Volume 3, Issue 8

9th June, 2010

Tax Alert
Indian   &   US   Competent   Authorities   reach   a   negotiated settlement   for  transfer   pricing   disputes  under  the  Mutual Agreement  Procedure


The Indian Transfer Pricing Authorities have been taking aggressive positions in the area of transfer pricing especially for Indian subsidiaries providing software, business & knowledge process outsourcing (BPO & KPO), and IT enabled services on a captive basis to their overseas affiliates. The Indian tax authorities have been assessing the transfer price of such software service providers at a mark‐up of 25-30 percent
The MAP article under the treaty allows designated representatives or Competent Authorities (CA) of both the Governments to interact with the intent to resolve the international tax and transfer pricing disputes.
on total costs, while the service providers have been generally charging 10‐15 per cent on total costs.

Even if the Indian tax payer enjoys tax holiday benefits, the upward adjustment in the profits, by the transfer pricing authorities is not eligible for the tax exemption and is subject to tax. Further such transfer pricing adjustment lead to economic double taxation for MNCs in both countries and hence are a matter of major concern for MNCs. In view of the above scenario several MNCs especially from USA invoked the Mutual Agreement Procedure (MAP) to resolve this dispute.

What is Mutual Agreement Procedure?

The MAP is a mechanism provided under double tax avoidance agreements (tax treaties) entered into by India with various countries. The MAP provides an opportunity to a resident tax payer to approach the Competent Authorities (CA) to resolve the issue in consultation with the CA of the other country. The MAP article under the treaty allows designated representatives or CA of both the Governments to interact with the intent to resolve the international tax and transfer pricing disputes. However, the MAP article generally does not compel them to resolve or reach an agreement but only to use their best endeavors to reach an agreement. This is an alternate dispute resolution mechanism, in addition to dispute resolution and appellate remedies available to tax payers under the respective domestic laws.

A Memorandum of Understanding (MOU) between India and US provides that the CAs would endeavor to resolve the dispute within two years and also provides for stay of collection of disputed taxes during the pendency of MAP.
Further, on conclusion of MAP the tax payers have an option whether to accept the decision of the CAs or not and in the latter case they can follow the normal appellate procedure in India.

Facts and Settlement

During the course of TP audits for financial year 2004‐05 (year ending 31st March 2005), a  number  of  Indian  affiliates of  US  MNCs,  which  were  engaged in  providing  various software, IT and BPO services were subject to adverse TP adjustments. The Indian tax authorities, adopting a different approach/criteria for accepting/rejecting comparable companies, determined arm’s length transfer price of such service providers at a mark‐up of 25‐30 per cent on total costs, as against 10‐15 per cent on total costs determined/declared by the tax payers.

Some of the US MNCs invoked MAP under Article 27 of the India‐US tax treaty. These MAP applications have resulted in discussions and consultations between CAs of India and USA to reach a settlement on the above issue.

Pursuant to on‐going discussions, as per media reports, the Indian and US CA have apparently reached a negotiated settlement whereby they have agreed to mark‐up of 17.50 per cent on total costs for software/IT service providers for FY 2004‐05.

The settlement provides relief of around 10‐12 per cent for those tax payers who have made applications under MAP. It could also provide correlative adjustment/corresponding deduction at the US end thereby eliminating double taxation. At the same time, the difference between 17.50 per cent mark‐up and mark‐up declared by the tax payer would continue to be liable to tax in India and will not be exempt under any tax holiday provisions in India.

Conclusion and Comments

The above information is based on secondary sources including media reports and there is no confirmation from the CA of either country . Also, the formal MAP order is not in public domain as yet. The factors and principles that were considered by the CA are also not known currently. While, the above settlement provides relief to tax payers who have invoked MAP, it must be noted that it is applicable only for the tax payers who have made an application under MAP and that too only for the year under consideration and would not apply to any other year(s). Further, it would be applicable only to the specific tax payer and may not carry persuasive value as the detailed facts and basis are not available in the public domain. However, this would be a useful reference pointer to the approach of Indian tax authorities and CA on similar matters in future. More importantly, this MAP settlement may provide a precursor of detailed safe harbor rules which are due to be announced shortly.

The above settlement may also provide a sense of succor to the Indian transfer pricing authorities at the field level as they have recently faced a series of setbacks in terms of reversal of their orders by the appellate authorities. In some cases, the appellate tribunal has upheld a mark‐up of 10‐12 per cent for software/IT service providers while rejecting the add‐hoc approach of the transfer pricing authorities. Such tribunal orders would, in turn, encourage the tax payers who had made applications under MAP not to accept the MAP settlement and litigate under the domestic appellate procedure.

However, tax payers following a lower mark‐up and who are averse to litigation may wish to revisit their transfer pricing policies and strategies in the light of the above MAP settlement.