Comparative analysis of Mutual agreement Procedure & Advance pricing agreement

Introduction:

“In this article, we embark on a thorough comparative analysis of two vital mechanisms in international taxation: the Mutual Agreement Procedure (MAP) and Advance Pricing Agreement (APA). Our objective is to discern which of these frameworks proves more effective and beneficial for entity engaged in international transactions and related party transactions. As globalization continues to drive an exponential increase in cross-border business activities, navigating the complexities of international tax compliance becomes increasingly challenging. Both MAP and APA offer mechanisms to address issues arising from double taxation and transfer pricing disputes, crucial concerns for multinational enterprises and entities engaging in related party transactions. By meticulously examining the features, processes, and outcomes of MAP and APA, we aim to shed light on their respective strengths and limitations. Through this comparative analysis, readers will gain valuable insights into selecting the most appropriate mechanism to optimize tax outcomes, mitigate risks, and ensure compliance in the dynamic landscape of international business.”

Following topics we are going to discuss for better understanding

a) Mutual Agreement Procedure

b) Compliance for MAP

c) Advance Pricing Agreement

d) Compliance for APA

e) Scenarios when Advance Pricing Agreements and Mutual Agreement Procedures are applicable

f) Effectiveness of APA & MAP

g) Conclusion

Mutual Agreement Procedure:

The Mutual Agreement Procedure (MAP) is a mechanism established under tax treaties between two or more countries. It allows taxpayers to resolve disputes related to double taxation or the interpretation and application of tax treaties. When a taxpayer believes they are subject to taxation that is not in accordance with the terms of a tax treaty or results in double taxation, they can request MAP assistance from the tax authorities of the countries involved. The competent authorities of these countries then work together to resolve the dispute through mutual agreement, aiming to provide relief to the taxpayer and ensure consistent interpretation and application of tax treaties.

Here are the key points about the MAP:

Purpose: The MAP aims to relieve double taxation either fully or partially by facilitating discussions and negotiations between the competent authorities of the countries involved.

How It Works:

When a taxpayer faces double taxation due to conflicting tax treatment in two countries, they can request the competent authority of one of the countries (usually their home country) to initiate the MAP.

The competent authorities from both countries engage in discussions to reach an agreement on how to resolve the tax dispute.

The goal is to ensure that the taxpayer is not unfairly burdened by overlapping tax liabilities.

Scope:

The MAP covers various aspects, including juridical and economic double taxation.

It addresses situations where the taxpayer’s income or capital is subject to taxation in both countries, leading to potential double taxation.

Process:

The taxpayer submits a request for MAP to the competent authority of their home country.

The competent authorities of both countries exchange information and negotiate to find a mutually acceptable solution. The agreement reached through the MAP process is binding on both countries.

Importance:

The MAP promotes cooperation and prevents tax disputes from escalating into lengthy legal battles.

It provides a non-judicial avenue for resolving cross-border tax issues, benefiting taxpayers and maintaining positive bilateral relations.

Remember that the MAP is not specific to the Indian Constitution but is governed by international tax treaties (DTAAs) that India has with other countries. It reflects India’s commitment to resolving tax disputes in a fair and efficient manner.

Compliance for MAP

The central board of direct tax has issued a notification amending Rule 44G with respect to the application and the procedure for MAP. It has also amended Form 34 F for application to the competent authority for invoking MAP.

The MAP guidance is presented in the following four parts:

I. Part A: Introduction and Basic Information;

II. Part B: Access and Denial of Access to MAP;

III. Part C: Technical Issues; and

IV. Part D: Implementation of MAP outcomes.

Part A: Introduction and Basic Information

• Taxpayers can initiate MAP if they believe actions by tax authorities lead to double taxation or taxation contrary to DTAAs. Common scenarios include transfer pricing adjustments, Permanent Establishment issues, and income re-characterization.
• To apply for MAP in India, taxpayers must submit Form No. 34F, providing relevant details such as PAN/Aadhar number, assessment years, and details of the tax authorities involved. Required documents include copies of notices/orders and evidence supporting the MAP application.
• Once a MAP application is accepted, CAs exchange views, typically through position papers. Negotiations follow, either in person or remotely, aiming to reach a resolution. If successful, a mutual agreement is formalized, with the option for taxpayers to accept or reject. Unresolved cases are closed with notification to the taxpayer.
• In certain cases, India can participate in multilateral MAP discussions, involving multiple treaty partners. Efforts are made to resolve MAP cases within an average timeframe of 24 months, in line with BEPS Action 14 recommendations.
• India commits to implementing MAP outcomes promptly, with procedures outlined in the Income-tax Rules, 1962, ensuring taxpayers and tax authorities adhere to agreed resolutions.

