THE LEGAL POSITION OF ADVANCE PRICING AGREEMENTS IN

INDIA: A CRITICAL ANALYSIS

- Tanvi Kini

International trade transactions are characterised by heavy tax burden, transfer pricing, audits, compliances, and not to forget litigation. Globally, one of the most promising solutions, over the past few years, has been the growing trust in Advance Pricing Agreements by taxpayers and tax authorities. An Advance Pricing Agreement is a prospective arrangement between a taxpayer, which in most cases is a multinational enterprise, and one or more national tax authorities, who negotiate and decide the method that the enterprise shall use to calculate transfer prices.

In India, the Ministry of Finance introduced the APA scheme by way of the Finance Act, 2012 which inserted Sections 92CC and 92CD to the Income Tax Act, 1961.This scheme was introduced with the vision that it would resolve transfer pricing disputes, eliminate or reduce the risk of double taxation, and abridge litigation. Undoubtedly, this scheme appears to assure the taxpayer and the tax authorities of a win-win situation with its promising results i.e. no transfer pricing dispute, no double taxation and no litigation. However, a deeper analysis of the APA scheme in India reveals that the risk of double taxation and disputes arising out of transfer pricing are not completely eliminated. In addition, there are several other problems faced during the APA process which need to be resolved in order to make the scheme more effective.

The purpose of this paper is to explain in detail the legal position of Advance Pricing Agreement in India, critically analyse the provisions of the Indian statutes, and suggest practical changes that ought to be made in order to establish the scheme successfully.

CONTENTS

1. INTRODUCTION ........................................................................................... 2 2. TYPES OF ADVANCE PRICING AGREEMENTS ........................................... 4

2.1. Unilateral Advance Pricing Agreement ........................................ 4 2.2. Bilateral Advance Pricing Agreement (BAPA) ............................ 5 2.3. Multilateral Advance Pricing Agreement (MAPA) ..................... 5

3. AN OVERVIEW OF ADVANCE PRICING AGREEMENTS IN INDIA ........... 6

IV year, BBA LLB., Symbiosis Law School, Pune.

3.1. Application for APA ....................................................................... 7 3.2. Binding Effect of APA under the Income Tax Act, 1961 ......... 8 3.3. Amendment to Application............................................................ 9 3.4. Revision of an APA ......................................................................... 9 3.5. Withdrawal and Cancellation of an APA ................................... 10 3.6. Effect to Advance Pricing Agreements ...................................... 11 3.7. Rollback Provisions of Advance Pricing Agreement Scheme. 12

4. THE SIGNIFICANCE OF APA IN INDIA ................................................... 13 4.1. Certainty About Transfer Pricing and Reduces the Risk of

Double Taxation ............................................................................ 14 4.2. Determination of Arm’s Length Price ........................................ 14 4.3. Rollback Provisions ....................................................................... 15 4.4. Time and Cost Effective ............................................................... 15 4.5. Better Tax Schemes and Policies ................................................. 16 4.6. Transparency in the System.......................................................... 16

5. SHORTCOMINGS OF ADVANCE PRICING AGREEMENTS IN INDIA ...... 16 5.1. Expensive and Time Consuming ................................................ 17 5.2. Confidentiality Uncertain .............................................................. 17 5.3. Trivial Role of the Taxpayer......................................................... 18 5.4. Lengthy APA Procedure ............................................................... 18 5.5. Disputes Arising Out of Advance Pricing Agreement and

Transfer Pricing .............................................................................. 19 5.6. Double Taxation Not Eliminated in Unilateral APA ............... 19 5.7. No Time Limit ............................................................................... 19

6. METHODS TO OVERCOME DIFFICULTIES ............................................... 19 6.1. Reduce and Refund Fee ................................................................ 19 6.2. Protect Taxpayer’s Information ................................................... 20 6.3. Encourage Information Flow to Taxpayer ................................ 20 6.4. Prescribed Time Limit Required ................................................. 20

7. CONCLUSION ............................................................................................. 21

1. INTRODUCTION

The concept of Advance Pricing Agreement (APA) was first introduced in Japan in 1987 to ensure the smooth and proper enforcement of transfer pricing regulations.1 In 1991, the United States Internal Revenue System adopted the system. Subsequently, it was adopted by Canada in 1994,

1 R. Athavale, “Advance Pricing Agreement- Scope and Procedure- Will It Mitigate

Litigation?” The Chamber’s Journal, 35 (2015).

China in 1998, the United Kingdom and France in 1999.2 India adopted the APA system in 2012, 25 years after it was first introduced.

