below:
TABLE 21: CRITICAL ASSUMPTIONS
Critical Assumptions involving the following:Number of APAs
Material changes to the business59
Material changes to tax and/or financial accounting practices45
Changes in affiliated companies18
Use of Mark-to-Market method13
Assets will remain substantial the same5
Major technological changes5
Cost sharing and licensing agreements remain in effect4
Catastrophic events4
Currency fluctuations4
Risks assumed and functions performed remain the same3
Minimum sales volume3
Material sales fluctuations3
Changes in market shares3

23
Change in market pricing policies3
Change in ratio of SG&A to sales2
Changes in sharing of risks of currency fluctuations2
Marketing conditions remain substantially the same2
Major regulatory changes2
Change in compensation policy that affects the covered entity or
transaction
2
Changes in sharing of risks of currency fluctuations2
Limitation on R&D expenditures2
Litigation hazards2
Changes in the interest rate1
Variation in budgeted versus actual expense1
Changes involving antidumping/countervailing duties1
Changes in other duties or tariffs1
New import/export non-tariff barriers1
Changes in ratio of R&D to sales1
Renewal of the APA1
Discussion
APAs include critical assumptions upon which their respective TPMs depend. Critical
assumptions are objective business and economic criteria that form the basis of a taxpayer's
proposed TPM. A critical assumption is any fact (whether or not within the control of the
taxpayer) related to the taxpayer, a third party, an industry, or business and economic conditions,
the continued existence of which is material to the taxpayer's proposed TPM. Critical
assumptions might include, for example, a particular mode of conducting business operations, a
particular corporate or business structure, or a range of expected business volume. Rev. Proc.
96-53, § 5.07. Failure to meet a critical assumption may render an APA inappropriate or
unworkable.
A critical assumption may change (and/or fail to materialize) due to uncontrollable changes in
economic circumstances, such as a fundamental and dramatic change in the economic conditions
of a particular industry. In addition, a critical assumption may change (and/or fail to materialize)
due to a taxpayer's actions that are initiated for good faith business reasons, such as a change in
business strategy, mode of conducting operations, or the cessation or transfer of a business
segment or entity covered by the APA.
If a critical assumption has not been met, the APA may be revised by agreement of the parties.
If such agreement cannot be achieved, the APA may be canceled. If a critical assumption has
not been met, it requires taxpayer's notice to and discussion with the Service, and possible
Competent Authority activity. Rev. Proc. 96-53, § 11.07.

24
Critical assumption provisions are crucial to the APA because a TPM is premised on certain
assumptions that apply to a particular taxpayer, its industry, and the dynamics of the economy.
Critical assumptions provide flexibility in an APA by recognizing the reality of change in
business cycles and economic circumstances and their effects on varying arm's length returns.
Whether critical assumptions change (and/or fail to materialize) is subject to the examination
process.
Sources of Comparables, Selection Criteria, and the Nature of Adjustments to
Comparables and Tested Parties
[§ 521(b)(2)(D)(v), (vi), and (vii)]
The sources of comparables, selection criteria, and rationale used in determining the selection
criteria for APAs executed in Year 2000 are described in Tables 22 through 24 below. Various
formulas for making adjustments to comparables are included as Attachment B.
TABLE 22: SOURCES OF COMPARABLES
Comparable SourcesNumber of Times
This Source Used
12
Compustat (database)
13
29
Disclosure (database)
14
8
Moody’s (database)
15
4
Global Vantage (database)
16
3
Worldscope (database)
17
1
Global Researcher’s SEC (database)
18
1
Public exchange or quotation media1
Other sources7

12
Although still guided by the arm’s length standard, some APAs do not use comparables, for example, when there
is a residual profit split or in the case of certain financial products.
13
See http://www.compustat.com.
14
See http://www.primark.com/pfid/content/disclosure.shtml.
15
See http://www.fisonline.com.
16
See http://www.standardpoor.com.
17
See http://www.bvdep.com.
18
See http://www.bvdep.com

25
TABLE 23: COMPARABLE SELECTION CRITERIA
Selection Criteria ConsideredNumber of Times
This Criterion
Used
Comparable functions39
Comparable risks30
Comparable industry32
Comparable products27
Comparable intangibles17
Comparable geographic market9
Contractual terms4
Comparable market levels2
TABLE 24: ADJUSTMENTS TO COMPARABLES OR TESTED PARTIES
AdjustmentNumber of Times
This Adjustment
Used
Asset Intensity: receivables24
Asset Intensity: payables24
Asset Intensity: inventory23
Asset Intensity: property, plant, equipment9
Accounting: LIFO to FIFO inventory7
Accounting: reclassification of expenses (e.g., from COGS to operating
expenses)
2
Accounting: reclassification of non-operating intangibles1
PLI: operating expense3
R&D adjustments2
Foreign exchange1
Commission expense adjustment to tested party1
Discussion
At the core of most APAs are comparables. The APA program works closely with taxpayers to
find the best and most reliable comparables for each covered transaction. In some cases, CUPs
or CUTs can be identified. In other cases, comparable business activities of independent
companies are utilized in applying the CPM or residual profit split methods. Generally, in the
APA Program's experience since 1991, CUPs and CUTs have been most often derived from the
internal transactions of the taxpayer.

