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Resurrecting Indo -US
Services & Trade
Recent initiatives to contain tax disputes
Indo American Chamber of Commerce
2
Background
Transfer Pricing (TP) adjustments have become highly contentious in recent times
Over 51% cases taken for TP audit result in adjustments to declared incomes
(Annual report of Ministry of Finance,2013)
For 2012-13 the figure is reported to be of the order of INR 671 billion
Variety of reasons for this situation
Year Number of cases taken for
TP audit
Adjustments made
( billion INR)
2010-11 1207 241.11
2011-12 1343 445.32
3
New initiatives by Income Tax department
Two major initiatives by Government to address the situation
1. Advance Pricing Agreements (APA) Scheme
2. Safe Harbour Rules
Advance Pricing Agreements - APA
5
APAs are agreements between Tax department and the taxpayer determining agreed price for ‘related party’ transaction(s)
These inter-alia -
Lay down the manner of its determination Arm Length Price (ALP) of an “international transaction” OR Determine the ALP
Bind the taxpayer and the ITD to adopt the agreed price
For a defined period not exceeding 5 consecutive years
Under certain clearly stated critical assumptions
Scheme applies to all sectors and there is no minimum threshold
APAs can be Unilateral, Bilateral or Multi lateral
Salient features of APA Scheme
6
Bilateral/ multi lateral APAs Bilateral APAs
Entered into between Board & the taxpayer based on agreement between Competent Authorities (CA) of two countries
Multilateral APA
Entered into between Board and taxpayer based on agreement between CAs of more than two countries
These ensure certainty at both ends of the transaction
However, bilateral/multilateral APA can be entered only if -
There are provisions in domestic law of the other country to enter into APAs
The concerned countries have DTAA with each other
The AE(s) situated outside India initiates the process in the other country
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1. Pre-filing application and consultations with a special Team of Board to -
Determine scope of proposed APA
Identify transfer pricing issues and past history
Determine suitability of the ‘international transaction’ for APA, and the critical assumptions behind the proposal
Transactions can be relating to transfer of tangible / intangible properties, cost sharing, provision / receipt of services, etc.
Discuss broad terms of understanding including time lines
The terms are recorded but are not binding
Anonymous pre-filing consultation permissible
Stages involved in finalisation of APAs
8
2. Filing of APA Application
Prescribed proforma, Application fees
For ongoing transactions - before 1st day of the year
For new transactions - before undertaking the transaction
Business structure, financial analysis, comparables etc
Functional analysis Functions performed by the taxpayer in relation to the controlled transactions, assets used to perform these and related business/ commercial risks
Critical assumptions – Facts the continued existence of which is critical to support the agreed ALP - such as industry, business, economic conditions, etc
Stages involved in finalisation of APAs
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3. Evaluation and Negotiation stage
Examination of documents by the Team,
Removal of defects,
Calling of additional information
Site inspection, if necessary
Negotiations with taxpayer
Negotiations with other jurisdictions where necessary
Preparation of draft report
Drafting of proposed agreement in case consensus is reached
Possible to withdraw from the process at any stage
Stages involved in finalisation of APAs
10
4. Finalisation of APA with approval of GoI, laying down - Particulars of the ‘international transaction’ covered
Definition of relevant terms, the business model, functional and risk profile etc
Critical assumptions – Factors and assumptions that are so critical and significant that neither party entering into an agreement will continue to be bound by the agreement if any of those is changed
May be Operational or Legal or Financial or Accounting
May be about the taxpayer or an affiliate or a third party or industry or general economic conditions.
Agreement not to be binding in case of change in any critical assumptions or failure to meet conditions subject to which the APA has been entered into
Agreed transfer pricing methodology or the ALP
Stages involved in finalisation of APAs
11
5. Post APA compliance For years covered under APA all completed or pending, assessments have to be completed in accordance with the APA
Regular TP audit will not be carried out for transaction(s) covered under APA
Annual compliance report to be filed for the covered transaction(s) to certify - Compliance with the terms of the agreement
Satisfaction of critical assumptions
Correctness of supporting data/ Information
Stages involved in finalisation of APAs
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Process is non adversarial
Mandatory pre-filing allows taxpayer to assess department’s view beforehand
Flexibility in determining ALP
Provides legal certainty regarding covered transaction(s), reducing cost of compliance
Elimination of potential double taxation in cases of bilateral or multilateral APA
APA can also provide guidance to the past litigation
Advantages of APAs
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High upfront cost – may not be suitable for mid size companiesLengthy and elaborate processExtensive information required to be shared
Issues of confidentiality in case of withdrawal from APA process
Time limit for completing the process not prescribedNo provision of roll back of APA terms to past disputesProcesses are still in nascent stage
Downside
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When APAs are best suited
Best suited in cases of complex controlled transactions with high TP risk
Revenue impact of possible TP adjustments is large
The Associated Enterprises are so deeply integrated in the business that a prudent businessman cannot assign functions and risks unambiguously to either entity
The value of intangibles contributes significantly to the business value of the transaction
Comparables do not exist for the type of transaction
Taxpayer needs legal certainty for strategic business decisions
Safe Harbour Rules
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What is safe harbour
“ Safe Harbour” in relation to computation of ALP
means the circumstances in which tax authorities shall
accept the transfer price declared by the taxpayer
Safe Harbour Rules (SHR) notified on 14.08.2013
These are applicable only to ‘eligible taxpayers’, and for
‘eligible international transactions’
If an eligible assessee opts for SHR then the
transfer price declared by him in respect of
eligible international transactions will be
accepted, provided the safe harbour conditions
are fulfilled
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Eligible assessees & eligible transactions
Persons engaged in international transactions relating to -Software development services,IT-enabled services, KPO services,Contract R&D services relating to -
Software development Generic pharmaceutical drugs
Manufacture & export of auto components,Intra-group loan to a non-resident wholly owned
subsidiary (WOS),Corporate guarantee provided to a non-resident
WOS.
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Prescribed safe harbour for eligible sectors
Eligible International Transaction Safe Harbour
Software development and IT enabled services
(i) transactions < INR 5 billion
(ii) transactions > INR 5 billion
(i) Operating profit Margin (OPM) 20% or more
(ii) OPM 22% or moreKPO services OPM is 25% or more
Contract research and development services
(i) relating to software development
(ii) relating to generic drugs
(i) OPM is 30% or more
(ii) OPM is 29% or more
Manufacture and export of core auto components
OPM is 12% or more
Manufacture and export of non-core auto components OPM is 8.5% or more
Advancing intra-group loans
(i) Aggregate value of transactions < INR 500 million
(ii) Aggregate value of transactions > INR 500 million
Interest rate is not less than
Base SBI rate+150 basis points
Base SBI rate+300 basis points
Providing corporate guarantees
(i) does not exceed INR 1 billion
(ii) exceeds INR 1 billion
Commission or fee is
(i) not less than 2%
(ii) not less than 1.75%
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Thanks
S.S KhanSenior Partner
Kochhar & Co
shahid.khan@ kochhar.com