As per the Organisation for Economic Co-operation and Development (OECD) Guidelines, an Advance Pricing Agreement is defined as,

“An arrangement, that determines, in advance of controlled transactions, an appropriate set of criteria (e.g. method, comparable, and appropriate adjustments thereto, critical assumptions as to future events) for the determination of the transfer pricing for those transactions over a fixed period of time.”3

It is an arrangement between two or more competent authorities which enable multinational enterprises to define a transfer pricing method in agreement with the tax authorities. The set of criteria used is decided upon by the competent authority and the enterprise(s) concerned based on what they deem to be most appropriate. This arrangement is applied over a fixed period and enables the enterprise concerned to calculate the transfer price to be used for future transactions between related enterprises. The purpose of this agreement is to eliminate the risk of double taxation by establishing an agreement between the two Contracting States.4 The APA system is a cooperative process from which “taxpayers and the government derive significant benefits.”5

In India, this type of agreement takes place between the Central Board of Direct Taxes (CBDT) and the taxpayer, which determines, in advance, the arm’s length price (ALP) or specifies the manner of the determination of ALP (or both), in relation to an international transaction.6 In 2012, the Ministry of Finance notified an “Advance Pricing Agreement”, defining it as,

“An agreement between the Central Board of Direct Taxes and any person, which determines, in advance, the arm’s length price or specifies the manner of the

2 Id, at 35.

3 OECD Guidelines, Para. 4, p. 124, available at http://www.oecd.org/ (last accessed on 20 July 2015).

4 Advance Pricing Arrangements: Approaches to Legislation, available at: http:// www.oecd.org/ctp/tax-global/4.%20Advance_Transfer_Pricing_Arrangements.pdf (last accessed on 20 July 2015).

5 M. P. Dolan, “IRS Acting Commissioner’s Testimony on Senate Appropriations Panel Hearing on IPS Budget”, Tax Notes Today, pp. 119-37 (1997).

6 Income Tax Department, Government of India, ‘Advance Pricing Agreement Guidance with FAQs’, Taxpayers Information Series, Vol. 43, 2012-13, available at www.itatonline.org/info/?dl_id=1215 (last accessed on 21 July 2015).

determination of arm’s length price (or both), in relation to an international transaction.”7

In order to analyse this arrangement, it is important to understand the meaning of two basic concepts i.e. transfer pricing and arm’s length price. Transfer pricing in brief can be defined as “the pricing of cross-border intra-firm transactions between related parties.”8 The problem of transfer pricing arises where corporations are divisionalised and have responsibility centres operating as strategic business units, a situation that presents challenges in determining suitable prices for intra-group transactions. The problem aggravates when a company has subsidiaries spread throughout the world, in countries that have varying tax rates.9 Another important concept is ‘arm’s length pricing’ which can be simply defined as “a transaction when a seller and buyer have no personal interest in the matter agree to a price with no pressure placed on them.”10

Once an APA has been entered into with respect to an international transaction, the ALP with respect to that international transaction, for the period specified in the APA, will be determined only in accordance with the APA.11 This APA is binding on the person as well as the Commissioner of Income Tax, his subordinates and the income tax authorities who have jurisdiction over such person and the said transaction. In India, there is no minimum period of an APA; however the maximum period is 5 years.12

2. TYPES OF ADVANCE PRICING AGREEMENTS

Advance Pricing Agreements may be categorised into Unilateral APA, Bilateral APA or Multilateral APA.

2.1. Unilateral Advance Pricing Agreement

7 Ministry of Finance, Government of India, Ministry of Finance Notifies Advance Price

Agreements (APA) Scheme, 2012, available at http://pib.nic.in/newsite/Print Release.aspx?relid=87164 (last accessed on 21 July 2015).

8 M. Markham, “Advance Pricing Agreements: Past, Present, Future”, Kluwer Law International (2012).

9 B. Tebogo, ‘The Transfer Pricing Problem: When Multinational Corporations Shift Profits Across International Borders’, available at SSRN: http://ssrn.com/abstract= 1899014 (last accessed on 1 August 2015).

10 The Law Dictionary, available at http://thelawdictionary.org/arms-length-price/ (last accessed on 1 August 2015).

11 Income Tax Department, Government of India, Advance Pricing Agreement Guidance with FAQs, Taxpayers Information Series- 43, 2012-13, available at www.itatonline.org/info/?dl_id=1215 (last accessed on 21 July 2015).

12 Id, at 2.

A Unilateral Advance Pricing Agreement is an APA made between a company and one tax authority. In India, the Unilateral APA is an agreement between the CBDT and the applicant and does not involve any agreement with any other party. It, therefore, does not guarantee the ALP or Transfer Pricing Method (TPM), determined under an APA, being accepted by the other party.13 In this type of APA, double taxation is possible as there is no prior agreement between the applicant and the competent authority of the other country.

2.2. Bilateral Advance Pricing Agreement (BAPA)

The parties involved in a BAPA are the taxpayer and the taxing authorities of the two countries involved in the agreement. It reduces the risk of potential double taxation.14 In India, the applicant entering into such an agreement is required to make an application with the competent authority of India and simultaneously an application must be made to the competent authority of the other country.15 Evidence of application made to the Competent Authority of the other country must be furnished to the Competent Authority of India.16Further, the two competent authorities are required to reach an arrangement through Mutual Agreement Procedure (MAP) negotiation, which is also required to be accepted by the applicant before a BAPA is entered into. This arrangement is binding on all three parties i.e. the taxpayer, the Competent Authority of India and the Competent Authority of the other Country.