26
For profit-based methods in which comparable business activities or functions of independent
companies are sought, the APA Program typically has applied a three-part process. First, a pool
of potential comparables has been identified through broad searches. From this pool, companies
having transactions that are clearly not comparable to those of the tested party have been
eliminated through the use of quantitative and qualitative analyses, i.e., quantitative screens and
business descriptions. Then, based on a review of available descriptive and financial data, a set
of comparable companies or transactions has been finalized. The comparability of the finalized
set has then been enhanced through the application of adjustments.
Sources of Comparables
Comparables used in APAs can be U.S. or foreign companies. This depends on the relevant
market, the type of transaction being evaluated, and the results of the functional and risk
analyses. In general, comparables have been located by searching a variety of databases that
provide data on U.S. publicly-traded companies and on a combination of public and private non-
U.S. companies. Table 22 shows the various databases and other sources used in selecting
comparables for the APAs executed in Year 2000.
Although comparables were most often identified from the databases cited in Table 22, in some
cases comparables were found from other sources. For example, comparables derived internally
from taxpayer transactions with third parties, those provided by the taxpayer’s representative
using an in-house database, comparables from trade publications in specific industries, and
comparables derived from taxpayer information on competitors.
Selecting Comparables
Initial pools of potential comparables generally have been derived from the databases using a
combination of industry and keyword identifiers. Then, the pool has been refined using a variety
of selection criteria specific to the transaction or entity being tested and the transfer pricing
method being used.
The listed databases allow for searches by industrial classification (generally, U.S. Standard
Industrial Classification (SIC)), by keywords, or by both. These searches can yield a number of
companies whose business activities may or may not be comparable to those of the entity being
tested. Therefore, comparables based solely on SIC or keyword searches are rarely used in
APAs. Instead, the pool of comparables is examined closely, and companies are selected based
on a combination of screens, business descriptions, and other information found in the
companies’ Annual Reports to shareholders and filings with the U.S. Securities and Exchange
Commission (SEC).
In virtually all cases, business activities are required to meet certain basic comparability criteria
to be considered comparables. Functions, risks, economic conditions, and the property (product
or intangible) and services associated with the transaction must be comparable. Determining

27
comparability can be difficult – the goal has been to use comparability criteria restrictive enough
to eliminate companies that are not comparable, but yet not so restrictive as to have no
comparables remaining. The APA Program normally has begun with relatively strict
comparability criteria and then has relaxed them slightly if necessary to derive a pool of reliable
comparables. A determination on the appropriate size of the comparables set, as well as the
companies that comprise the set, is highly fact specific and depends on the reliability of the
results.
In addition, the APA Program, consistent with the regulations, generally has looked at the results
of comparable companies over a multi-year period. Sometimes this has been three years, but it
has been more or less, depending on the circumstances of the controlled transaction. Using a
shorter period might result in the inclusion of companies in different stages of economic
development or use of atypical years of a company subject to cyclical fluctuations in business
conditions. Of the APAs executed in Year 2000 in which financial data over a period of years
was used, 5 APAs looked at data over 1 year, 28 looked at data over 3 years, 1 looked at data
over a period of 5 years, 1 over 6 years, and 2 over 7 years.
Many covered transactions have been tested with comparables that have been chosen using
additional criteria and/or screens. These include sales level criteria and tests for financial distress
and product comparability. These common selection criteria and screens have been used to
increase the overall comparability of a group of companies and as a basis for further research.
The sales level screen, for example, has been used to remove companies that, due to their size,
might face fundamentally different economic conditions from those of the entity or transaction
being tested. In addition, some APA analyses have incorporated selection criteria related to
removing companies experiencing "financial distress" due to concerns that companies in
financial distress often have experienced unusual circumstances that would render them not
comparable to the entity being tested. These criteria include: an unfavorable auditor's opinion,
bankruptcy, and in certain circumstances, operating losses in a given number of years.
An additional important class of selection criteria is the development and ownership of
intangible property. In some cases in which the entity being tested is a manufacturer, several
criteria have been used to ensure, for example, that if the controlled entity does not own
significant manufacturing intangibles or conduct research and development (R&D), neither will
the comparables. These selection criteria have included determining the importance of patents to
a company or screening for R&D expenditures as a percentage of sales or costs. Another
criterion used in some cases has been a comparison of the book and market values of a company;
this can be another indicator of intangible value. Again, quantitative screens related to
identifying comparables with significant intangible property generally have been used in
conjunction with an understanding of the comparable derived from publicly available business
information.
Selection criteria relating to asset comparability and operating expense comparability have also
been used at times. A screen of property, plant, and equipment (PP&E) as a percentage of sales
or assets, combined with a reading of a company's SEC filings, has been used to help ensure that

