Effectiveness of Advance Pricing Agreements in India’s Complex Transfer Pricing Environment

This article discusses India’s advance pricing agreement (APA) program, the sector-wise distribution of APAs, and their usefulness given the country’s complex transfer pricing regime. This article is part three of a four-part series. See here for the first part, which covers transfer pricing regulations in India and see here for analysis of accepted TP methods and services offered by professional firms.

The question of ascertaining the price at which multinational corporations (MNCs) transact with their associated enterprises in India, called transfer price (TP), is a key area of interest to tax authorities as any profits that are not taxed in India will erode the country’s tax base.

Ever since transfer pricing was introduced in India in 2001, years of audits have also increased the number of tax disputes and litigation, involving major MNCs like Microsoft Corp., Vodafone International Holdings, International Business Machines Corp. etc.

In response, the Indian government decided to launch the Advance Pricing Agreement (APA) program through the Finance Act, 2012 through the insertion of sections 92CC and 92CD in the Income Tax Act, 1961 to supplement appeals and other dispute resolution mechanisms provided in the Income Tax Act, 1961 and double taxation avoidance agreements for resolving transfer pricing disputes.

Goals of India’s advance pricing agreement program

India’s APA program is a voluntary program to not only prevent transfer pricing disputes but also address actual or potential disputes and provide tax certainty to MNCs by allowing them to negotiate how profit margins for India operations will be calculated.

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The APA program provides an alternate and effective dispute resolution mechanism to bring uniformity in laws dealing with transfer pricing in India, as the existing administrative and judicial institutions fail to address specific questions of law while focusing primarily on the questions of facts.

Through the APA program, India aims to deliver a non-adversarial tax regime for foreign investors. Other benefits of an APA include avoiding rigorous and burdensome audit requirements while delivering the tax outcome on the basis of agreed terms of the agreement.

Over time, APAs can lower compliance costs of MNCs and substantially reduce the cost of administration and litigation incurred by the tax authorities.

Status of advance pricing agreements in India

An APA can be unilateral, bilateral, or multilateral, and is an agreement between a taxpayer and tax authority determining the TP methodology for pricing the taxpayer’s international transactions for future years. The agreement includes international transactions, agreed transfer pricing policy, determination of arm’s-length price, including the TP methodology to be applied and critical assumptions and the conditions, within its scope.

The methods prescribed for determining arm’s-length price include Comparable Uncontrolled Price (CUP) Method, Resale Price Method (RPM), Cost Plus Method (CPM), Profit Split Method (PSM), and Transactional Net Margin Method (TNMM).

Almost a decade since its launch, the increasing popularity of the APA program among foreign investors can be seen in the high number of APA applications received and executed. According to India’s Annual APA Report 2018-19, from financial year (FY) 2012-13, through March 2019, India received a total of 1155 APA applications, out of which 271 APAs were successfully executed, as of FY 2018-19.

Subsequently, by September 2019, India had inked a total of 300 APAs and in 2020, additional APAs have been signed though the data for same is not yet available. Moreover, while India was able to conclude 271 APAs in the six-year period from 2012-13 to 2018-19, in contrast, China entered into just 156 APAs in the 14 years between 2005 and 2018.

Through these 271 APAs, India is estimated to have gained an additional income of about INR 100 billion (US$1.35 billion). In the 271 APAs concluded till March 2019, India managed to provide tax certainty for 1779 years to these taxpayers, including 477 years covered under the rollback period.

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This translates into an estimate of over 890 scrapped/prevented litigations that India would have otherwise faced in the absence of such APAs, thereby clogging Indian courts and Income Tax Appellate Tribunals (ITATs). This further translates to a tax and interest payment of about INR 36 billion (US$484.98 million) on account of avoiding any possible dispute and subsequent litigation.

Out of the pending 802 applications, 50 applicants have not formally withdrawn but neither are they active participants in the process, as many compliance requirements like furnishing relevant documents have not been fulfilled by them.