2.3. Multilateral Advance Pricing Agreement (MAPA)

An agreement entered into between a taxpayer, the tax authority of the host country and the tax authorities of one or more foreign countries. Therefore, in India, the agreement would be entered into by the taxpayer, the Competent Authority of India and the Competent Authorities of one or more foreign Countries. In this case as well, the Competent Authority of India must reach an arrangement with the Competent Authorities of the foreign countries before the agreement is offered to the applicant17 and the arrangement must be agreed on by the applicant. A MAPA is

13 Ibid.

14 Ministry of Finance, Government of India, Ministry of Finance Notifies Advance Price Agreements (APA) Scheme, 2012, available at http://pib.nic.in/newsite/Print Release.aspx?relid=87164 (last accessed on 21 July 2015).

15 Supra note 11.

16 Supra note 14.

17 Supra note 11.

generally used in cases where the stakes are high and more than two tax jurisdictions are involved.18

Applications for bilateral or multilateral APA(s) are accepted by Indian Competent Authorities on fulfilling the following conditions:19

i. where a tax treaty containing an article on “Mutual Agreement Procedure” exists between India and the other country or countries;

ii. in case of international transactions resulting in economic double taxation arising out of transfer pricing agreements, the said tax treaty contains provisions similar to Article 9, paragraph 2 of the OECD model convention regarding “Associated Enterprises”; and

iii. The corresponding APA programme exists in the other country.

3. AN OVERVIEW OF ADVANCE PRICING AGREEMENTS IN INDIA

Sections 92CC and 92CD in the Income Tax Act 1961 introducing the provisions of Advance Pricing Agreement (APA) were inserted by the Finance Act, 2012.20 These provisions are to be read with Rules 10F to 10T and 44GA21of the Income Tax Rules, 1962.22The Ministry of Finance introduced the Advance Pricing Agreement Scheme by the notification which also stated that it would be advantageous, i.e.:

“It will provide tax certainty with regard to determination of arm’s length price of the international transaction with respect to which the APA has been entered into, reduce the risk of potential double taxation through bilateral or multilateral APA, reduce compliance cost by eliminating the risk of transfer pricing audit and resolving long drawn and time consuming litigation and other dispute resolution process and alleviate the burden of record keeping as the taxpayer knows in advance the required documentation to be maintained to substantiate the agreed terms and conditions of the agreement.”23

In 2014, the CBDT signed the first batch of five unilateral APAs, all of which covered a period of five years and specified the arm’s length price for the covered international transactions entered into by the taxpayers.24The agreements pertain to different industrial sectors

18 Supra note 1.

19 Supra note 11.

20 Supra note 14.

21 Ministry of Finance, Government of India, Notification, S.O 2005 (E) (30/8/2012).

22 N. Anand, “The Concept of Transfer Pricing and Advance Agreement Pricing In India”, Vol. 2 Indian Journal of Research, pp. 198, 199 (2013).

23 Supra note 14.

24 Ministry of Finance, Government of India, CBDT Signs The First Batch Of Five (5) Unilateral Advance Pricing Agreements (APA); Agreements Cover A Period Of Five

including pharmaceuticals, telecom, exploration and financial services and cover a range of international transactions, including interest payments, corporate guarantees, non-binding investment advisory services and contract manufacturing.25 The APA scheme is envisioned to be taxpayer-friendly with regard to transfer pricing and also minimise the disputes which arise from transfer pricing.

Under Section 92CC, the CBDT, with the approval of the Central Government, may enter into an APA with any person, determining the ALP or specifying the manner in which ALP is to be determined, in relation to an international transaction, to be entered into by that person.26On analysing the provisions of the Income Tax Act, 1961 and the Income Tax Rules, 1962, the following can be derived:27

3.1. Application for APA

The provisions under the Act do not provide for any specific criteria to apply for an APA. However, Rule 10G prescribes the eligibility of the applicant i.e. any person who:

i. has undertaken an international transaction;28or

ii. is contemplating to undertake an international transaction,29 is eligible to enter into an agreement.

The application can be made by any person, resident or non-resident, whether a company, firm, limited liability partnership or otherwise. Therefore, an application can also be made by:

a. A foreign company having a subsidiary in India; b. A subsidiary of a foreign company; c. An Indian holding company having a foreign subsidiary; d. A foreign subsidiary of an Indian holding company.

The Application, in the case of a unilateral agreement, shall be furnished to the Director General of Income Tax and in the case of a bilateral or

(5) Years From AY 2014-15 To AY 2018-19 And Specify The Arm’s Length Price For The Covered International Transactions Entered Into By The Taxpayers, 2014, available at http://www.finmin.nic.in/press_room/2014/CBDT_5APAsigen 31032014.pdf (last accessed on 23 July 2015).