Part B: Access and Denial of Access to MAP

Access to Mutual Agreement Procedure (MAP):

• Indian taxpayers have easy access to MAP if they believe actions of foreign tax authorities result in taxation not in accordance with relevant DTAAs.
• Access is also granted when foreign CAs accept MAP applications from their taxpayers, involving actions of Indian tax authorities or treaty partners leading to taxation not in accordance with DTAAs.
• MAP access is provided for various cases including transfer pricing adjustments, Permanent Establishment issues, and income characterizations or re-characterizations.
• Even in situations where Indian anti-abuse provisions are applied, access to MAP is ensured.
• MAP access is extended to non-resident entities anticipating double taxation due to disputed orders under section 201 of the Income-tax Act, 1961.
• Certain circumstances like unilateral Advance Pricing Agreements (UAPA), safe harbour provisions, and orders of the Income Tax Appellate Tribunal (ITAT) involve restricted MAP negotiations.
• Multilateral MAP discussions can also be pursued under specific conditions.

Denial of Access to MAP:

• Delayed MAP applications beyond specified timeframes outlined in relevant DTAAs are not granted access.
• Access may be denied if taxpayer objections are deemed unjustified, or if MAP applications lack completeness.
• Cases already settled by the Income-tax Settlement Commission (ITSC) or resolved through Authority for Advance Rulings (AAR) are not eligible for MAP.
• No MAP access is provided for issues solely governed by India’s domestic law implementation.

Part-C: Technical Issues in Mutual Agreement Procedure (MAP):

a) Downward Adjustment:

Indian CAs can negotiate MAP cases to withdraw adjustments made by Indian tax authorities but cannot reduce below returned income due to domestic law restrictions.

In transfer pricing cases, adjustments leading to reduced income or increased loss per Section 92(3) cannot be applied.

b) Resolution of Recurring Issues:

Recurring issues can be resolved based on prior MAP resolutions but cannot prevent tax authorities from acting contrary to prior resolutions.

c) Interest and Penalties:

Interest and penalties arising from MAP resolutions are not within the mandate of CAs but are governed by domestic laws.

If interest and penalties are linked to income, they’re adjusted proportionately with income variation under MAP.

d) Secondary Adjustments:

CAs must include secondary adjustments in MAP resolutions for cases from financial year 2016-17 onward.

e) Bilateral & Multilateral APAs:

MAP applications shouldn’t be filed for issues covered by bilateral or multilateral APAs. If APA fails, MAP applications can be made and accepted if they meet MAP conditions.

f) Suspension of Collection of Taxes:

With certain treaty partners, MoUs allow for tax collection suspension during MAP. In the absence of such MoUs, Indian domestic law governs tax collection suspension procedures.

g) Adjustment of taxes paid under Section 201:

Taxes paid due to Section 201 orders by Indian taxpayers can be adjusted against non- resident taxpayer’s liability upon MAP resolution for relevant issues and years.

Part D: Implementation of MAP Outcomes:

a) Commitment to Implementation:

India is committed to implementing MAP outcomes without legal or administrative impediments.

Exceptions include cases where ITAT orders contradict resolved MAP outcomes.

b) Timelines:

Rule 44G establishes clear timelines for MAP implementation:

Taxpayer: 30 days to accept MAP resolution and withdraw domestic appeals.

Assessing Officer1 month to give effect to MAP resolution.

Intimations regarding MAP resolutions must be sent to relevant authorities for expedited implementation.

c) Information to CAs of India:

Assessing Officer must provide details of tax payments/refunds, withdrawal of appeals, and other relevant information to the CA of India.

d) Adherence to Guidance:

Taxpayers, practitioners, Indian tax authorities, and CAs of India should adhere to MAP guidance.

In case of conflict with domestic legislation, rules, instructions, circulars, or DTAAs, domestic provisions prevail.

Advance pricing agreement:

An Advance Pricing Agreement (APA) is a formal arrangement between a taxpayer and tax authorities regarding transfer pricing
methodology for cross-border transactions between related entities. The purpose of an APA is to provide certainty and prevent disputes
regarding transfer pricing, which involves determining the price at which related entities trade goods, services, or intangible assets.