The number of APAs signed in 2018-19 was significantly lower at 52, than the preceding years, with the tally peaking in 2016-17 at 88. The reduction in approval to APA applications can be attributed to the increasing complexity of cases in the later APAs, which require more time to analyze the international transactions covered. Additionally, shortage of executive and administrative manpower in the APA teams of India’s tax authority – Central Bureau of Direct Taxes (CBDT) – has slowed down the overall processing time of APA applications.

Duration of processing APAs

One of the most important aspects of an APA is the time taken in processing an application and concluding it. In India, the average time taken to process and approve an application is 32.5 months as calculated on the basis of all the APAs signed till March 31, 2019.

The average time taken for processing bilateral APAs for the same period is 44.32 months. In 2018-19, the average time taken by the CBDT to conclude the 41 unilateral agreements was 45.22 months and to conclude 11 bilateral agreements was 51.82 months.

In contrast, the United States had an average timeline of 35.4 months for unilateral APAs and 47.8 months for bilateral APAs in 2018.

Sectoral distribution of agreements signed

In 2018-19, out of the total 52 APAs signed, 41 were unilateral and 11 were bilateral.

Out of the 41 unilateral APAs, 20 APAs were concluded in the services sector. It was followed by the manufacturing and trading sector, which saw the signing of 14 APAs in 2018-19.

Within these sectors, the industrial distribution of APAs in 2018-19 saw the information technology (IT) industry emerge as the leader, with a total of 11 APAs claiming a 27 percent share. It was followed by the healthcare industry and industrial/commercial goods industry with six (15 percent) and five (12 percent) APAs, respectively.

In case of bilateral APAs too, the services sector led the tally with five signed APAs in 2018-19, followed by four in manufacturing and two in trade. The industrial distribution of these bilateral APAs were the IT industry at 46 percent, followed by the automotive industry (27 percent).

Nature of covered transactions in APAs in 2018-19 and transfer pricing method

Unilateral APAs

Of the total 41 unilateral APAs concluded in 2018-19, a total of 164 transactions were covered, with payment of royalty and receipt of various kinds of support services (intra[1]group services) featuring at the top.

This is a deviation from previous trends where provision of IT-enabled services usually occupied the top spot. It is indicative of the increasing complexity of cases in the incoming APA proposals.

In 2018-19, only three transfer pricing methods were used for the 164 transactions, with TNMM method employed for 132 transactions, followed by CUP method for eight transactions and other unspecified method for 24 transactions.

It is to be noted that the US (29), UK (17), Singapore (16), Germany (14), and China (12) emerged as the top five countries in terms of number of unilateral APAs signed with India.

Bilateral APAs

Of the total 11 bilateral APAs signed in 2018-19, a total of 35 transactions were covered, dominated by service transactions. For bilateral APAs too, the TNMM method continued to the most favored, followed by profit split method and CUP method.

The US, UK, Singapore, and Japan have been the top countries in terms of filing applications for bilateral APAs. In 2018-19, out of the 11 agreements signed, four pertained to Japan, three to Australia, two to Switzerland, and one each to the US and Netherlands.

Conclusion

Ever since its introduction in 2012, India’s APA program has come a long way, equipped to address increasingly complex issues like AMP expenses, payment of royalty, and transfer of intangibles etc., which entail the adoption of transfer pricing methods like profit split and CUP.

By successfully concluding these complex APAs, India is moving forward to adapt to fast evolving realities.

Apart from reducing the compliance requirements as well as forging strategies for dispute prevention, an unplanned positive externality of the program has been assured revenue flow to the Indian treasury, in line with the terms and agreements specified in the APA.

Even though India’s APA program has come a long way, certain loopholes which generate lag and delay in the process need to be tackled.

Outsourcing subject matter experts from the private sector can not only cater to the shortage of manpower but will also bring clarity to the emerging complexities with their expertise. It remains to be seen whether this will become a priority for India’s tax authorities.

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