25 Ibid.

26 Income Tax Act, 1961, s. 92CC (3).

27 P.S. Shah & R.S. Kadakia, Taxmann’s Master Guide to Income Tax Act, 2012.

28 Income Tax Rules, 1962, rule 10G (i).

29 Income Tax Rules, 1962, rule 10G(ii)

multilateral agreement, to the Competent Authority in India.30 The Application should also be accompanied with proof of payment of fees, which is31:

i. ₹. 10 Lakhs, where the international transaction is of an amount not exceeding

₹. 100 crores.

ii. ₹. 15 Lakhs, where the international transaction is of an amount not exceeding

₹. 200 crores.

iii. ₹. 20 Lakhs, where the international transaction is of an amount exceeding ₹. 200 crores.

3.2. Binding Effect of APA under the Income Tax Act, 1961

i. The APA shall be binding on the following parties: a. The person in whose case, the APA has been entered into in

respect of the transaction in relation to which the APA has been entered into,32and

b. On the Commissioner, and the income tax authorities subordinate to him, in respect of the said person and the said transaction.33

However, on a plain reading, the agreement would not be binding on the counter party or the income tax authorities of the counter-party.34 Further, there is no express provision to the effect that an APA would be binding in the case of a successor to the business where a successor opts to continue with the same arrangement.

ii. The APA ceases to be binding in the following situations:

a. There is a change in law or facts having bearing on the agreement so entered. The term “bearing” could mean ‘in relation with’,35 ‘relevance’36 or ‘to be relevant’37. Therefore, if the person alters or modifies the terms of the transaction and if such modification has

30 Income Tax Act, 1962, rule 10I (2).

31 Income Tax Act, 1962, rule 10I (5).

32 Income Tax Act, 1961, s. 92CC (5) (a).

33 Income Tax Act, 1961, s. 92CC (5) (b).

34 Supra note 27.

35 P. Ramanatha, the Law Lexicon, 2012.

36 Dictionaries, Collins Online English Dictionary, available at http://www.collins dictionary.com/ (last accessed on 23 July 2015).

37 Macmillan Dictionary, available at http://www.macmillandictionary.com/ (last accessed on 23 July 2015).

a bearing on the APA, the APA ceases to be binding on the parties.

b. The Agreement has been obtained by the person by fraud or misrepresentation of facts. If the CBDT finds that the agreement has been obtained by the applicant by fraud or misrepresentation of certain facts, it may pass an order to declare the agreement to be void ab initio.38The CBDT, however, is required to obtain the approval of the Central Government before doing so.39

3.3. Amendment to Application

Rule 10N of the Income Tax Rules, 1962 enables an applicant to amend his application at any stage before the finalisation of the terms of the agreement, provided he makes a request in writing to Director General of Income Tax in the case of a unilateral agreement or the Competent Authority of India, in the case of a bilateral or multilateral agreement.40 The amendment shall be given effect to if it does not alter the nature of the agreement41, and must be accompanied by an additional fee as provided in the rules prescribed.42

3.4. Revision of an APA

Rule 10Q43 provides for the Board to revise the agreement subsequent to it having been entered into if:

i. there is a change in critical assumptions or failure to meet a condition on which the agreement was entered into;44

ii. there is a change in law that modifies any matter covered by the agreement but does not render the agreement to be non-binding;45 or

iii. There is a request from competent authority in the other country requesting revision of agreement, in case of bilateral or multilateral agreement.46

38 Income Tax Act, 1961, s. 92CC (7).

39 Ibid.

40 Income Tax Rules, 1962, rules 10N (1) & (2).

41 Income Tax Rules, 1962, rule 10N (2).

42 Income Tax Rules, 1962, rule 10N (3).

43 Income Tax Rules, 1962.

44 Income Tax Rules, 1961, rule 10Q (1) (a).

45 Income Tax Rules, 1961, rule 10Q (1) (b).

46 Income Tax Rules, 1961, rule 10Q (1) (c).

The Board may revise the agreement, either suo motu or on request of the assessee, the competent authority of India or the Director General of Income Tax.47 An opportunity of being heard must be given to the assessee before revising the document, and he must therefore agree with the proposed revision.48 Where the assesse is not in agreement with the proposed revision, the agreement may be cancelled with Rule 10R.49Duration and Expiry of APA.

An APA shall be valid for the period specified in the agreement, but in no case shall exceed five consecutive previous years50; the provisions of the Act do not provide for a minimum validity period. Also, there is no time limit within which the CBDT and the applicant have to reach an APA.

The provisions of the Act do not provide for any express provision for renewal of APA after the expiry of its validity period, in case the business model of the taxpayer remains the same. Whether the APA can be renewed or not upon expiry, depends on the scheme framed by the CBDT.51

3.5. Withdrawal and Cancellation of an APA

Withdrawal of an application for agreement has been provided for in Rule 10J of the Income Tax Rules, 1962 which states that that applicant may withdraw the application for agreement at any time before the finalisation of the terms of the agreement.52 However, the fees paid shall not be refunded on withdrawal of application by the applicant.53

Under Rule 10R of the Income Tax Rules, 1962, the Board can cancel an agreement for any of the following reasons:

i. the compliance audit of the agreement referred to in Rule 10P has resulted in the finding of failure on the part of the assessee to comply with the terms of the agreement;54or

