The Transfer Pricing Regulations were introduced in the Indian statute in 2001. The Indian Transfer Pricing landscape kept evolving since then. India is considered as one of the most aggressive nation where transfer pricing disputes is concerned. However, with the present Government's promise of a non-adversarial tax regime the transfer pricing sky is seeing newer lights.
In the nascent transfer pricing audit years, the TP adjustments increased year on year. The adjustments peaked to INR 70,000 crore in Financial Year 2013-14. Also the number of cases scrutinized has nearly quadrupled from 1,061 in 2005-06 to 4,290 in 2014-15. However the quantum of adjustments have reduced in the past few years. The reduction in adjustments is a spectacle of the current Governments effort towards moving to a non-adversarial tax regime.
The Government has taken various steps towards this, notably revising the Safe Harbor provisions, expanding the Advance Pricing Agreement (APA) team with the endeavor of expediting the APA process, signing the Multilateral Instruments (MLI) with various countries to open new corridors to resolve disputes, amending the transfer pricing regulations by introducing the range concept, use of multiple year data, moving to scrutiny based on risk parameters etc.
Currently the taxpayers have various routes available with them to resolve the transfer pricing disputes which are as follows:
Routine TP Litigation Route:
Figure 1 depicts the routine litigation route available to a taxpayer. The first level for dispute resolution is the AO/TPO. Section 92CA of the Income Tax Act, 1961, provides that where an AO considers it expedient, the AO can refer to the TPO for computation of arm's length price for the international transactions or specified domestic transactions. The Central Board of Direct Taxes (CBDT) Instruction No. 3 of 2016 issued on 10 March 2016 provides guidance on reference by an AO to a TPO. This Instruction No. 3 has replaced Instruction no. 15 of 2015 wherein the reference to the TPO will now be made on based on risk parameters.
There are also certain non-risk parameters for reference to the TPO which include non-filing of Accountant's report, failure to disclose any international transaction in the Accountant' s report and in cases where the Accountant's report has certain qualifying remarks. This instruction has reduced the number of cases referred to the TPO. This will result in improving the quality of audits undertaken by the TPO.
Certain challenges with this route is that it generally takes around eight to twelve years for a dispute to attain finality. Most of the TP litigation jams up at the appellate channels. It takes more time to resolve at this stage since in many cases, the appellate tax tribunals restore the disputed issue back to the TPO to re-examine the facts of the case. Another challenge is that the TPOs are prejudiced in case of litigatious issues where there are favourable or unfavourable precedents by appellate authorities. These challenges make this option unviable in case of complex issues which involve high quantum or require timely resolution.
Advance Pricing Agreement (APA):
APA provisions were introduced in India with effect from July 1, 2012 by the Hon'ble Finance Minister in the Union Budget 2012. APA is an arrangement between the taxpayer and the tax authority covering future transactions, with a view to solve the potential transfer pricing disputes. As per APA annual report 2016-17 the total number of APAs signed stands at 171 (Unilateral-159 and Bilateral-12).
The steps involved in an APA process is depicted in figure 2.
The APA program is taxpayer friendly and provides certainty for 9 years i.e. 5 future years and 4 roll-back years. The APA program provides a platform where the taxpayer can explain the business and industry dynamics which are given due consideration by the APA team. It also gives relief from double taxation.
The time frame taken to conclude an APA is an average of 29 months for unilateral APA and 39 months for bilateral APA. The long time frame is considered as a draw back in cases where the issue is small or where the quantum involved is not significant or where the resolution is required in a short time frame. To better the timeline for conclusion of the APA process, one additional APA commissioner in Mumbai and Bangalore have been appointed.
Overall, APA program is a success where the issues are complex, where there is an interplay of business facts on the transfer price or where the stakes are high. In such cases, the pragmatic approach of the APA authorities has kept the interest of the taxpayers integral.
Safe Harbour Provisions
One of the key provisions to reduce TP litigation was introduction of Safe Harbour provisions for the first time by the Finance (No. 2) Act, 2009 with the intention of providing certainty, administrative simplicity and reduced litigation. However, the margin prescribed in the Rules were high and therefore the response on safe harbours were lukewarm.
The revised Safe Harbour provisions effective from 1 April 2017 has reduced the margins for various transactions like IT/ITES, Knowledge Process Outsourcing, contract R&D, intra-group loans etc. It has also introduced safe harbours for low value added services.
Table 1 gives a comparison of the Safe Harbour rules.
With this revision, the safe habour rules will make transfer compliance simpler, give certainty and thereby will be considered as a lucrative dispute resolution option by the taxpayers.
Mutual Agreement Procedure
MAP is a dispute resolution mechanism under tax treaties which enables elimination of double taxation. This procedure enables tax authorities of two countries to come together, negotiate the ALP and arrive at an agreement that is acceptable to both sides. The resolution of MAP is not mandatory and binding in case countries are unable to resolve disputes.
More than 150 tax disputes involving tax demand of approximately USD 800 million were resolved through MAPs recently. Majority of these were with the United States. The disputes between India-US were pending for years on account of major differences. Currently there are other countries like United Kingdom, Japan with which India is resolving disputes under MAP.
Treaties with Singapore and South Korea are amended to allow corresponding adjustments in the other tax jurisdiction as a result of a tax on profits in one country. Signing of the multilateral instruments under the OECD BEPS action plan will also pave way to resolve disputes under MAP.
With the above routes available, the taxpayer should evaluate which is the most optimum route suitable to them depending on various parameters like the facts of the case, complexity of the matter, resolution time taken, the tax exposure involved, interplay of business/industry dynamics etc. The outcome under each route is evolving over the years for e.g. IT/ITeS – the margins expected by the tax authorities under the routine litigation route was 30%-35% in the primary years which has reduced to 20%-25%, safe harbours have been revised, APA and MAP space is evolving day by day. Therefore one should weigh in all the parameters together to determine the best suitable route for dispute resolution.