The Advance Pricing Agreement program has been a key dispute prevention mechanism in the Indian direct taxes set-up. There are three kinds of Advance Pricing Agreements – unilateral, bilateral and multilateral. Credibility of a tax administration depends to a large extent upon the efficacy of its dispute resolution mechanism. Advance Pricing Agreements have played a large role in preventing avoidable disputes from occurring. The Finance Act, 2012 introduced Advance Pricing Agreement (APA). While introducing the provisions, the then Finance Minister said, “In a globalized economy with expanding cross-border production chains and growing trade within entities of the same group, Advance Pricing Agreement (APA) can significantly bring down tax litigation and provide tax certainty to foreign investors.”
An Advance Pricing Agreement is an agreement between a taxpayer and tax authority determining the transfer pricing methodology for pricing the tax payer’s international transactions for future years. These agreements can be of three types – unilateral, bilateral and multilateral. However, in India there has been no multilateral agreement, as far as 2018. A unilateral agreement involves only the tax payer and the tax authority of the country where the tax payer is. A bilateral agreement involves the taxpayer, associated enterprise of the tax payer in the foreign country, tax authority of the country where the tax payer is, as well as the tax authorities of the associated enterprises. A multilateral agreement involves the taxpayer, two or more associated enterprises of the taxpayer in different foreign countries, tax authority of the country where the tax payer is, and the tax authorities of the associated enterprises. Advance Pricing Agreements have multiple benefits. Agreeing in advance to the pricing methodologies to be applied on the taxpayers international transactions provides a certainty with respect to the tax outcome. The compliance costs for tax payers as well as administrative costs for the authorities are reduced over time.
Advance Pricing Agreements particularly serve to avoid transfer pricing disputes by agreeing on the arm’s length price in advance. The process is that taxpayers and their counsel can come in and meet with specialists of the APA division to explore whether the relevant facts in their case qualify for an APA or not. During an APA evaluation, the taxpayer and tax authorities usually review the relevant facts, discuss the appropriate transfer pricing method for those facts, and then agree that for the next 4-5 years, that is what the taxpayer will abide by and report as an arm’s length margin/price, unless extraordinary circumstances or events occur.
Previously, India had placed an embargo on requests for entering into bilateral APAs with a country, unless the DTAA with that particular country contained a ‘corresponding adjustment clause’. Therefore, unless specifically provided in the tax treaty, transfer pricing disputes could only be settled through domestic litigation. However, now, India has allowed for Bilateral APAs, irrespective of the DTAA. This is a huge benefit for India in terms of international business transactions. Although unilateral APAs are faster to conclude, bilateral APAs have an advantage in that they help to avoid double taxation. Since the bilateral APA with USA, there has been an increase in the number of bilateral APAs being filed, as well as requests for conversion from unilateral to bilateral APAs.
We will now focus on the relationship between Germany and India with respect to transfer pricing disputes, and how it has evolved over time. In recent times, enterprises of both countries extended their business relationship. India, being one of the fastest growing economies in the world offers various opportunities for German companies, which is why, today, more than 1700 German companies are active in India. Similarly, investments of Indian enterprises in Germany have remarkably increased over the last years. Indian entities have invested over EUR 6.5 billion in Germany, especially in sectors of IT, automotive, pharma and biotech. Today, there are more than 200 Indian companies operating in Germany. There are more than 1600 Indo-German collaborations and over 600 Indo-German Joint Ventures in operation. Inevitably, over the last few years, the number of transfer pricing disputes continues to grow in both countries. In the DTAA between India and Germany, there was an Article (Article 25) which provided for Mutual Agreement Procedure (MAP). However, until late 2017, India did not accept MAP and Bilateral APA applications. This was because the Corresponding Adjustment Clause was absent from he DTAA between India and Germany. However, this changed when in November 2017, India announced that MAP and Bilateral APA applications would be accepted regardless of the Corresponding Adjustment Clause being present in the DTAA. This change in India is a great opportunity for the enterprises of both jurisdictions currently suffering double taxation. There is the opportunity for clearing the past tax issues and/or to obtain certainty in the tax treatment in future years.
As discussed above in the case of Germany as well as in general, Advanced Pricing Agreements have been beneficial to India. However, there are certain suggestions that can be implemented, so as to improve the efficiency of the system. An e-filing system can be adopted for APA applications and submissions, an APA manual should be compiled giving the best practices so that APA teams can benefit from them, a separate team can be set up for renewal of APAs, this will speed up the process. APA program should not be very restrictive on business restructuring considering the dynamic nature of the businesses, it should be the endeavor of the APA officers to use more commercially and justifiable Transfer Pricing method. Otherwise, it defeats the very purpose of the APA program.
Therefore, it is clear that allowing Advance Pricing Agreements was a step in the right direction for India. It has solved various issues and also brought global acceptance.