47 Income Tax Rules, 1961, rule 10Q (2).

48 Income Tax Rules, 1961, rule 10Q (3).

49 Income Tax Rules, 1961, rule 10Q (4).

50 Income Tax Act, 1961, s. 92CC (4).

51 Income Tax Act, 1961, s. 92CC (9).

52 Income Tax Rules, 1962, rule 10J (1).

53 Income Tax Rules, 1962, rule 10J (3).

54 Income Tax Rules, 1962, rule 10R (1) (i).

ii. the assessee has failed to file the annual compliance report in time;55 or

iii. the annual compliance report furnished by the assessee contains material errors;56or

iv. The agreement is to be cancelled in case the assesse is not in agreement with the proposed revision.57

The assessee is entitled to an opportunity to be heard by the Board before the cancellation of the application.58 In addition, the cancellation must be in writing and must provide reasons for non-acceptance of assessee’s submission, if any.59

3.6. Effect to Advance Pricing Agreements

Section 92CD60 provides for the effect of APA on return of income or assessment. Under this section:

i. Where any person has entered into an APA and has, prior to the date of entering into the APA, furnished any return of income under section 139 of the Act for any assessment year relevant to a previous year to which such agreement applies, such person shall furnish a modified return in accordance with and limited to the APA, within 3 months from the end of the end in which the said APA was entered into.61

ii. If the assessment or reassessment proceedings for an assessment year relevant to a previous year to which the agreement applies have been completed before the expiry of the period allowed for furnishing of modified return, the Assessment Officer shall reassess the total income of the relevant assessment year, in accordance with the APA.62 The assessment or reassessment proceedings for any assessment year shall be deemed to have been completed where:

a. An assessment or reassessment order has been passed; or

55 Income Tax Rules, 1962, rule 10R (1) (ii).

56 Income Tax Rules, 1962, rule 10R (1) (iii).

57 Income Tax Rules, 1962, rule 10R (IV).

58 Income Tax Rules, 1962, rule 10R (2).

59 Income Tax Rules, 1962, rule 10R (4).

60 Income Tax Act, 1961.

61 Income Tax Act, 1961, s. 92CD (1).

62 Income Tax Act, 1961, s. 92CD (3).

b. No notice has been issued under section 143(2) which provides for regular assessment after detailed enquiry, till the expiry of the limitation period provided under the said section.

iii. Where the assessment or reassessment proceedings for an assessment year relevant to the previous year to which the agreement applies are pending on the date of filing of modified return, the Assessment Officer shall proceed to complete the assessment or reassessment proceedings in accordance with the APA taking into consideration the modified return so furnished.63The order of assessment or reassessment of total income shall be passed within a period of one year from the end of the financial year in which the modified return is furnished and the period of limitation for completion of pending assessment or reassessment proceedings shall be extended by a period of 12 months.64

3.7. Rollback Provisions of Advance Pricing Agreement Scheme

An agreement may provide for determining the ALP or specifying the manner in which the ALP is to be determined in relation to the international transaction entered into by the person during the rollback year, this is called the rollback provision.65 The rollback provision was added it in the APA scheme by inserting sub-section (9A) in Section 92CC by the Finance Act (No.2) Act, 2014 and the relevant rules, namely, Rules 10MA and 10RA, which were notified in 2015.66

An agreement in respect of an international transaction shall contain a rollback provision provided that:

i. the international transaction is the same as the as the international transaction entered into under the agreement;67

63 Income Tax Act, 1961, s. 92CD (4).

64 Income Tax Act, 1961, s. 92CD (5).

65 Income Tax Rules, 1962, rule 10MA (1).

66 Ministry of Finance, Government of India, Clarifications on Rollback Provisions of Advance Pricing Agreement Scheme, F.No. 500/7/2015-APA-II, Circular No. 10/2015, (2015) available at: http://incometaxindia.gov.in/communications/circular/circular_ no_10_2015.pdf (last accessed on 28 July 2015).

67 Income Tax Rules, 1962, rule 10MA(2)(i)

ii. the return of income for the relevant rollback year has been or is furnished by the applicant before the due date specified in Explanation 2 of Section 139(1) of the Act;68

iii. the report in respect of the international transaction has been furnished as prescribed by Section 92E;69

iv. the applicability of the provision has been requested by the applicant for all the rollback years in which the said international transaction has been undertaken by the applicant;70 and

v. The applicant has made an applicant seeking rollback in the Form prescribed by the Rules.71

The Rules lay down that a rollback provision in respect of the international transaction shall not be provided for the rollback year if:

i. the determination of ALP for the said year has been in dispute before the Appellate Tribunal and it has passed an order disposing of such appeal at any time before the signing of the agreement;72 or

ii. The application for rollback provision has the effect of reducing the total income or increasing the loss of the applicant as declared in the return of income of the said year.73

The procedure for giving effect to a rollback provision is laid down in Rule 10RA. The applicant must carry out the actions specified in the sub-rules to Rule 10RA which include furnishing the necessary modified returns and other requirements, non-compliance of which will result in the cancellation of the entire agreement.74

4. THE SIGNIFICANCE OF APA IN INDIA

This evolving concept in India has proven to be of great significance and has brought about several positive changes in the international taxation laws and schemes in our Country. APAs are significant for the following reasons:

68 Income Tax Rules, 1962, rule 10MA(2)(ii)

69 Income Tax Rules, 1962, rule 10MA(2)(iii)

70 Income Tax Rules, 1962, rule 10MA(2)(iv)

71 Income Tax Rules, 1962, rule 10MA (5).

72 Income Tax Rules, 1962, rule 10MA (3) (i).

73 Income Tax Rules, 1962, rule 10MA (3) (ii).

74Supra note 66.

