Recent initiatives to contain tax disputes Indo American Chamber of Commerce.

Resurrecting Indo -US

Services & Trade

Recent initiatives to contain tax disputes

Indo American Chamber of Commerce

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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

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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

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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

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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

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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

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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

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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