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Indian Transfer Pricing: Paradigm Shift in the Offing

India's new government has embarked on several unprecedented initiatives to regain investors' confidence by taking bold steps. Recent examples include the decision not to challenge the Bombay High Court's ruling in the Vodafone case at the Supreme Court, the quick response on MAT and FII, and the introduction of the arm's length range and multiple-year data concepts to bring India's transfer pricing rules more in alignment with globally accepted practices. Apart from resolving long drawn issues, the Indian government has also been instrumental in wooing the international business community by introducing new programs such as the "Make in India" campaign and simplifying the tax and regulatory norms for doing business in India.

If we go by the numbers, India's economy has expanded 7 percent in first fiscal quarter of financial year (FY) 2015, and year-on-year increase in industrial production reached 3.80 percent. Further, foreign direct investment has reached $ 43.5 billion in financial year 2014-15, approximately 7.4 percent of GDP.

Since its introduction, India's transfer pricing regime has been a key tax challenge for multinational enterprises (MNEs) doing business in India. It is estimated that 70 percent of the volume, if not the value, of the transfer pricing litigation around the world is generated in India. The total value of transfer pricing adjustments during recently concluded transfer pricing audits in FY 2013-14 was about US $9 billion, resulting in adjustments in 53 percent of all cases. From FY 2005-06 to FY 2014-15, approximately 9,311 cases have been subject to adjustment, and in value terms these adjustments would be about US $41 billion.

As per the data analysis, out of the 1670 rulings the Indian tax courts had handed down through August 2015, only 13 percent has ruled in favor of the Indian tax authorities. This track record, and a general sense of grievance from the taxpayer community, suggests a paradigm shift in Indian tax authorities' approach to transfer pricing audits.

While this may present a gloomy picture to MNEs, the cost arbitrage that still exists on account of the availability of still comparatively low cost talent with high skills and coupled with large consumer base, India still ranks among the top investment destinations around the world.

Further, the current Indian government quickly sensed the need to change the roots of unique Indian transfer pricing regulations, thereby settling unwanted and protracted litigation. With this objective, the recent developments in the Indian transfer pricing regulations are:

Introduction of the "Range" and "Multiple Year" concepts.

With the objective of aligning Indian transfer pricing rules with globally followed best practices, the Indian government recently issued draft rules for the introduction of "Range" and "Multiple Year data" concept for the determination of an arm's length price. Earlier, the focal point of the transfer pricing conflict between taxpayers and the Indian tax authorities revolved around the issue of comparability analysis, which mandated the use of the arithmetic mean instead of range of arm's length prices, and current-year data instead of multiple-year data.

Overwhelming success of Advance Pricing Agreement Scheme.

Introduced in July 2012, the advance pricing agreement (APA) scheme has become a game-changer in the Indian transfer pricing regulations. Coupled with the positive approach and response of the Indian APA authorities during the pre- and post-filing of APA applications, the entire APA scheme has become a catalyst for infusing confidence in foreign MNEs. Testimony to the same can be seen in the large numbers: more than 585 APA applications filed by taxpayers in the last three years. Of these, one bilateral APA and 14 unilateral ones (including one with a rollback provision) have been concluded by the Indian APA authorities to date. These 15 concluded APAs pertain to various sectors, ranging from telecommunications, oil exploration, pharmaceuticals, finance, banking, software development services, and ITeS (BPOs). Further, a good number of applications are on the verge of conclusion.

With this response from both taxpayers and the APA authorities, it can be said that the APA scheme has struck the right chord in reducing transfer pricing-related conflicts and mitigating future uncertainty.

Settlement of cases through Mutual Agreement Procedure.

The recent resolution of pending Mutual Agreement Procedure (MAP) cases by arriving at a "framework agreement" between India and the United States has been a major breakthrough for US MNEs operating in India. Historically, pending MAP cases between the Indian and US Competent Authorities have been a major concern for MNEs operating in India. However, from the beginning of fiscal year 2015, MAP received a boost with the Indian Finance Ministry's announcement that approximately 35 India-US transfer pricing disputes had been resolved, and that it expects another 200 India–US cases to be concluded in the current financial year. The positive approach of both countries' competent authorities can be witnessed by the fact that the negotiated margin under the decided cases has either eliminated or reduced transfer pricing adjustments substantially, in which case double tax relief is provided by the parent MNE's tax authorities.

In addition to cases with the US, 15 MAP cases with Japan are also expected to be resolved in the current financial year, which will bring relief of USD 1.5 billion to Japanese MNEs in India.

These recent developments in the Indian transfer pricing arena have allowed the international business community to breathe a sigh of relief. A few additional steps, such as rationalizing safe harbor rules and aligning audit practices with the APA/MAP approach would go a long way in addressing their concerns, and would further boost their confidence about doing business in India.