Advance pricing agreement

What it means

An advance pricing agreement, or APA, is a procedure in which a company asks the tax administrator to approve its transfer pricing method before carrying out transactions with related parties. In Slovakia it is set out in the Income Tax Act as a decision on the use of a pricing method.

The outcome is a decision binding on the tax administrator for the agreed period, at most five years. If the company follows the approved method and the assumptions on which the decision rests, the tax administrator cannot challenge the method in an audit. The company thus gains legal certainty in one of the most frequently disputed areas.

The agreement can be unilateral, concluded only with the Slovak tax administrator, or bilateral or multilateral, involving the tax authorities of other states under a double tax treaty. A multilateral agreement protects better against double taxation but takes longer.

How it works in practice

An APA makes sense for significant, recurring intra-group transactions such as royalties, management services, financing or contract manufacturing, where pricing is complex and there is a risk of a large gap between the views of the company and the tax administrator. For small routine transactions it is usually not worth it.

The application is filed before the start of the period the decision should cover. It contains a description of the group and transactions, a functional and risk analysis, the proposed method, comparable data and critical assumptions. An administrative fee is charged for the decision, considerably higher for a cross-border agreement. The procedure can take months or even years.

While the agreement is in force the company still keeps transfer pricing documentation and shows each year that its transactions follow the approved method. If circumstances change substantially, such as a group restructuring or new functions, it must ask for the decision to be amended. Otherwise the protection lapses.

What to watch out for

The agreement covers the method, not a specific price level. If the company applies the method incorrectly, for example uses different comparables or fails to meet the critical assumptions, the tax administrator may adjust the result in a tax audit. Strict compliance with the conditions is therefore as important as obtaining the decision.

The application discloses a great deal about the group to the tax administrator. If the procedure ends without agreement, that information stays with the administrator. Before filing we recommend assessing the strength of the arguments with a tax adviser and considering whether robust documentation would be the better route.