28
distributors (generally lower PP&E) were not compared with manufacturers (generally higher
PP&E), regardless of their SIC classification. Similarly, a test involving the ratio of operating
expenses to sales or total costs has helped to determine whether a company undertakes a
significant marketing and distribution function.
Table 25 shows the number of times various screens were used in APAs executed in Year 2000:
TABLE 25: COMPARABILITY SCREENS
Comparability Screen UsedNumber of Times
Used
Sales18
Ratio of R&D/Sales12
Non-Startup or Startup Company7
Ratio of Foreign Sales/Total Sales6
Ratio of Operating Expenses/Sales5
Ratio of PP&E/Sales2
Financial Distress Screens—
Bankruptcy7
Unfavorable Auditor’s Opinion4
Losses in One or More Years7
Adjusting Comparables
After the comparables have been selected, the regulations require that "[i]f there are material
differences between the controlled and uncontrolled transactions, adjustments must be made if
the effect of such differences on prices or profits can be ascertained with sufficient accuracy to
improve the reliability of the results." Treas. Reg. §1.482-1(d)(2). In almost all cases involving
income-statement-based profit level indicators (PLIs), certain "asset intensity" or "balance sheet"
adjustments for factors that have generally agreed-upon effects on profits have been carried out.
In addition, in specific cases, additional adjustments have been performed to improve reliability.
The most common asset intensity adjustments used in APAs are adjustments for differences in
accounts receivable, inventories, and accounts payable. The APA Program generally has
required adjustments for receivables, inventory, and payables based on the principle that holding
assets such as receivables benefits customers in a way that increases the entity’s operating profit.
Such adjustments are based on the assumption that the increase in operating profit is equal to the
carrying cost of the assets. Conversely, the holding of accounts payable is considered to burden
suppliers in a way that decreases the entity’s profit. The decrease in operating profit has
generally been assumed to be equal to the cost of funds implicitly borrowed from suppliers.

29
To compare the profits of two entities with different relative levels of receivables, inventory, or
payables, the APA Program has estimated the carrying costs of each item and adjusted profits
accordingly. Although different formulas have been used in specific APA cases, Attachment B
presents one set of formulas used in many APAs. Underlying these formulas are the notions that
(1) balance sheet items should be expressed as mid-year averages, (2) formulas should try to
avoid using data items that are being tested by the transfer pricing method (for example, if sales
are controlled, then the denominator of the balance sheet ratio should not be sales), (3) a short
term interest rate should be used, and (4) an interest factor should recognize the average holding
period of the relevant asset.
The APA Program has also required that data must be compared on a first-in first-out (FIFO)
accounting basis. Although financial statements may be prepared on a last-in first-out (LIFO)
basis, cross-company comparisons are less meaningful when one or more companies use LIFO
inventory accounting methods. This adjustment directly affects costs of goods sold and
inventories, and therefore affects both profitability measures and inventory adjustments.
Less commonly used but still important in some cases is the adjustment for differences in
relative levels of PP&E between a tested entity and the comparables. Ideally, comparables and
the entity being tested will have fairly similar relative levels of PP&E, since major differences
can be a sign of fundamentally different functions and risks. Typically, the PP&E adjustment is
made using a medium term interest rate, while short term interest rates are used for receivables,
inventories, and payables.
Additional adjustments used less infrequently include those for differences in other balance sheet
items, operating expenses, R&D, or currency risk. Accounting adjustments, such as
reclassifying items from cost of goods sold to operating expenses, for example, have also been
made when warranted to increase reliability. Often, data has not been available for both the
controlled and uncontrolled transactions in sufficient detail to allow for these types of
adjustments.
The adjustments made to comparables or tested parties in APAs executed in Year 2000 are
reflected in Table 24 above.
Nature of Ranges and Adjustment Mechanisms
[§ 521(b)(2)(D)(viii)–(ix)]
The types of ranges used in APAs executed in Year 2000 are described in Table 26 and 27
below.

