Volume 5, Issue 20

3rd September, 2012

Tax Alert
Advance Pricing Agreements- the mystery unravelled!


In the current environment, global companies face significant risks of disputes with tax authorities across the globe over their transfer pricing practices and policies. The amounts at stake are enormous and the audit process and litigation bring uncertainty and add to the tax & litigation costs of these companies. To mitigate these uncertainties, many governments across the world have introduced an Advance Pricing Agreement (“APA”) scheme.

An APA is an agreement entered into between a taxpayer and tax authority in advance on an appropriate transfer pricing methodology or price for a set of transactions for a fixed period of time. The objective of an APA is to reduce the uncertainty in determination of arm’s length price of international transactions covered by it and putting further litigation to rest.

India too has witnessed significant activity on the transfer pricing side with some reports suggesting that the value of additions made by Indian tax authorities in last one year alone were around USD 9 billion. Consequently, taxpayers have been demanding an APA mechanism to end their woes and achieve certainty.

Towards this end, the Government had announced the introduction of APA in the Finance Act, 2012. However, the details of how the scheme would operate were awaited by everyone with lot of expectations and apprehensions.

The long wait finally seems to have got over with the Central Board of Direct Taxes (“CBDT”) issuing a Notification No. 36 dated 30th August 2012 (‘Notification’), in this regard. The Notification contains a set of rules (Rule 10F to 10T) called “Advance Pricing Agreement Scheme”. This Alert throws light on the procedure laid down to enter into an APA and certain key points to be noted in this respect.

Some salient features of Indian APA

  • APA mechanism is available to any person who either has entered into an international transaction or is contemplating entering into an international transaction.
  • All types of APA i.e. unilateral (between the taxpayer and the Indian tax authority), bilateral (between two competent authorities) and multilateral (between more than two competent authorities) agreements are provided for in the Rules.
  • APA team to consist of experts from the field of economics, statistics, law etc. apart from income tax officials.
  • The applicant to propose number of years for which APA is required subject to maximum 5 years as provided under the Act.
  • Withdrawal of application allowed at any time before finalising the terms.

Indian APA – the process

Stage 1: Pre Filing Consultation

  • Every tax payer intending to file APA has compulsorily to request for a pre-filing consultation in Form No. 3CEC with Director General of Income-tax (International Tax).
  • Pre-filing consultation can be kept anonymous - no need to provide name of the tax payer or associated enterprise. Instead, details of representatives appearing on behalf of tax payer / applicant are to be given.
  • Non binding on both tax payer and tax authorities
  • Purpose of pre-filing consultation is to discuss broad terms of agreement, scope of agreement, identify issues etc.
  • In case of bilateral / multilateral APA, the Competent Authority of India (CA) would get involved.

Stage 2: Actual APA Application

  • After pre-filing consultation, if the tax payer intends to proceed, an actual application for APA can be filed in Form 3CED along with requisite fees.
  • The APA application to be filed with DGIT (Intl Tax) in case of Unilateral APA and with CA in case of Bilateral or Multilateral APA.
  • APA filing fees range from INR 1 Million to 2 Million depending on the volume of transactions for which APA is sought.
  • APA application to be filed before first day of financial year in respect of continuing transactions or before undertaking transactions in respect of remaining transactions. This implies, in case of continuing / existing transactions, the first year for which a tax payer may be able to apply for an APA would be FY 2013-14.
  • The application should also state the period for which APA is proposed along with the date from which APA is sought to be applicable.
  • Other details in APA application include details of transactions, transfer pricing method sought to be used, terms and conditions and critical assumptions and host of details that are generally part of transfer pricing documentation report such as functional analysis, economic characterisation and industry and market analysis.
  • The APA process provides for a preliminary processing by DGIT (Intl Tax) and provides an opportunity for the tax payer to rectify the deficiencies, if any.
  • In case of bilateral or multilateral APA, the associated enterprises involved are also required to invoke APA process in respective countries. The process in such a case includes Indian CA to ascertain willingness of CA of other countries to initiate the process of consultation.
  • Further, the tax payer or their representatives are not allowed in the consultation process between CAs.