4.1. Certainty about Transfer Pricing and Reduces the Risk of Double Taxation

A means to overcome tax uncertainty and prevent the risk of double taxation is an advance pricing agreement which determines the appropriate transfer pricing method for a certain period.75

As mentioned above, the transfer price is the price that one division of a company or one entity charges for goods or services supplied to another division of the company or another entity in multi-department, multi-office or multinational firms.76However in practice, it is much more complicated as several difficulties arise in these transactions due to dual pricing methods, decentralised organization or lack of adequate information etc. According to the OECD, even if one tax authority accepts the transfer pricing audits and its documentation, it may still be that the other authority unilaterally adjusts the transfer price, in which case, at least a part of the firm’s income is taxed in more than one tax jurisdiction.77Bilateral and multilateral APAs also help reduce the incidence of double taxation for the period covered under the agreement.

Advance pricing agreements help in overcoming the problem of transfer pricing and double taxation as it is an agreement wherein the taxpayer and the tax authority or tax authorities fix its transfer pricing methodology and the tax rate that is applicable in inter-country and inter-company transactions. It also ensures some degree of flexibility, as the APA indicates the circumstances under which the transfer pricing method would be violated and has to be rearranged.78

4.2. Determination of Arm’s Length Price

An ALP is the price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.79An APA determines in advance, the arm’s length price or the manner of the determination of ALP, or both, in relation to international transactions.80 Once an APA is signed and entered into, the ALP can only be determined in the manner prescribed by this

75 OECD Transfer Pricing Guidelines, p. 4.123.

76 Business Dictionary, available at http://www.businessdictionary.com/definition/tra nsfer-price.html (last accessed on 26 July 2015).

77 OECD Transfer Pricing Guidelines, p. 4.123.

78 OECD Transfer Pricing Guidelines, p. 4.123, 4.135.

79 Income Tax Act, 1961, s. 92F (ii).

80 Supra note 66.

agreement. Although Rule MA(1) provides that the agreement may provide for determining ALP or manner of determination of ALP, it must be duly noted, that the ALP can be different for different years, as long as the manner for determining is in accordance with the APA for all the years covered in the agreement, as per Rule MA(4).81 Therefore, although the manner of determining the APA which includes the method, comparability analysis, and tested party remain the same the arm’s length price could vary for different years. This helps in striking the balance between the taxpayer and tax authorities, as there is scope for flexible prices for different years. This scheme also ensures that the ALP is determined in tune with economic conditions such as inflation, recession etc., thereby providing a practical solution to transfer pricing disputes.

4.3. Rollback Provisions

Until the rollback provisions were introduced, an APA could only be applicable for 5 prospective financial years, however after its introduction in 2015, an APA is not only applicable for the five prospective years but also for the immediately preceding four years, thereby providing certainty to the taxpayer for a maximum period of nine years.82This provision offers tangible benefits to both the taxpayer and the tax authority, making India a much easier place to do business and inspire confidence in multinational enterprises impending transfer pricing disputes.83 Also, retrospective applicability of an APA would imply that the cases pending in Court are ended, thereby reducing the protracted and long drawn litigation burden.84 Most importantly, as there would be lesser tax uncertainty, taxpayers can manage cash flows better on account of unforeseen tax demands.85 Therefore, the introduction of APA rollback rules is a positive and encouraging move by the Government.86

4.4. Time and Cost Effective

81 Ibid.

82 Raghav Hari, ‘The APA Rollback Solution’, Financial Express, 20 March 2015, available at http://www.financialexpress.com/article/fe-columnist/the-apa-rollback-solution /55516/ (last accessed on 26 July 2015).

83 Ibid.

84 Supra note 82.

85 Ibid.

86 ‘Indian Advance Pricing Agreements- Rollback Rules Notified and Pre-filing Consultation Made Option’, KPMG India, 16 March 2015, available at https://www.kpmg.com/in/en/services/tax/flashnews/apa-rollback-rules.pdf (last accessed on 30 July 2015).

Advance pricing agreements reduce the prospective disputes that may arise out of transfer pricing and also do away with the disputes pending in Court. Therefore, it is a win-win situation for the tax-payer and the tax authorities, saving the time and effort of both. On signing the agreement, various income tax related suspicions of income tax officers, tax departments and income tax tribunals are resolved; thereby reducing the threat of auditing and reducing the chances of any litigation is this already-burdened judicial system. This in turn reduces the cost of litigation for the taxpayer and the cost of administration for the tax authorities.