30
TABLE 26: TYPES OF RANGES
Type of RangeNumber
19
Interquartile range14
Floor (i.e., result must be no less than x)14
Financial products – statistical confidence interval to test for internal CUP8
Specific result (“point”)7
Agreed range4
Ceiling (i.e., result must be no more than x)2
TABLE 27: ADJUSTMENTS WHEN OUTSIDE OF THE RANGE
Adjustment mechanismNumber
Taxpayer makes an adjustment to the closest edge of the range24
Taxpayer makes an adjustment to a specific point17
Competent Authority process invoked if results are outside the range4
Taxpayer makes an adjustment to the median of the range3
APA canceled or revoked if results are outside the range, subject to
renegotiation, cancellation, or revocation
2
APA canceled or revoked if results beyond certain limits, otherwise
taxpayer makes an adjustment to the closest edge
1
Taxpayer adjusts to specific point each year (annual comparables
adjustment)
1
Discussion
Treas. Reg. § 1.482-1(e)(1) states that sometimes a pricing method will yield "a single result that
is the most reliable measure of an arm's length result." Sometimes, however, a method may yield
"a range of reliable results," called the "arm's length range." A taxpayer whose results fall within
the arm's length range will not be subject to adjustment.
Under § 1.482-1(e)(2)(i), such a range is normally derived by considering a set of more than one
comparable uncontrolled transaction of similar comparability and reliability. If these
comparables are of very high quality, as defined in the Regulations, then under § 1.482-
1(e)(2)(iii)(A), the arm's length range includes the results of all of the comparables (from the
least to the greatest). However, the APA Program has only rarely identified cases meeting the
requirements for the full range. There were no APAs executed in Year 2000 that used a full
range. If the comparables are of lesser quality, then under § 1.482-1(e)(2)(iii)(B), "the reliability
of the analysis must be increased, when it is possible to do so, by adjusting the range through
application of a valid statistical method to the results of all of the uncontrolled comparables."

19
This table does not include royalties, cost sharing agreements, and cost plus TPMs. In Year 2000, TPMs
involving these methodologies did not use ranges.

31
One such method, the "interquartile range," is "ordinarily . . . acceptable," although a different
statistical method "may be applied if it provides a more reliable measure." The "interquartile
range" is defined as, roughly, the range from the 25th to the 75th percentile of the comparables'
results. See § 1.482-1(e)(2)(iii)(C). The interquartile range was used 14 times in Year 2000.
A variant on the interquartile range involves a "Tukey filter," which is described as follows.
First, the set of comparables is used to derive a standard interquartile range. Then the difference
D between the top and bottom of the interquartile range is computed. Next, all comparables
whose results are more than a certain multiple of D (often the multiple 1.5 is used) outside the
interquartile range are discarded as "outliers." Finally, the reduced set of comparables (without
the outliers) is used to compute a second interquartile range, which is then used as the arm's
length range. The Tukey filter’s primary purpose has been to eliminate companies that were so
anomalous that they arguably should not have been included as comparables in the first place. In
the past, this approach has only occasionally been used for APAs, and it was not used for any of
the APAs executed in Year 2000.
In 7 APAs executed in Year 2000, the APA specified a single, specific result, or "point." Five of
these involved profit splits in which the taxpayer’s results for a given APA year under the TPM
depended on the amount of system profit. Another of these specific result APAs involved a
bilateral APA with a term encompassing entirely filed years. In the absence of any prospectivity,
the Competent Authorities agreed on a particular result for each year. Finally, one APA
involved a CPM in which the taxpayer agreed to a specific result. Some APAs specify not a
point or a range, but a "floor" or a "ceiling." When a floor is used, the tested party's result must
be greater than or equal to some particular value. When a ceiling is used, the tested party's result
must be less than or equal to some particular value. Fourteen APAs executed in Year 2000 used
a floor and 2 used a ceiling. Finally, 4 APAs used an agreed range other than interquartile range.
Some APAs involving financial products have employed a statistical confidence interval to
compare pricing of a large set of controlled transactions with a comparable set of uncontrolled
transactions. A statistical confidence interval is typically applied to a financial institution with
autonomous branches in several countries. Pursuant to the business profits article of the
applicable income tax treaties and Prop. Reg. § 1.482-8(b), APAs have been executed allowing
the taxpayer to allocate profits between branches with reference to the branches' internal
accounting methods, taking into account all trades, including interbranch and/or interdesk trades.
In order for this method to provide a reliable result, however, it is necessary to ensure that all
such controlled trades be priced on the same market basis as uncontrolled trades. To test
whether this is so, a branch's controlled trades are matched with that branch's comparable
uncontrolled trades made at times close to the controlled trades. A statistical test is performed to
detect pricing bias, by which the controlled trades might as a whole be priced higher or lower
than the uncontrolled trades. This has been accomplished by construction of a statistical
confidence interval (typically 95%), with the tested hypothesis being that controlled trades are
priced on the same basis as uncontrolled trades. An adjustment is necessary if the results of the
controlled trades fall outside of this confidence interval. During Year 2000, there were 8 APAs
executed that employed the statistical confidence interval.

