Person filing tax return forms. (Photographer: Luke Sharrett/Bloomberg)

India Must Nurture Its Six-Year-Old Advance Pricing Agreement Program

BloombergQuintOpinion

India began using Advance Pricing Agreements as an alternative mechanism to resolve transfer pricing issues from 2012 (a decade after transfer pricing provisions were introduced in the Income Tax Act), which means that the APA program is at a nascent stage compared to, say, China, where it was formally introduced in 2002. Ever since its launch, the APA program has received fulsome praise from all corners and has almost never been criticised by the tax community.

This is not to call into question the purpose or objective of the APA program (like it is done in Brazil and South Africa). No doubt, the APA program has been largely effective in the sense that it allows multinationals to obtain a binding, prior approval from the tax authority of the criteria (methods, comparable etc.) for determining the transfer pricing for related-party transactions over a fixed period of time. As a result, the APA program ensures certainty and predictability of (rather complex) transfer pricing regime.

In India, the increase in the number of APA applications alone is the yardstick on which the success of the APA program is largely measured. However, the success of the APA program depends on the care taken in properly administering the APA program.

A Lengthy Process

At the end of August 2018, India’s Central Board of Direct Taxes released the second annual report on the APA program for the FY17-18. The report reveals that, from 2012-18, a total of 197 bilateral APA applications were filed, out of which 33 were converted from unilateral APA applications.

India Must Nurture Its Six-Year-Old Advance Pricing Agreement Program

Out of this, 16 bilateral APA applications were disposed-off for reasons not disclosed in the report. This means that out of 181 bilateral APA applications, the CBDT has only signed 20 bilateral APAs since 2012, 17 of which were signed in the last two years alone. That is an average of three bilateral APAs in a year.

India Must Nurture Its Six-Year-Old Advance Pricing Agreement Program
The CBDT signed only a total of nine bilateral APAs in 2017-18 (with the Netherlands, the UK, and the US). As of date, more than 150 bilateral APA applications are pending. 
India Must Nurture Its Six-Year-Old Advance Pricing Agreement Program

According to the report, the CBDT takes an average time of close to four years to sign one bilateral APA. While the US and Canada too, take almost the same time, the Indian APA process seems to be drastically slow when compared to China, which processes APA applications within a timeframe of 12 months.

Which part or aspect of the APA process consumes the most time is not clear from the report though. Given that the duration to conclude an APA is counted from the date the APA was filed, the time taken during the pre-filing consultation is disregarded. So presumably, the delay is attributable to

  • the taxpayer in submitting documentation or,
  • to the CBDT in processing APA applications or,
  • in preparing the ‘draft Indian Position Paper’ or,
  • to the competent authorities in concluding APA negotiations.
The delay in concluding bilateral APAs is a major cause of concern and discourages businesses from applying for the program and the CBDT must take urgent pro-active steps to reduce the backlog and strive for concluding bilateral APAs within a specified time frame. 

Perhaps some of the elements of the APA process could be done away with for the sake of speed. The OECD Transfer Pricing Guidelines recommends tax administrations to ensure that the APA process is not “unnecessarily cumbersome.” As regards the compulsory pre-filing consultation process, questions were asked earlier whether the CBDT should have a system where the pre-filing consultation is not mandatory, where businesses or the tax authority may request for a pre-filing consultation on a case-to-case basis. Though this was subsequently taken care of, a pre-filing consultation is frequently requested for in practice and this needs to change.

Additionally, there is no target or planned timeline for completion of various steps of the APA process, such as scheduling of the pre-filing meeting, filing of APA applications after the pre-filing meeting, the conclusion of APAs, among other things. These timelines need to be well documented, like the 24 months minimum standard requirement to settle cases under the mutual agreement procedure – an alternative dispute resolution mechanism to resolve tax treaty-related disputes.

One of the reasons for the delay, as noted below, is that the competent authorities are taking longer to come to conclusions and agreements in view of the changing transfer pricing landscape post base erosion and profit shifting recommendations. 

But that aside, structural problems could be tackled quickly and efficiently. There is definitely a shortage of manpower at the Commissioner level in the APA team, which slow down the processing of applications. This problem was also highlighted in the first annual report published in the previous year, but it is not clear what steps has the CBDT taken since to improve efficiency and tackle the backlog.

The Big Picture

The APA report reveals that the CBDT received a total of 53 bilateral APAs in 2017-18, which is twice the number of bilateral APA applications received in the previous year. The report rightly notes that India will be flooded with a huge number of bilateral APA applications in coming years. There are several reasons for this increase.

First, is the opening up of bilateral APAs by the US in 2016 (in 2017-18, 18 applications pertained to India-US bilateral APAs).

Secondly, the BEPS project introduced several important measures to fix the international tax rules such that the rules are not exploited by large businesses. But the BEPS project, (mainly BEPS Action 8-10 in the context of transfer pricing), also brought great uncertainty as a byproduct.

The apprehension of increased transfer pricing audits and resultant litigation in the wake of anti-BEPS measures adopted by treaty partners means that the APA program will offer the much-needed certainty and eliminate or minimize double taxation risks and transfer pricing disputes.

Thirdly, large businesses used to be wary of bilateral APAs as the APA process (right from initiating a pre-filing consultation to the conclusion of the APA) involves submitting additional documentation and information that is otherwise not required (implying voluntary exposure to tax risks). However, with the new documentation requirements introduced as part of BEPS Action 13, large businesses would, in any event, have to submit detailed information to the tax authority.

Fourthly, India, like many other countries, does not have a very effective MAP framework and few cases are resolved in a timely manner. Nor does India provide for MAP arbitration. Taxpayers have very little say in the MAP process (and countries only 'endeavor' to settle). Above all, unlike APA (which is preventative), MAP is reactive.

An ineffective MAP framework makes a reasonably workable APA program look more attractive.

Finally, the CBDT previously did not accept bilateral APA applications where the relevant tax treaty did not contain a corresponding adjustments provision similar to Article 9(2) of the OECD Model Tax Convention. A corresponding adjustments provision allows tax authorities to eliminate double taxation resulting from a transfer pricing adjustment made by a treaty country. However, in November last year, the CBDT clarified that bilateral APAs will be available even in cases where the relevant tax treaty did not contain such a provision. No doubt, the applications for bilateral APAs will keep increasing in coming years for these reasons.

The CBDT is admittedly aware of the benefits of the bilateral APA program and how it is helping in creating a conducive environment for multinationals.

That the government collected (over the last five years) 30 billion rupees (approx.) in additional taxes from large businesses using its APA program is a testimony to the significance of the program in India, though it is not clear how much of that is attributable to bilateral APAs. 

Going forward, the CBDT must also take stock of the challenges facing the APA program and commit to strengthening the APA program by providing it with adequate infrastructure and resources.

Shilpa Goel is an independent tax lawyer practicing in the Bombay High Court and the Supreme Court.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.