IT-BPO companies and their tax advisors are hoping that the Advance Pricing Agreement (APA) which is provided for in the Direct Taxes Code to deal with transfer pricing matters will be introduced in the forthcoming Budget.
They say the Indian tax department is becoming increasingly aggressive in determining arms length profit margins for the software and ITeS industries. Over Rs 40,000 crore is estimated to be locked up in such disputes.
“Transfer pricing rules are being applied inconsistently across the country. There is secrecy all around,” said Mr Som Mittal, President of Nasscom. “Thirty-five per cent of Indian outsourcing revenues come from captive units of MNCs here. In some cases tax authorities have even sought to tax global profits in India.”
People come to India because it is cost effective and one wants to improve the environment, he said. He hoped the APA and safe harbour provisions would be introduced in the coming Budget.
The Tax Department is acting on the premise that transfer pricing is being used as a means to shift profits to more tax friendly jurisdictions. They say the captive arms of MNCs in India, for example, are adding more value than they are actually declaring so that they will be taxed less.
To determine the appropriate value added, the Tax Department has been going by the ‘arm's length principle', that is, the captive units must provide services at the same price as a third party would to another unrelated party.
Mr Partho Dasgupta, Partner, Tax Advisory Services at BDO, says that the authorities are looking at cost plus 25-35 per cent for captive units which is “absurd and very high.”
The value add of captive units is being compared with the cost of services that companies such as Wipro or HCL provide, he says. “They must arrive at a process for identifying comparable companies, You cannot compare a unit of Rs 100-crore turnover with a large company several times that size. Litigation has only gone up and not decreased.”
One is hopeful that the APA system will kick in this year, said Mr S.P. Singh, Senior Director, Deloitte Haskins & Sells.
In APA, the taxpayer and tax authorities enter into an agreement, valid for five years, on the calculation method for arms length price for international transactions. This is contained in the DTC, but since that may take time to implement, everybody is speculating that the APA will be introduced in this budget itself, he said.
“Currently a majority of the litigation is going in favour of taxpayers but it is not leading to any permanent solution,” he said.
There also exists a Mutual Agreement Procedure (MAP) where the tax authorities in India and the US sit together and decide on the transfer pricing. The range one is hearing is that agreements have settled at a cost plus 17-19 per cent through several MAPs, said Mr Singh.
“We feel the tax administration officials have sufficient experience with MAPs and can now easily deal with an APA regime,” added Mr Singh. “A Deloitte white paper has said 14 per cent is a reasonable margin while taxpayers themselves feel 10-12 per cent is in order; dispute settlements have happened at 18-19 per cent. The IT-BPO industry wants some certainty.”
Mr Dasgupta also feels that the tolerance limit (variation from arms length pricing) must be increased from 5 per cent to 10-15 per cent.