32
Adjustments
Under § 1.482-1(e)(3), if a taxpayer's results fall outside the arm's length range, the Service may
adjust the result "to any point within the arm's length range." Accordingly, an APA may permit
or require a taxpayer and its related parties to make an adjustment after the year's end to put the
year's results within the range, or at the point, specified by the APA. Similarly, to enforce the
terms of an APA, the Service may make such an adjustment. When the APA specifies a range,
the adjustment is sometimes to the closest edge of the range, and sometimes to another point
such as the median of the interquartile range. Depending on the facts of each case, such
automatic adjustments are not always permitted. Some APAs specify that if a taxpayer's results
fall outside the applicable point or range, the APA will be canceled or revoked. Some bilateral
APAs specify that in such a case there will be a negotiation between the Competent Authorities
involved to determine whether and to what extent an adjustment should be made. Some APAs
permit automatic adjustments unless the result is far outside the range specified in the APA.
Thus they provide flexibility and efficiency (permitting adjustments when normal business
fluctuations and uncertainties push the result somewhat outside the range).
In order to conform the taxpayer's books to these tax adjustments, the APA usually permits a
"compensating adjustment" as long as certain requirements are met. Such compensating
adjustments may be paid between the related parties with no interest, and the amount transferred
will not be considered for purposes of penalties for failure to pay estimated tax. See § 11.02
Rev. Proc. 96-53.
APA Term and Rollback Lengths
[§ 521(b)(2)(D)(x)]
The various term lengths for APAs executed in Year 2000 are set forth in Table 28 below:

33
TABLE 28: TERMS OF APAS
APA Term in YearsNumber of APAs
12
23
37
46
537
64
70
81
90
10 or more3
Number of rollback years to which an APA TPM was applied in Year 2000 are set forth in Table
29 below:
TABLE 29: NUMBER OF YEARS COVERED BY ROLLBACK OF APA TPM
Number of Rollback YearsNumber of APAs
12
26
33
41
52
61
72
80
91
10 or more1
Nature of Documentation Required
[§ 521(b)(2)(D)(xi)]
APAs executed in Year 2000 required various that documents be provided with the Annual
Reports filed by the taxpayers. These documents are described in Table 30 below:

34
TABLE 30: NATURE OF DOCUMENTATION REQUIRED
DocumentationNumber of Times
This
20
Documentation
Required
Financial analysis demonstrating compliance with the TPM60
Statement identifying all material differences between the taxpayer’s
business operations during the APA year and the description of the
business operations contained in the request for the APA, and if there
have been no such material differences, a statement to that effect
61
Statement identifying all material changes in the taxpayer’s accounting
methods and classifications, and methods of estimations, from those
described or used in the request for the APA, or if there have been none,
a statement to that effect
62
Description of any failure to meet critical assumptions, or if there have
been none, a statement to that effect
62
Financial statements as prepared in accordance with GAAP59
Certified Public Accountant’s opinion that the financial statements
present fairly the financial position of the taxpayer and the results of its
operations, in accordance with GAAP
59
Description of, reason for, and financial analysis of an compensating
adjustments with respect to any APA year, including the means by
which any compensating adjustment has been or will be satisfied
58
Profit and Loss statement29
Various workpapers27
United States income tax return19
Schedule of costs and expenses (e.g., intercompany allocations)17
Certified Public Accountant’s review of financial statements11
Narrative description of the taxpayer’s business8
Book to tax reconciliation7
Cash flow statement6
Description of any matters economically or substantively related to the
covered transactions, but that are not subject to the APA
5
Form 5471 or 54724
Organizational chart4
Pertinent intercompany agreements5
Royalty computations2

20
The first seven categories of documentation listed in this table are drawn from the standard APA language found
in Attachment A. Certain APAs did not include this standard language, typically when all of the years covered by
the APA were already past and the taxpayer’s results were known. In addition, under some financial product APAs,
the taxpayer agrees to maintain certain records, but the compliance with the TPM is determined by a later audit
under an agreed statistical methodology. In these cases, a number of the standard documentation requirements may
not be appropriate.

