Advance pricing agreements: the Indian situation outlined

The introduction of advance pricing agreements (APAs) in the Union Budget 2012-13, which is now part of the Finance Act, 2012, was a significant development in the Indian transfer pricing (TP) administration. An APA is basically an agreement signed between a taxpayer and a taxing authority on an appropriate TP methodology for a set of transactions over a fixed period in the future.

Mechanism & administration

The APA scheme has been introduced as part of the existing TP regulations. The Central Board of Direct Taxes (CBDT) will be responsible for entering into an APA with any person for determining the arm’s length price of an international transaction. Such an agreement would remain in force for a period not exceeding five consecutive years.

To demonstrate its intent to seriously implement a programme aimed at reducing taxpayer grievances, the Department of Revenue under the Ministry of Finance, through a CBDT order issued in February, announced the posting of a TP officer as Director-APA for a period of five years. Further, the APA teams in Delhi, Mumbai and Bangalore have been ramped up through a CBDT order in June. Officers with TP skill-sets/experience from varied backgrounds in the Revenue Department have been allotted added responsibilities under the APA programme.

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One reason for not transferring the officers to the programme full time could be that the department is uncertain about the volume of APA applications and would not want to move resources until greater clarity on this front is available. This may also be a sign that the department does not have enough staff.

Simultaneously, with an aim to deter frivolous applications, the proposed fee for an APA has been set quite steep for interested applicants. Accordingly, an applicant must pay a fee of ₹1 million (US$18,000) for international transactions not exceeding ₹1 billion, ₹1.5 million for transactions up to ₹2 billion, and ₹2 million for transactions above ₹2 billion.

Eventually, the success of the APA programme will be gauged by the number of decisions in favour of the taxpayer applicants, however the efficacy of APAs should also be measured in terms of the time it takes to achieve an acceptable resolution and the contribution of APAs towards avoiding litigation arising from TP issues.

Future considerations

It should be kept in mind that despite a mandate whereby taxpayers will be required to provide detailed disclosures, APA programme outcomes are not assured. This is a major deterrent to instilling faith and confidence in the programme. Additional issues which need to be addressed by the CBDT are outlined below.

Documentation: Taxpayers who transact with an associated enterprise are required to maintain robust and contemporaneous documentation on an annual basis. It needs to be specified whether such documentation must be maintained for the years under an APA.

Audit/assessment: It further needs to be clarified whether TP audit will continue as a parallel procedure during an APA. Typically in other countries, any assessment proceedings during an APA are mostly to verify that the taxpayer’s outcomes are in compliance with the APA conditions.

Penalty: It needs to be clarified whether a taxpayer will be seen to be in default while an APA is being processed and, where a taxpayer’s results depart from an APA, whether there will be an opportunity for a course correction or whether a penalty would be imposed automatically.

Rollback: There is no explicit provision for rolling back an APA to prior years. A rollback option may need to be negotiated between the interested/affected parties.

Timeframe: To provide certainty, the law should provide mandatory timelines for completion of APAs, which should be binding even on authorities.

Approval procedure: The present scheme requires APAs to be approved by an APA authority (to be constituted), as well as by the CBDT and then the central government. This seemingly long process (possibly augmented by delayed government approvals due to political factors) will need to be reduced.

Safeguard measures: Most importantly, safeguard measures are needed in the event that APA negotiations fail. In such a scenario, taxpayers need assurance that disclosures made in good faith will not be used against them during audits or assessments by the tax authorities. Further, taxpayers need to be assured not only about the confidentiality of their business information but also that access to their cases would be restricted to the designated APA authority and not shared with the assessing or TP officer.

In the end, it is hoped that the success witnessed elsewhere in providing confidence to taxpayers in managing the tax risks of their businesses through APAs will be emulated in India. Overall, this scheme is being welcomed as a positive step.

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Economic Laws Practice is a full-service law firm with headquarters in Mumbai and offices in New Delhi, Pune and Ahmedabad. Ajit Tolani is a partner at the firm and Ashish Bhatnagar is a senior associate.