APAs typically specify the transfer pricing method to be used, the period covered, and any adjustments necessary to ensure compliance with arm’s length principles. There are three types of APAs:

Unilateral APA: Involves an agreement between the taxpayer and tax authorities of one jurisdiction.

Bilateral APA: Involves an agreement between the taxpayer and tax authorities of two jurisdictions. It is used when a transaction involves entities in multiple countries.

Multilateral APA: Involves an agreement between the taxpayer and tax authorities of multiple jurisdictions. It is used when a transaction involves entities in more than two countries. APAs provide certainty for taxpayers by establishing a predetermined pricing methodology, reducing the risk of disputes and audits. They also offer benefits to tax authorities by streamlining compliance and enforcement efforts. However, APAs require extensive documentation and negotiation, and the terms must be adhered to by both parties for the agreement to remain valid.

The APA process involves determining the arm’s length price or specifying the method for determining it in relation to international transactions.

Compliance for Advance Pricing Agreement

Eligibility:

Any person who has undertaken or is contemplating an international transaction can apply for an APA. There are no monetary or other specific criteria; any type of international transaction can be covered.

Pre-filing Consultation:

Before formally applying for an APA, taxpayers can seek pre-filing consultation to assess the possibility.

This helps in understanding the feasibility and requirements.

Applying for Advance Pricing Agreement [Rule 10-I]

(a) Anyone eligible to make an agreement can apply by filling out a form and paying the required fee. They should send this application to the Director General of Income-tax (International Taxation) for unilateral agreements, or to the competent authority in India for bilateral or multilateral agreements.

(b) The application can be submitted:

• • Before the start of the previous year related to the first assessment year for which the agreement is requested, for transactions that are ongoing from existing dealings.
  • Before starting the transaction for remaining transactions.

Applicable Fee: The application has to be accompanied by proof of payment of fees as given below:

Amount of international taxation entered into or proposed to be undertaken in respect of which agreement is proposed during the proposed period of agreement Fee

Amount < Rs. 100 crores	Rs. 10 lakhs
Amount > Rs. 100 crores but not exceeding < Rs. 200 crores	Rs. 15 lakhs
Amount > Rs. 200 crores	Rs. 20 lakhs

Withdrawal of application for Advance pricing agreement

The applicant may withdraw the application for agreement at any time before the finalisation of the terms of the agreement. However, application fees paid shall not be refunded on withdrawal of application by the applicant.

Role of the Central Government:

The Central Board of Direct Taxes (CBDT), with the approval of the Central Government, can enter into APAs with taxpayers.

Validity of APA: The APA will be valid for a period stated in the agreement, but it won’t be more than five years in a row.

APA Terms and Conditions:

Agreement Terms :

(a) An agreement can include:

• • What international transactions it covers.
  • The agreed method for pricing transfers, if applicable.
  • How the fair price is determined, if applicable.
  • Definitions for important terms used in (ii) or (iii).
  • Critical assumptions, meaning factors and assumptions so important that if they change, neither party is bound by the agreement anymore.
  • A provision for rolling back, as mentioned in Rule 10MA.
  • Conditions, if any, beyond what’s in the law or rules.

(b) The agreement won’t be binding on the tax authority or the taxpayer if critical assumptions change or conditions aren’t met.

(c) The agreement only stops being binding if one party gives proper notice to the other party.

(d) If critical assumptions change or conditions aren’t met, the agreement can be changed or cancelled.

The maximum term of an APA is 5 years, and a 4-year rollback APA is also possible.

The APA is binding on the applicant assessee, Principal Commissioner of Income Tax (Pr. CIT)/ Commissioner of Income Tax (CIT), and subordinate income tax authorities.

However, if there is a change in law or facts affecting the agreement, it may not be binding. Fraud or misrepresentation can render the agreement void-ab-initio.

Revising an Agreement :

(a) After being made, an agreement can be changed by the tax authority:

• • If there’s a change in critical assumptions or if conditions aren’t met.
  • If there’s a change in the law affecting the agreement but not making it invalid.
  • If the tax authority of another country asks for changes in a bilateral or multilateral agreement.

(b) Unless the taxpayer asks for changes, revisions won’t happen without giving them a chance to speak and agree to the changes.

