India’s APA Programme: Stirring Certainty

Background

The transfer pricing debate between the taxpayers and the Indian tax authorities has been a never-ending story. The taxpayers in India have faced eleven rounds of transfer pricing audits so far. Each round of transfer pricing audit has seen new controversies in areas such as marketing intangibles, share valuation, corporate guarantees, business restructuring and location savings, in addition to litigation on selection of comparables and attribution of high markups for routine activities.

With close to INR 46,465 crore of adjustments made in the eleventh round of transfer pricing audits, transfer pricing has gained paramount importance for both taxpayers and the tax authorities. With such huge adjustments, India has been reckoned as a jurisdiction with high litigation in transfer pricing matters. This impacted Indian Government’s efforts to project India as an investor friendly jurisdiction and business destination for multinational companies.

In order to regain confidence of the business community across the globe and put Indian back on the investors map, introduction of a program with an objective of providing stability and certainty to tax payers on transfer pricing matters was the call of the hour. With this intention in mind, the Indian Government introduced advance pricing agreement (‘APA’) program in 2012. The APA program is a major initiative of the government which essentially aims at a negotiated arrangement between a taxpayer and the tax authorities that sets out in advance the method and arm’s length price for the transactions between affiliated entities.

The India APA programe offers three types of APAs, namely unilateral APAs, bilateral APAs and multilateral APAs. While a unilateral APA is an agreement between the taxpayer and the CBDT, bilateral / multilateral APA involves an agreement between the competent authorities of India and the competent authorities of the country of the taxpayer’s associated enterprise. The APA entered into by a taxpayer and the CBDT may include the agreed transfer pricing methodology and the determination of the arm’s length price related to the covered international transaction for the APA. There is no time limit prescribed for concluding an APA.

The Story So Far

The APA program was welcomed by the tax payers which is evident from the fact that a large number of APA applications have been filed with the APA authorities in three rounds of filings completed in March 2015. According to sources, approximately 580 APA applications have been filed till date since its introduction in July 2012. The icing on the cake was introduction of roll-back provisions early this year, giving an opportunity to the tax payers to obtain certainty for their existing transfer pricing disputes for past 4 years. In essence, the APA program now provides certainty to a tax payer for a period of 9 years i.e. certainty on arm’s length price for future 5 years and past 4 years. It is expected that this will further accelerate this process whereby it is expected that even those tax payers who have been waiting and watching the progress and outcome of APA from sidelines will also join the move.

The Indian Government has demonstrated its commitment to make the APA program a big success, which is evident from the fact that in the very first year of the program, it signed the first batch of five unilateral APAs covering a varied range of international transactions. The signed APAs covered variety of international transactions such as interest payments, corporate guarantees, non-binding investment advisory services and contract manufacturing from diverse sectors, including pharmaceuticals, telecom, natural resources exploration and financial services.

In June 2015, the CBDT signed first APA with a taxpayer engaged in the Information Technology Enabled Services (‘ITES’) industry. The ITES industry has always been a soft target with the transfer pricing authorities expecting high margins resulting in transfer pricing adjustments. This development is likely to encourage many other ITES players in industry to follow the APA route.

The process received a momentum with CBDT signing the first bilateral APA with Japan. Further, in a significant development, within a period of four months post notification of roll-back rules in March 2015, the CBDT signed a unilateral roll-back APA in August 2015. The signing of an APA roll-back in such a short span is expected to boost taxpayer’s confidence greatly and can go a long way in more and more taxpayers to opt for APAs with roll-back rather than following the litigation route.

In its ongoing drive to close the pending APA applications, on 13 October 2015, CBDT further signed four unilateral APAs including India’s second APA with a rollback provision marking an important step in the country’s attempts to provide a predictable transfer pricing regime. The nature of the transactions covered under these agreements varied from software development to share price valuation. According to government sources, the total number of APAs signed till date is 20.

India is the first country in the world to achieve this success in the very first year. The Government believe that the APA program will go a long way in creating a framework for avoiding litigation arising from the aggressive transfer pricing environment and providing an environment to the business community whereby they can focus on business rather than litigation.

The Approach

The success of any APA depends on the intention of the Government and approach of the APA authorities as well as the taxpayers. The key aspect of the entire APA process is that the taxpayers should be transparent and proactive in sharing relevant information and documents with the APA authorities. Similarly, the APA authorities need to analyses each case by looking at the business realities and economic factors and should not be driven by a biased approach, which will help in reaching an acceptable arrangement with the taxpayer.

India has a dedicated APA team which ensures consistency in interpretation of critical assumptions of the APA and thus enhances effectiveness of APA negotiation. The positive response of the APA team during pre-filing discussions as well as post-filing meetings/discussions has been a driving factor in successful conclusion of the APAs so far. The professional approach adopted by the APA team in maintaining balance between the business realities and interest of the revenue has been appreciated by transfer pricing specialists and foreign investors.

Way Forward

Introduction of the APA regime and its success are evidence of the Indian Government’s commitment to create a tax friendly environment in India. Towards this, APA authority’s approach in distinguishing the APA process from the traditional audits and acting as a facilitator to the negotiation process is quite commendable. It is certainly a positive step towards a more certain economy.

With the experience so far, it is now expected that the APA program will evolve and develop a collaborative mechanism that can lead to win-win situations for both tax payers as well as tax authority. This is all the more critical at this stage as safe- harbor rules have failed to attract most taxpayers and hence achieving certainty through an APA will surely be an effective solution.