35
R&D costs as a percentage of WW sales2
Various other documents or statements
21
33
Approaches for Sharing of Currency or Other Risks
[§ 521(b)(2)(D)(xii)]
During Year 2000, there were three APAs that specifically addressed the sharing of currency
risks. In one, there was an adjustment to the tested party’s cost of goods sold if the exchange
rate changed by more than a certain amount, in which case the adjustment was a percentage of
the change in the exchange rate. In a second APA, there was an adjustment for currency
fluctuations through a change in the operating margin range. Finally, in a third all currency risk
was specifically allocated to the foreign parent.
Other explicit risk sharing in APAs completed in Year 2000 included one APA in which it was
provided that if the U.S. licensor’s worldwide ratio of research and development expenses to
sales changed, the royalty paid by the foreign subsidiary to the U.S. parent changed too. In
another, all risks were specifically allocated to the foreign parent, and in a third, the market and
inventory risk on all tangibles purchased from the foreign parent were assumed by the U.S.
subsidiary.
In addition, there were three APAs that specifically addressed the risks of a business start-up.
The first provided that the risk of start-up losses was allocated to the foreign parent. The second
allowed for the start-up businesses to have a three year phase-in, and the third APA allowed for
losses during the startup phase.
Efforts to Ensure Compliance with APAs
[§ 521(b)(2)(F)]
As described in Rev. Proc. 96-53, section 11, APA taxpayers are required to file annual reports
to demonstrate compliance with the terms and conditions of the APA. The filing and review of
annual reports is a critical part of the APA process. Through annual report review, the APA
program monitors taxpayer compliance with the APA on a contemporaneous basis. Annual
report review provides current information on the success or problems associated with the
various TPMs adopted in the APA process.
All reports received by the APA Office are tracked by one designated APA team leader who also
has the prime responsibility for annual report review. Other APA team leaders also assist in this
review, especially when the team leader who negotiated the case is available, since that person
will already be familiar with the relevant facts and terms of the agreement. Once received by the
APA Office, the annual report is sent out to the district personnel with exam jurisdiction over the

21
This category includes particular documents that were highly fact specific to the particular taxpayer involved.

36
taxpayer. This process changed in November 2000; previously reports were held until reviewed
by an APA team leader. This change has facilitated simultaneous review of the reports and sped
up processing time.
The statistics for the review of APA annual reports are reflected in Table 31 below. As of
December 31, 2000, there were 374 pending annual reports. In Year 2000, there were 118
reports closed. This is up considerably from the 211 reports closed in the 1994-1999 period. As
noted below, annual report review in 2000 resulted in agreed adjustments involving 8 taxpayers
for 38 APAs.
TABLE 31: STATISTICS OF ANNUAL REPORTS
Number of APA annual reports pending as of December 31, 2000374
Number of APA annual reports closed in Year 2000118
Number of APA annual reports requiring adjustment in Year 200038
Number of taxpayers involved in adjustments8
Number of APA annual reports required to be filed in Year 2000273
Number of APA annual reports actually filed in Year 2000239
22
Number of APA annual report cases over one and less than two years old197
Number of APA annual report cases two or more years old89

22
Of the 34 reports that were due in Year 2000, but not filed by Dec. 31, 2000, there were 28 filed late after January
1, 2001.

37
ATTACHMENT A
MODEL ADVANCE PRICING AGREEMENT
between
TAXPAYER
and
THE INTERNAL REVENUE SERVICE
THIS ADVANCE PRICING AGREEMENT (“APA”) is made by and between Taxpayer
and the Internal Revenue Service (“Service”), acting through the Director, Advance Pricing
Agreement Program.
WHEREAS, Taxpayer and the Service (the "Parties") wish to establish a method for
determining whether certain prices used in international transactions involving Taxpayer are in
accordance with the principles of section 482 of the Internal Revenue Code of 1986 as amended
(the "Code") and attendant Regulations and, to the extent applicable, income tax conventions to
which the United States is a party;
NOW, THEREFORE, in consideration of the mutual promises contained herein, the
Parties agree as follows:
1. Identifying information. Taxpayer's EIN is __________. [Taxpayer is included in the
consolidated federal income tax return filed by ________________, EIN ________. All

38
references to Taxpayer's United States income tax return in this APA refer to that consolidated
return, and all references in this APA to "Taxpayer" shall refer to the ______________
consolidated return group.]
2. Covered transactions. This APA governs the pricing of the transactions specified in
Appendix A (the "Covered Transactions").
3.Legal Effect.
3.1.Taxpayer agrees to comply with the terms and conditions of this APA, including
the transfer pricing methodology ("TPM") that is described in Appendix A. If Taxpayer
complies with the terms and conditions of this APA, then the Service will not contest the
application of the TPM to the Covered Transactions and will not make or propose any
reallocation or adjustment under section 482 of the Code with respect to Taxpayer concerning
the transfer prices in Covered Transactions for the years covered by this APA (the "APA
Years").
3.2.Regardless of the date on which Taxpayer filed its request for this APA, Taxpayer
and the Service agree, unless otherwise specified to the contrary in this APA, that Rev. Proc. 96-
53, 1996-2 C.B. 375, and not any predecessor to Rev. Proc. 96-53, governs the interpretation,
administration, and legal effect of this APA.
3.3.If, for any APA Year, Taxpayer does not comply with the terms and conditions of
this APA, then the Service may:
i.enforce the terms of this APA and propose adjustments to the income,
expenses, deductions, credits, or allowances reported on Taxpayer's U.S.
federal income tax return in keeping with the terms of this APA;