(c) The revised agreement will specify the dates when the original and revised agreements are in effect.

Cancelling an Agreement :

(a) The tax authority can cancel an agreement for these reasons:

• • • If the taxpayer doesn’t follow the agreement’s terms after a compliance audit.
    • If the taxpayer doesn’t submit the annual compliance report on time.
    • If the annual compliance report has significant mistakes.
    • If the taxpayer disagrees with proposed changes or if the agreement needs to be cancelled under rule 10RA(7).

(b) The tax authority will let the taxpayer speak before cancelling an agreement.

(c) The cancellation order will be in writing and explain why it’s happening and why any objections from the taxpayer aren’t accepted.

(d) The cancellation order will also say when the agreement ends, if applicable.

(e) If an agreement is declared void from the beginning because of fraud or false information, a written order will explain why and why any objections from the taxpayer aren’t accepted.

Effect of APA:

If an APA is entered into after filing a return of income, the applicant must furnish a modified return within a specified period.

The modified return is treated as filed under section 139 for all purposes.

If assessment or reassessment is pending, it will consider the modified return.

Annual Compliance:

The taxpayer must submit an annual compliance report.

The Transfer Pricing Officer (TPO) conducts a compliance audit and submits a report to the Director General of International Taxation within 6 months.

The timeline for compliance is either within 30 days of the due date of filing the return or within 90 days of entering into the agreement.

Scenarios when Advance Pricing Agreements and Mutual Agreement Procedures are applicable:

Here are a few hypothetical examples of situations where the Mutual Agreement Procedure (MAP) might be used to resolve transfer pricing disputes between countries:

Case of Divergent Transfer Pricing Assessments:

• A multinational company (MNC) operates in Country A and Country B. The tax authorities in Country A and Country B conduct transfer pricing audits and come up with different assessments regarding the pricing of intra-group transactions.
• The MNC initiates the MAP process, requesting the competent authorities of Country A and Country B to resolve the discrepancy and prevent double taxation.
• Through MAP, the tax authorities of both countries engage in discussions, exchange information, and negotiate an agreement on the appropriate transfer pricing adjustments to be made, ensuring consistency and fairness across jurisdictions.

Attribution of Profits to Permanent Establishment (PE):

• A foreign company operates through a permanent establishment in Country X, and there is a dispute between the tax authorities of Country X and the foreign company regarding the attribution of profits to the PE.
• The foreign company invokes the MAP provision of the tax treaty between its home country and Country X to resolve the dispute.
• Competent authorities from both jurisdictions engage in discussions to determine the appropriate allocation of profits to the PE, considering factors such as functions performed, assets used, and risks assumed by the PE.

Transfer Pricing Adjustment on Intangibles:

• A transfer pricing audit in Country Y results in a significant transfer pricing adjustment related to the valuation of intangible assets transferred between related entities.
• The MNC disagrees with the adjustment and initiates the MAP process to resolve the dispute between the tax authorities of Country Y and the MNC’s home country.
• Through MAP, the competent authorities of both countries analyse the valuation methodologies, economic substance, and other relevant factors to reach a consensus on the appropriate pricing of the intangible assets, aiming to avoid double taxation and ensure fair allocation of profits.
• In each of these examples, the MAP process provides a mechanism for resolving transfer pricing disputes by facilitating discussions and negotiations between the tax authorities of the relevant jurisdictions. The goal is to reach a mutually acceptable resolution that prevents double taxation and promotes consistency in the application of transfer pricing rules across borders.

Certainly, here are some hypothetical examples illustrating how Advance Pricing Agreements (APAs) might be used in India:

Manufacturing and Distribution Operations:

• A multinational company (MNC) has a subsidiary in India responsible for manufacturing products and another subsidiary in a different country responsible for distribution.
• The MNC wishes to establish transfer pricing arrangements between these entities to determine the appropriate pricing for the products sold by the manufacturing subsidiary to the distribution subsidiary.
• The MNC applies for a bilateral APA involving the Indian tax authorities and the tax authorities of the other country.
• After detailed negotiations and analysis, the tax authorities agree on an acceptable transfer pricing methodology for the transactions between the manufacturing and distribution subsidiaries for a specified period, providing certainty to the MNC regarding its tax liabilities in India.

