Recent negotiations between the Competent Authorities (CAs) of India and the USA under Article 27 of the India-US tax treaty (Tax treaty), which deals with the Mutual Agreement Procedure (MAP), provides for a dispute resolution mechanism where the CAs shall endeavor by mutual agreement to resolve the situation of taxpayers subject to taxation not in accordance with the provisions of the Tax Treaty. A Memorandum of Understanding (MoU) between the two countries provides that the CAs would endeavor to resolve such disputes within a period of two years and also provides for obtaining a stay on collection of the disputed taxes during the pendency of the MAP.
It has recently been reported that, pursuant to an MAP, the US and Indian CAs have proposed to resolve a transfer pricing (TP) dispute involving provision of intra-group information technology services, by an Indian affiliate to a US multinational enterprises (MNE). The proposed resolution involves the CAs agreeing to accept a mark-up on costs of 18% as the arm’s length price as compared to an adjustment in the range of 25-30% made by the Indian revenue authorities. The taxpayers involved have the option to either accept the MAP resolution or follow the course of appeal prescribed under the domestic tax laws.
Background –The TP provisions were introduced in the Indian Tax Laws (ITL), with effect from 1 April 2001. Over the past few years, TP disputes have emerged as a significant challenge faced by MNEs doing business in India.
A number of MNEs have established information technology (IT), R&D and back-office operations for providing intra-group services. The Indian affiliates providing such services have been subject to adverse TP adjustments in recent times. While a number of these operations may enjoy the benefit of a tax holiday under the ITL, any income allocated pursuant to an upward TP adjustment made during the course of an audit, would not qualify for the tax holiday. Further, a TP adjustment in the hands of the Indian affiliate could potentially result in economic double taxation for the MNE if the MNE is not able to obtain a correlative relief.
The MAP article of a tax treaty allows designated representatives i.e. CAs from the governments of the contracting states to interact with the intent to resolve international tax disputes, including TP disputes. A MAP article in most tax treaties does not compel CAs to actually reach an agreement and resolve their tax disputes. They are obliged to only use their best endeavors to reach an agreement. The disputes resolution under the MAP article of a tax treaty is in addition to the dispute resolution and appellate remedies that a taxpayer may have under the domestic tax laws.
Facts and proposed settlement:-During the course of TP audits for the tax year 2004-05, a number of Indian affiliates of US MNEs, which were engaged in providing intragroup IT services were subject to adverse TP adjustments. This resulted in the Indian revenue authorities determining mark-ups on costs in the range of 24-30% as the arm’s length price for such transactions.
The Indian revenue authorities asserted these adjustments largely by adopting a different approach/criteria for accepting/rejecting comparable data, as compared to the taxpayer’s approach.
Some of the US MNEs invoked MAP under Article 27 of the Tax Treaty. These MAP applications have resulted in discussions between the CAs of India and the US to reach a settlement on the TP adjustments made by the Indian revenue authorities.
Pursuant to ongoing discussions, it has been reported that India and the US CAs have proposed to the taxpayers on whether a resolution based on a mark-up of 18% on costs would be acceptable.
If the taxpayers accept the proposal of the CAs, the Indian affiliate would be subject to tax based on the MAP agreement. In addition, it could also enable the US taxpayer to consider whether it could be eligible to seek correlative relief based on the MAP resolution.
Comments:-The above information is based on secondary sources, including media reports, and there is no official confirmation from the CAs. The factors and the principles that were considered by the CAs before making the above proposal are also not known at this stage.
Where a MAP resolution has been arrived at and accepted in respect of a particular issue for a relevant tax year, it should have effect only for the specific taxpayer for that relevant tax year and for that particular issue. A MAP resolution does not typically set a binding precedent for either the taxpayers or the revenue authorities in regard to adjustments or issues relating to subsequent years or for CA discussions on the same issues for other taxpayers. Nevertheless, it does provide an indication of settlements that could be expected from MAP proceedings, especially in a similar fact pattern.
The taxpayers in the above case have the option to either accept the MAP resolution or follow the course of appeal prescribed under the domestic tax laws. If the taxpayers choose to give their consent to the MAP resolution, the Indian affiliate would need to withdraw any appeal filed under the domestic tax appellate procedure.