Practical Valuation of Risk Transfer in Advance Pricing Agreements

Zvika Afik, Yaron Lahav


A recently published paper argues that Advance Pricing Agreements adopting the Comparable Profits Method or the Transactional Net Margin Method, overlook the risk transferred from the tested party (subsidiary) to the party related to the transaction (parent) - a shift caused by fixing the profitability of the tested party. In this paper, we propose a practical implementation methodology to estimate the model parameters and discuss the theoretical and practical reasons for our proposed method. Finally, we also provide numerical examples demonstrating the miss-allocation of profits and taxes. According to our examples, fixing the profitability level of a manufacturer equals a shift of 0.5% of its profitability, while fixing the profitability of a management entity means a shift of 0.85% of its profitability. These amounts can be significant on aggregate levels.

Full Text:



Afik, Z. & Lahav, Y. (2016). Risk Transfer Valuation in Advance Pricing Agreements

between Multinational Enterprises and Tax Authorities. Journal of Accounting, Auditing

and Finance, 31(2), 203-211.

APA Program. (2014). Announcement and Report Concerting Advance Pricing Agreements.

Issued on March 27, 2014. (

Bodie, Z., Kane, A. & Marcus, A. (2009). Investments, 8th edition. McGraw-Hill.

Borkowski, S. C. (2000). Transfer Pricing Advance Pricing Agreements: Current Status by

Country. The International Journal, 26: 1-16.

Borkowski, S. C. (2008). The History of PATA and its Effect on Advance Pricing

Arrangements and Mutual Agreement Procedures. International Journal of Accounting,

Auditing and Taxation, 17: 31-50.

Broomhall, D. (2007). Dynamic Adjustments in Transfer Pricing Agreements. Business

Economics, 42 (2): 22-30.

Clausing, K. & Lahav, Y. (2011). Corporate Tax Payments under Formulary Apportionment:

Evidence from the Financial Reports of 50 Major U.S. Multinational Firms. International

Journal of Accounting, Auditing and Taxation, 20 (2): 97-105.

Damodaran A. (2010). Applied Corporate Finance, 3rd edition. Wiley.

Damodaran, A. (2011). Equity Risk Premiums (ERP): Determinants, Estimation and

Implications – The 2011 Edition. working paper (available on SSRN).

De Waegenaere, A., Sansing, R. & Wielhouwer, J. (2007). Using Bilateral Advance Pricing

Agreements to Resolve Tax Transfer Pricing Disputes. National Tax Journa,l 60 (2):


Fama, E. & French K. R. (2004). The Capital Asset Pricing Model: Theory and Evidence.

Journal of Economic Perspectives, 26 (3): 1-16.

Fan, X. (2008). Difficulties in Pressing Forward Advance Pricing Agreement (APA) in

China. Asian Social Science, 4(11), 53-58.

Felgran, S. D., Harris, S. D., Kamen, A. & Subramanian, P. (2009). Adjusting Pricing

Methods for APAs in an Economic Downturn, In Practice, 18 (8), 468-474.

Fernandez, P, Aguirreamalloa, J. & Avendaño, L. C. (2011a). US Market Risk Premium

Used in 2011 by Professors, Analysts and Companies: A Survey with 5.731 Answers.

SSRN, April 8.

Fernandez, P, Aguirreamalloa, J. & Avendaño, L. C. (2011b). Market Risk Premium Used in

Countries in 2011: A Survey with 6,014 Answers. SSRN, April 25.

Hull J.C. (2011). Options, Futures, and Other Derivatives. 8th edition, Pearson.

Internal Revenue Services. (2006). Section 482.–Allocation of Income and Deductions

Among Taxpayers. Rev. Proc, 2006-9.

Internal Revenue Services, APA Program. (2013). Announcement and Report Concerning

Advance Pricing Agreements. March 25, 2013.

International Monetary Fund and OECD. (2017). Tax Certainty: IMF/OECD Report for the

G20 Finance Ministers. March, 2017.

Jagannathan, R., & Wang, Z. (1996). The Conditional CAPM and the Cross-Section of

Expected Returns. The Journal of Finance, 51 (1): 3-53.

Kandel, S., & Stambaugh, R.F. (1987). On Correlations and Inferences about Mean-Variance

Efficiency. Journal of Financial Economics, 18, 61-90.

Kandel, S., & Stambaugh, R.F. (1995), Portfolio Inefficiency and the Cross-Section of

Expected Returns. Journal of Finance, 50, 157-184.

Organisation for Economic Co-operation and Development. (2010). Transfer Pricing

Guidelines for Multinational Enterprises and Tax Administration.

Prono, T. (2009). Market Proxies, Correlation, and Relative Mean-Variance Efficiency: Still

Living with the Roll Critique. MPRA working paper.

Ring, D. M. (2000). On the Frontier of Procedural Innovation: Advance Pricing Agreements

and the Struggle to Allocate Income for Cross Border Taxation. Michigan Journal of

International Law, 21, 143-234.

Roll, R. (1977). A Critique of the Asset Pricing Theory's Tests. Journal of Financial

Economics, 4, 129-176.

Shanken, J. (1987). Multivariate Proxies and Asset Pricing Relations: Living with the Roll

Critique. Journal of Financial Economics, 18, 91-110.

Tomohara, A. (2004). Inefficiencies of Bilateral Advanced Pricing Agreements (BAPA) in

Taxing Multinational Companies. National Tax Journal, LVII (4), 863-873.


  • There are currently no refbacks.

Copyright ©  Journal of Tax Administration. All rights reserved. | Hosted by Docuracy Ltd | Powered by Open Journal Systems