4.5. Better Tax Schemes and Policies

The APA Scheme has guided the Government in the right direction with regards to formulation of practical and innovative taxing policies and schemes. The experience gained from the APA schemes has potentially helped with future improvements in the substantive regulations.87 This Scheme has been designed in such a way as to ensure that there is a win-win situation between the taxpayer and the tax authorities, leaving neither of them in dismay. Such a scheme will broaden the perspective of the Government while entering into international transactions and also while formulating policies, plans, schemes, regulations etc. regarding the same.

4.6. Transparency in the System

An applicant is required to produce several documents, forms, and information related to his business or company at the time of applying for an APA. The tax authorities thoroughly analyse and evaluate the data and ensure that an up-to-date audit has been conducted. In case of any defect or non-disclosure in the documents, the tax authority duly rejects the application on providing the applicant an opportunity of being heard. If the application is accepted, the tax authorities ensure that the enterprise has complied with audits as and when required, in accordance with the Income Tax Act and Income Tax Rules. The authority also regularly monitors and checks the compliance of the terms and conditions of the Advance Pricing Agreement. Therefore, the whole procedure for applying and obtaining the grant for an APA ensures that the taxpayer is not trying to evade taxes and reduce his tax burden, thereby maintaining transparency in the scheme.

5. SHORTCOMINGS OF ADVANCE PRICING AGREEMENTS IN INDIA

The introduction of the APA scheme in India has done wonders for taxpayers, corporates dealing in international transactions, the revenue

87Supra note 1.

department, and foreign tax authorities; nevertheless, there are several drawbacks in the scheme formulated by legislature which need to be looked into in order to make the transfer pricing process smoother:

5.1. Expensive and Time Consuming

APAs are cost effective to the extent of litigation; however, the process of entering into an APA is expensive. There is usually a high fee associated with concluding such an agreement, these fee arrangements may vary from fixed fees payable at the time of application to an APA scheme, or variable fee arrangements based on certain actual costs like travel and accommodation costs incurred by the revenue authorities in processing an APA application.88Another pertinent issue is that the fee will not be refunded in case the application is rejected by the tax authorities. Only wealthy and the top bracket taxpayers can afford to enter into APAs.

Moreover, the process of applying and concluding an APA scheme is time consuming and it utilises more resources as compared with transfer pricing channels. In countries like Japan and the United States, where the scheme of APA is well established, the process could take from a minimum of 14 months and could go up to 3 years.89 Bilateral and multilateral advance pricing agreements take even longer given that they involve two or more tax authorities from different jurisdictions. As there is no specific time frame mentioned in Indian tax statutes, an APA in India takes a long time as well. Unilateral APAs take not less than 14 months, while bilateral and multilateral agreements could take from 36 to 48 months for completion.

5.2. Confidentiality Uncertain

A taxpayer is expected to share a lot of confidential information which may not be related to audit such as marketing strategies, group policies, prospective technological advancement, business plans, trade secrets, revenue models, etc. In doing so, the taxpayer is taking a huge business risk by jeopardizing the market position of his business. Established APA jurisdictions like Japan and the United States have provisions pertaining to the confidentiality of information provided by the taxpayers, thereby ensuring that no information is shared or released to other persons or

88 Indian Advance Pricing Agreement Regime: The Game Changer, Grant Thornton, Vol.

20 (2012), available at http://gtw3.grantthornton.in/assets/Indian_APA_regi me_The_Game_changer.pdf (last accessed on 30 July 2015).

89 Id, at 17.

governments who are not authorised to receive the information.90 However, in India, there are no provisions to protect the taxpayer from confidential information being released to the public. Therefore, whether or not the APA application has been granted and concluded, the tax authorities in India are not bound to protect the privacy of the taxpayer and in fact, are at full liberty to share the information within the income tax department.

5.3. Trivial Role of the Taxpayer

In APA schemes, the taxpayer’s involvement is menial. His role in the scheme is only limited to application for the agreement, assisting onsite inspection of taxpayer’s business or premises and other procedures required for the APA process. The taxpayer is required to keep the tax authorities up-to-date with all audit compliances, books of accounts and other required information. However, the taxpayer does not receive the same in return i.e. the tax authorities do not reciprocate significant information to the taxpayer, and often the taxpayer is excluded from internal discussions of the tax authorities. In case of bilateral/ multilateral APA, it would be advisable that the revenue authorities keep the taxpayer updated and informed about the progress of any discussion with any foreign tax authority and ensure confidentiality in respect of any information obtained from the taxpayer.91

5.4. Lengthy APA Procedure

The APA procedure involves a tedious sequence of compliances including pre-filing consultation, application for an APA, analysis and evaluation of all relevant documents, application for withdrawal of APA request, annual compliance report on APA, finalising APA, signing APA, execution, monitoring, reviewing, and renewal of the APA. The process also includes several negotiations between the taxpayer and the tax authorities in order to fix the transfer price, this too is a cumbersome process, as the taxpayer is required to negotiate with two or more tax authorities on several occasions. Although the length of the procedure depends largely on the

90 Indian Advance Pricing Agreement Regime: The Game Changer, Grant Thornton, Vol.

19 (2012), available at: http://gtw3.grantthornton.in/assets/Indian_APA_regi me_The_Game_changer.pdf (last accessed on 31 July 2015).