Research and Development (R&D) Services:

• An Indian subsidiary of an MNC provides research and development services to its parent company and other related entities.
• The Indian subsidiary seeks an APA with the Indian tax authorities to determine the arm’s length pricing for these R&D services, considering the unique functions performed, risks assumed, and assets utilized by the Indian entity.
• The APA process involves extensive discussions, documentation, and analysis of comparable to establish a transfer pricing methodology that is acceptable to both the taxpayer and the tax authorities.
• Once agreed upon, the APA provides assurance to the Indian subsidiary regarding the tax treatment of its R&D transactions for the agreed period, reducing the risk of transfer pricing adjustments and disputes.

Intercompany Financing Arrangements:

• A multinational group has a financing company located in India that provides loans to its subsidiaries and affiliates worldwide.
• The financing company applies for a unilateral APA with the Indian tax authorities to establish the arm’s length interest rates for its intercompany loans.
• Through the APA process, the financing company provides detailed documentation and analysis demonstrating the comparability of its financing arrangements with third-party transactions.
• The Indian tax authorities review the documentation and, after negotiations, agree on the acceptable interest rates for the intercompany loans, providing certainty to the financing company regarding its tax liabilities in India.
• In these examples, APAs offer a proactive approach for taxpayers to obtain certainty and predictability in their transfer pricing arrangements by reaching agreements with tax authorities upfront. This helps to mitigate the risk of transfer pricing audits, adjustments, and disputes, providing a stable tax environment for multinational businesses operating.

Effectiveness of APA & MAP

Both the Mutual Agreement Procedure (MAP) and Advance Pricing Agreement (APA) are mechanisms provided by tax authorities to resolve transfer pricing disputes and provide certainty in tax matters. However, the effectiveness or preference for one over the other may vary depending on the specific circumstances of each case. Here’s a brief overview of both:

Mutual Agreement Procedure (MAP):

• MAP is a mechanism provided under tax treaties between countries to resolve disputes arising from transfer pricing adjustments or other cross-border taxation issues.
• It involves the tax authorities of the respective countries negotiating to reach a resolution that prevents double taxation and ensures that the profits are appropriately allocated between the jurisdictions involved.
• MAP provides a way to resolve disputes after they have arisen, offering a way to rectify situations where tax authorities in different countries have reached conflicting conclusions about the transfer pricing arrangements.
• MAP can be time-consuming and may not always result in a favourable outcome for the taxpayer, as it relies on negotiation between tax authorities.

Advance Pricing Agreement (APA):

• APA is a mechanism through which taxpayers can proactively seek agreement with tax authorities on the transfer pricing methods and pricing arrangements for transactions with related parties.
• It provides certainty to taxpayers by establishing upfront the transfer pricing methodology that will be accepted by tax authorities for a predetermined period.
• APA can be unilateral (between the taxpayer and one tax authority), bilateral (between the taxpayer, the tax authority of the home country, and the tax authority of the other country involved in the transaction), or multilateral (involving multiple tax authorities).
• APA requires detailed documentation and analysis of the related-party transactions, and it involves a negotiation process with tax authorities, but once agreed upon, it reduces the risk of transfer pricing audits and disputes during the period covered by the agreement.

Conclusion

In India, both MAP and APA mechanisms are available to taxpayers. The choice between MAP and APA depends on various factors such as the nature of the transactions, the likelihood of disputes, the desired level of certainty, the complexity of transfer pricing arrangements, and the taxpayer’s risk tolerance.

Generally, if a taxpayer seeks certainty and wants to avoid the risk of transfer pricing disputes, an APA may be preferable as it provides upfront agreement with tax authorities on transfer pricing methods. However, if a dispute has already arisen, or if the taxpayer prefers a more flexible approach, MAP may be the appropriate mechanism to resolve the issue. Ultimately, it’s advisable for taxpayers to consult with tax advisors or specialists to determine the most suitable approach based on their specific circumstances.

Disclaimer:

The information provided is for general informational purposes only and should not be considered as legal, tax, or financial advice. Readers are advised to consult with qualified professionals regarding specific situations involving advance pricing agreements (APAs) and Mutual Agreement Procedures (MAPs).

While efforts have been made to ensure accuracy, no guarantee is made as to the accuracy or timeliness of the information. APAs and MAPs outcomes may vary based on individual circumstances and jurisdictional regulations.

Readers should conduct thorough due diligence and seek professional advice tailored to their circumstances before making decisions. The author and publisher disclaim any liability for loss or damage arising from reliance on the information presented herein.