Stage 3: Finalising the terms of APA

  • The APA process would consist of the APA team holding meetings with the tax payer or its representatives, calling for further information, or visiting tax payer’s business premises if required.
  • An APA would include the following:
    • International transaction covered by the APA;
    • Agreed TP methodology if any;
    • Determination of arm’s length price, if any;
    • Critical assumptions
    • Other conditions etc.
  • In case of bilateral or multilateral APA, once the CA of both the countries formalise the terms of agreement, the tax payer has the option to either accept or reject the same. The tax payer has to convey its decision within 30 days of it being communicated.  In case the tax payer does accept the bilateral or multilateral APA, he can proceed with unilateral APA if he so wishes.

Stage 4: Post APA Compliances

  • Taxpayer to furnish an Annual Compliance Report in Form 3CEF with the DGIT (Intl Tax) for each year covered under APA.
  • The Transfer Pricing Officer would conduct a compliance audit for each of the years covered under APA.
  • The regular transfer pricing audit would not be undertaken for the period and transactions covered under the agreement.
  • Modified return to be filed within a period of 3 months to give effect to the APA in case the return has already been filed.

Revision, Renewal, Withdrawal & Cancellation of APA

  • The tax payer can also amend or withdraw the APA application any time before the finalisation of the terms. Amendments to the APA application are allowed if the amendments do not seek to alter the nature of application originally filed.
  • An APA would not be binding on the Government or tax payer if there is any change in the critical assumption or failure to meet conditions specified therein.
  • An APA entered into between tax payers and Government can be revised by either parties if:
    • there is any change in the critical assumption  or
    • there is change in law or
    • on request from competent authority of the other country in case of bilateral / multilateral APA.
  • The Government can cancel an APA for the following reasons:
    • Failure on the part of the tax payer to comply with the terms of the agreement
    • Failure on the part of the tax payer to file Annual Compliance Report or for material error in Annual Compliance Report
    • If the tax payer does not agree with the revised APA.
  • Renewal of agreement is also permitted after the expiry of the original period with the same process having to be followed except for pre-filing consultation.

The Missing Elements

  • Time limit for completion of APA process is not specified and remains uncertain.
  • Roll back of APA is not available.
  • The rules are silent on the confidentiality of data.
  • The tax payer or the APA team are required to select one of the methods currently specified under the IT Act, and are not provided the freedom to bring in any new method which would justify the arm’s length price of the transactions.
  • There is also no assurance that if the APA fails, the information submitted would not be used against the tax payer or no adverse conclusion would be drawn and used against tax payer.

SKP Comments

The APA regime introduced in India has as much to ponder about, as there is to cheer for. The APA Rules no doubt encapsulate the best practices followed in most countries. The tax payers can now look forward to attain certainty in transfer pricing policies and can mitigate themselves from the risk of adverse transfer pricing assessments. Globally, the APA programme is a huge success in most countries and more and more countries are rolling out the APA schemes.

A matter of concerns is the wide powers given to the tax authorities to revise or cancel the APA. Also, terms such as “critical assumption” etc need to be articulated well as they are vaguely drafted and could lead to litigation. Another major concern and which generally determines the success of an APA programme is the time taken to conclude an APA. We have observed that in most developed countries an APA is concluded within 12-15 months. Currently, there is no time limit provided for the APA process to be concluded and we hope that the Government would bring in some limit at a later stage based on their experience. In the meantime, if the APA process is going to be long winding, some safeguards to the tax payer in the intervening period (such as no TP audit) ought to have been provided.

Most critical for the APA programme to be successful would be the administration of the programme. In the background of the recent bitter experiences with DRP, the tax payers hope that the APA process would be fair and just without revenue bias. Towards, this end it is heartening to note that the rules provide for inclusion of number of experts from the field of economics, law, statistics etc. in the APA team.

Thus, as goes with any policy matter in India, while the regulations are a welcome move, tax payers would eagerly wait to see how the same is administered. Most taxpayers may adopt a wait and watch policy and may also like to see Government’s approach on the safe harbour provisions which are under consideration and consultation currently before taking a plunge into the APA process.