39
ii.cancel or revoke this APA pursuant to section 11.05 or 11.06 of Rev. Proc.
96-53; or
iii.revise this APA, upon agreement on revision with Taxpayer.
3.4.This APA addresses the arm's length nature of prices charged or received in the
aggregate between Taxpayer and [name of foreign group], and except as explicitly provided in
this APA does not address, and does not bind the Service with respect to, prices charged or
received, or the relative amounts of income or loss realized, by particular legal entities that are
members of Taxpayer or that are members of [foreign group]. The true taxable income of a
member of an affiliated group filing a U.S. consolidated return shall be determined under the
regulations governing consolidated returns. See, e.g.
, Treas. Reg. section 1.1502-12. Similarly,
to the extent relevant for United States tax purposes, and except as explicitly provided in this
APA, the relative amounts of income of different entities that are members of [foreign group]
shall be determined under the arm's length standard of section 482 without reference to this
APA.
3.5.The Parties agree that nonfactual oral and written representations, within the
meaning of sections 10.04 and 10.05 of Rev. Proc. 96-53 (including any proposals to use
particular TPMs), made in conjunction with this request constitute statements made in
compromise negotiations within the meaning of Rule 408 of the Federal Rules of Evidence.
4.Term. This APA shall apply only to the APA Years, which shall include only
________________.
5.Financial Statements and APA Records. The determination whether Taxpayer
has complied with this APA will be based on its United States income tax return; its financial
statements as prepared in accordance with generally accepted accounting principles ("GAAP")

40
on a consistent basis (the "Financial Statements"); the additional records ("APA Records")
specified in Appendix B; and all information specified in section 8 of this APA. Taxpayer will
not be in compliance with the TPM unless an independent certified public accountant renders an
opinion that the Financial Statements present fairly, in all material respects, the financial position
of Taxpayer and the results of its operations, in accordance with GAAP. Taxpayer agrees to
maintain the Financial Statements and APA Records and to make them available within thirty
days of a request by the Service in connection with an examination described in section 11.03 of
Rev. Proc. 96-53. Compliance with this section 5 of the APA will constitute compliance with
the record maintenance provisions of sections 6038A and 6038C of the Code, with respect to
Covered Transactions during the APA Years.
6.Critical Assumptions. The Critical Assumptions of this APA, within the meaning
of section 5.07 of Rev. Proc. 96-53, are listed in Appendix C.
7.Tax and Compensating Adjustments. In the event Taxpayer’s actual transactions
did not result in compliance with the TPM described in Appendix A, Taxpayer’s taxable income
must nevertheless be reported in an amount consistent with the TPM and the requirements of the
APA, either on a timely filed original return or on an amended return. Taxpayer may make
Compensating Adjustments as described in and subject to the rules of section 11.02 of Rev. Proc.
96-53, and subject to any restrictions stated in this APA.
8.Annual Report. Taxpayer shall file a timely Annual Report for each APA Year
pursuant to the rules of section 11.01 of Rev. Proc. 96-53. The Annual Report shall contain the
information described in Appendix D. In connection with an examination described in section
11.03 of Rev. Proc. 96-53, the District Director may request and Taxpayer shall provide

41
additional facts, computations, data or information reasonably necessary to clarify the Annual
Report or verify compliance with the APA.
9.Disclosure. This APA, and the information, data, and documents related to this
APA and Taxpayer’s APA request are: (1) considered return information pursuant to section
6103(b)(2)(C) of the Code; and (2) not subject to public inspection as a written determination
pursuant to section 6110(b)(1) of the Code. Pursuant to section 521(b) of the Ticket to Work and
Work Incentives Improvement Act of 1999, Pub. L. 106-170, however, the Secretary of the
Treasury is obligated to prepare a report for public disclosure that would include certain
specifically designated information concerning all APAs, including this APA, in such form as
not to reveal taxpayers’ identities, trade secrets, and proprietary or confidential business or
financial information.
10.Disputes. Should a dispute arise concerning the interpretation of this APA, the
Parties agree to seek resolution of the dispute by the Associate Chief Counsel (International), to
the extent reasonably practicable, prior to seeking alternative remedies. Disputes not related to
the interpretation of this APA shall be pursued consistent with section 11.03(4) of Rev. Proc. 96-
53.
11.Section Captions. The section captions contained in this APA are for
convenience and reference only and shall not affect in any way the interpretation or application
of this APA.
12.Notice. Any notices required by this APA or Rev. Proc. 96-53 shall be in writing.
Taxpayer shall send notices to the Service at the address and in the manner prescribed in section
5.13(2) of Rev. Proc. 96-53. The Service shall send notices to Taxpayer at
_____________________________________.

