Amity from advance pricing

Updated on: Apr 29, 2012

Advance pricing agreements can be a powerful tool in avoiding long-drawn and tedious transfer pricing litigation.

Transfer-pricing audits in India are becoming more and more common, and multinational companies are forced to pay closer attention to their transfer-pricing policies and procedures. In the latest and seventh round of audits, it is estimated that transfer pricing adjustments were made in more than 50 per cent of the cases audited, with adjustments totalling approximately $8,900 million. Some of the challenges in transfer pricing audit are:

India's TP rules require the use of “current year” data (pertaining to the year in which the taxpayer has transactions with group concerns) for transfer pricing analysis. Taxpayers generally rely on data from publicly available databases, but usually there is a time lag and current year data is not available before taxpayers file their return and finalise their TP analysis. Meanwhile, by the time the case comes up for a TP audit, current-year data becomes available and the tax authorities insist on using such data. Further, tax authorities also use data obtained using powers they have under the income-tax law.

Over the years, the application of +/-5 per cent safe harbour rules by tax authorities has been the subject of different interpretations.

Use of arithmetic mean as opposed to any other sophisticated statistical measure (like inter-quartile range) for the computation of arm's length prices. The arithmetic mean is affected by extreme results of comparables, which has become a regular audit issue between the taxpayers and tax authorities.

The introduction of the Dispute Resolution Panel in 2009, as an alternative dispute resolution mechanism, has also not been able to reduce the transfer pricing litigation in India.

Finance Bill 2012 proposes introduction of an Advance Pricing Arrangement scheme from July 1. Such arrangements can be a powerful tool in avoiding the long-drawn and tedious transfer pricing litigation. The CBDT is expected to prescribe forms, rules and procedures by that date.

One of the primary and most important advantages of an APA scheme is to provide certainty, remove an audit threat, deliver a particular tax outcome based on the terms of the agreement between the taxpayers and tax authorities, and, often, substantially reduce compliance costs over the term of the APA. The arrangements are intended to supplement the traditional administrative, judicial, and treaty mechanisms for resolving transfer pricing issues.

From the proposed provisions it is clear that the rules permit the use of any transfer pricing method, apart from the prescribed ones, with any adjustments or variations as may be critical for the APA. It thus paves the way for addressing some of the challenges discussed above.

Some of the key considerations for the Indian APA regime to ensure the desired level of certainty are:

Defining in advance the critical assumptions for any APA. A critical assumption is any fact (whether or not within the control of the taxpayer or tax authorities) related to the taxpayer, a third party, an industry, or business and economic conditions. While entering into an APA it should be clarified that the business activities, functions, risks, assets, accounting methods and estimates of the taxpayer shall remain materially the same for the period of the APA.

Any collateral issue, that is, any material issue other than the covered transactions (for example, PE-related issues), should be distinguished from ancillary and administrative issues integrally linked with the transfer pricing issues. Collateral issues should be processed in parallel with the APA.

If required, the rules should permit the use of independent experts where complex issues are involved.

Although the proposed provisions indicate that APAs can be entered into for prospective transactions, considering the pending litigation it is worthwhile for the Government to provide roll-back option for open years.

The time is apt for the Government to deliver on the expectations of taxpayers by introducing a well-thought out APA regime that will go a long way in reducing complex transfer-pricing litigation in India.

Mudigonda Vishweshwar is Senior Director, Deloitte Touche Tohmatsu India Pvt Ltd.

Published on November 15, 2017

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