Transfer pricing is an area that has seen a substantial amount of litigation. The Budget has introduced an Advance Pricing Agreements (APAs) mechanism that seeks to address this issue.
An APA is an agreement between a taxpayer and at least one tax administration on an appropriate transfer pricing methodology for a related party transaction. This agreement applies over a fixed period of time.
Key aspects
The APA will apply to transactions that are to be undertaken — they are unlikely to cover transactions undertaken in the past. To determine the arm's length price (ALP), the method to be used need not be restricted to the five prescribed one — this may enable the taxpayer to negotiate an economic method or put forth a business rationale to defend the proposed transfer price beyond what is prescribed. The parties to the APA have to agree on the period for which the APA will apply — however, the period cannot exceed five years. The agreement is binding on the tax payer and the tax administration — an APA being an agreement, there is no process for appealing against it. It will not be binding if there is a change in law or if the facts which have a bearing on the APA have undergone a change.
Bilateral mechanism
The APA provisions, as have been currently introduced suggest a unilateral APA mechanism. However, a bilateral APA mechanism may provide a more equitable result to the tax payer. For example, if a foreign company licenses software to its Indian subsidiary, the Indian company can enter into an APA to determine the ALP for the royalties to be paid for the use of the software. The price determined by the Indian subsidiary and the Indian tax administration may not be acceptable to the tax administration of the home country of the foreign company which licenses the software.
Even on the assumption that India will not provide for a bi-lateral APA mechanism, tax payers may consider entering into APAs for ensuring certainty in margins to be earned/retained. This can result in lesser litigation and obviate the risk of levy of penalties and payment of additional tax and interest on account of transfer pricing adjustments
Again, in certain situations, tax payers may find it difficult to identify direct comparables (for example in the case of licensing of intangibles). Entering into an APA may help the tax payer in reaching a more palatable transfer pricing result with the Indian tax administration.
While the framework for the implementation of APAs is to be notified, one hopes the following aspects are taken into account:
Time limit within which the tax administration would reach an agreement;
Confidentiality of information provided by the tax payer;
Manner/situations under which the tax payer can seek a dissolution of the APA in case there is a change in the tax payers facts which provides a better result to the tax payer;
A reasonable time limit within which the APA needs to be implemented;
Whether the APA should agree a range within which the tax payer's ALP should fall or whether the APA would determine an exact price or margin that the tax payer needs to comply with.
It is too early to state with certainty whether the APA framework would be popular with tax payers in India. To reach an APA, tax payers need to remember that they may need to disclose information which may not have been normally sought for in the course of assessment proceedings and it is hoped that the tax administration approaches these proceedings in a non-confrontational manner with the intent of reaching a fair result.
(The author is Partner, BMR Advisors. The views are personal. With inputs from Sonal Kotak.)