42
13.Effective date. This APA shall become binding when both Parties have executed
the APA [,and the competent authorities of ____________ and the United States have executed a
mutual agreement that is consistent with this APA].
14.Counterparts. This APA may be executed in counterparts, with each counterpart
deemed an original.
IN WITNESS WHEREOF, the Parties have executed this APA on the dates indicated
below.
TAXPAYER
By:___________________________ Date:_________
[Name of Signature]
[Title]
INTERNAL REVENUE SERVICE
By:___________________________ Date:_________
[Name of Signature]
Director, Advance Pricing Agreement Program

43
APPENDIX A
TRANSFER PRICING METHODOLOGY
For each APA Year:
Covered Transactions.
The Covered Transactions for this APA consist of ___________________.
Transfer Pricing Methodology (“TPM”).

44
APPENDIX B
APA RECORDS
1.All documents listed in Appendix D for inclusion in the Annual Report, as well as all
documents, notes, work papers, records, or other writings that support the information
provided in such documents.
2.[Insert here other records.]

45
APPENDIX C
CRITICAL ASSUMPTIONS
1.The business activities, functions performed, risks assumed, assets employed, and
financial [and tax] accounting methods and classifications [and methods of estimation] of
Taxpayer shall remain materially the same as described or used in Taxpayer's request for
this APA.
2.[Insert here other Critical Assumptions.]

46
APPENDIX D
ANNUAL REPORT
Taxpayer shall include the following in its Annual Report for each APA Year:
1.A statement identifying all material differences between Taxpayer's business operations
(including functions performed, risks assumed and assets employed) during the APA
Year and the description of the same contained in Taxpayer's request for this APA, or if
there have been no such material differences a statement to that effect.
2.A statement identifying all material changes in Taxpayer's accounting methods and
classifications [and methods of estimation] from those described or used in Taxpayer's
request for this APA, or if there have been no such material changes a statement to that
effect.
3.The Financial Statements.
4.A financial analysis demonstrating Taxpayer's compliance with the TPM.
5.A description of any failure to meet Critical Assumptions, or if there have been no such
failures, a statement to that effect.
6.A description of the reason for, and financial analysis of, any Compensating Adjustments
with respect to the APA Year, including the means by which any such Compensating
Adjustment has been or will be satisfied.

47
7.A copy of the certified public accountant's opinion, described in section 5 of this APA,
for the APA Year.
8.[Insert here other items to be included in Annual Report.]

48
ATTACHMENT B
FORMULAS FOR BALANCE SHEET ADJUSTMENTS
Definitions of Variables:
AP=average accounts payable
AR=average trade accounts receivable, net of allowance for bad debt
cogs =cost of goods sold
INV =average inventory, stated on FIFO basis
opex =operating expenses (general, sales, administrative, and depreciation expenses)
PPE =property, plant, and equipment, net of accumulated depreciation
sales =net sales
tc=total cost (cogs + opex, as defined above)
h=average accounts payable or trade accounts receivable holding period,
stated as a fraction of a year
i=interest rate
t
=entity being tested
c
=comparable
Equations:
If Cost of Goods Sold is controlled (generally, sales in denominator of PLI):
Receivables Adjustment (“RA”):RA = {[(AR
t
/ sales
t
) x sales
c
] - AR
c
} x {i/[1+(i x h
c
)]}
Payables Adjustment (“PA”):PA = {[(AP
t
/ sales
t
) x sales
c
] - AP
c
} x {i/[1+(i x h
c
)]}
Inventory Adjustment (“IA”):IA = {[(INV
t
/ sales
t
) x sales
c
] - INV
c
} x i
PP&E Adjustment (“PPEA”):PPEA = {[(PPE
t
/ sales
t
) x sales
c
] - PPE
c
} x i
If Sales are controlled (generally, costs in the denominator of PLI):
23
Receivables Adjustment (“RA”):RA = {[(AR
t
/ tc
t
) x tc
c
] - AR
c
} x {i/[1+(i x h
c
)]}
Payables Adjustment (“PA”):PA = {[(AP
t
/ tc
t
) x tc
c
] - AP
c
} x {i/[1+(i x h
c
)]}
Inventory Adjustment (“IA”):IA = {[(INV
t
/ tc
t
) x tc
c
] - INV
c
} x i
PP&E Adjustment (“PPEA”):PPEA = {[(PPE
t
/ tc
t
) x tc
c
] - PPE
c
} x i
Then Adjust Comparables as Follows:
adjusted sales
c
= sales
c
+ RA
adjusted cogs
c
= cogs
c
+ PA - IA
adjusted opex
c
= opex
c
- PPEA

23
Depending on the specific facts, the equations below may use total costs (“tc”) or cost of goods sold (“cogs”).