91 Indian Advance Pricing Agreement Regime: The Game Changer, Grant Thornton, Vol. 18 (2012), available at http://gtw3.grantthornton.in/assets/Indian_APA_regime _The_Game_changer.pdf (last accessed on 31 July 2015).

type of APA, the time span to conclude an APA is generally from a minimum of 14 months and could go up to 48 months.

5.5. Disputes Arising Out of Advance Pricing Agreement and Transfer Pricing

Although the primary purpose of the APA scheme is to reduce transfer pricing disputes, it must be noted that this is not a guaranteed outcome of APA. Transfer pricing disputes may or may not reduce; the results have not yet shown as APA is at a nascent stage in India. Further, there is a high possibility that disputes arise out of APAs, as it is a contract. The manner of determination of ALP and transfer price cannot change; therefore, it could result in a conflict. An APA does not complete eliminate the likeliness of a dispute.

5.6. Double Taxation Not Eliminated in Unilateral APA

Unilateral APAs do not eliminate the risk of double taxation as these agreements are between the taxpayer and the tax authority of the Country the taxpayer is situated at. Bilateral and multilateral APAs are a more preferable choice than unilateral APAs, as unilateral APAs are of limited utility. In order to reduce the risk of double taxation, the taxpayer must apply for a multilateral or bilateral APA which is impractical as it involves more expenses and time.

5.7. No Time Limit

Another major drawback is that there is no prescribed time limit in the Act or the Rules with regards to conclusion of an APA. This implies that the tax authorities can conduct negotiates at their own pace. There is no compulsion for the tax payer or tax authorities to conclude the contract within a certain period of time. This could further result in the wastage of time and money.

6. METHODS TO OVERCOME DIFFICULTIES

The APA scheme was introduced in India primarily to overcome the problem of transfer pricing and double taxation, however, there is still some room for improvement as far as Indian laws are concerned.

6.1. Reduce and Refund Fee

The fee in India for applying and filing of APA application is exorbitant,

ranging from a minimum of ₹. 10 Lakhs to a maximum of ₹. 20 Lakhs. Jurisdictions such as Australia, United Kingdom, and Japan do not impose such fees on the applicant, whereas in India, the fee is imposed, whether the application has been accepted or not. Also, in case of rejected of the

application, the fee is not refunded to the applicant. The fee is only refunded if the applicant withdraws it at the stage of pre-filing consultation. This is a major difficulty from the taxpayer’s perspective. The Indian legislature should encourage Indian businessmen to trade in foreign jurisdictions rather than discouraging them with such a high fee. If the application has been rejected, there should be a refund policy, wherein at least a portion of the fee is returned to the applicant.

6.2. Protect Taxpayer’s Information

It is important that the taxpayer’s information is kept concealed from public domain. In many cases, not only is it a risk to the business or corporate that is applying for APA, but it could also result in a threat to the economy of the country if important and strictly confidential information is disclosed. Also, as the applicant is paying such a high fee, he should to receive some security from the tax authorities with respect to the information disclosed by him.

6.3. Encourage Information Flow to Taxpayer

Continuous flow of information is essential for any type of arrangement or contract to be successful. Where one party to the agreement is side-lined and the other parties have an understanding amongst themselves, chaos and confusion breaks loose. Applicants are usually unaware of what the status of their application is, whether there are any changes to be made, the status of negotiations between the tax authorities, and other information vital to him. On one side, he is made to disclose every little detail about his business; while on the other hand, he is kept in the dark from information important to him. An arrangement as large as an APA cannot and should not function like this. The Act should be amended to include the continuous flow of information from the tax authorities to the taxpayer, in any viable for, such as letters, notifications, circulars etc.

6.4. Prescribed Time Limit Required

It is important for there to be a prescribed time limit within which the advance pricing agreement must be concluded in the Act or Rules. The time limit should be practical enough for to accommodate all the procedures and formalities to be complied with by the taxpayer and to some extent, the tax authorities. Further, there should also be a penalty or any form of repercussion in case of non-compliance with the time limit prescribed in the Act or the Rules.

7. CONCLUSION

The APA scheme has opened the door to many businessmen who were previously hesitant to deal in international transactions and removed the problem of transfer pricing and double taxation. This scheme is beneficial to both the taxpayers and the tax authorities, by removing uncertainty, reducing litigation and the cost of compliance, thereby making international transactions and negotiations much smoother and simpler. Nevertheless, several changes could be made to the existing laws and rules relating to APA in India. Enterprises are often discouraged to opt for this scheme as there is a high fee, lengthy procedures and compliances. Also, taxpayers are often unaware of the negotiations that are taking place between the taxing authorities as there is almost no flow of information from the authorities to the taxpayer, until the APA has been concluded. With the required amendments, the APA scheme in India will prove more efficient in solving issues such as transfer pricing and double taxation and if implemented dexterously it will be a huge success in India. On the whole, the introduction of the APA scheme is a huge step forward