CA Rahul Kumar

Finance act 2012 has brought two landmark changes pushing us towards a comprehensive TP legislation. TP has been made applicable to domestic transactions and the much awaited Advance Pricing Agreement (APA) has been introduced.

In the part I of this series we have tried to analyze proposed enactment relating domestic transfer pricing bringing out the purpose, impact and issues related with it.

In the part II of this series we have analyzed the proposed enactment relating Advance Pricing Agreement bringing out its benefits and issues. Also to add a broader perspective we have put forward a study of the integral features of APAs prevalent across the globe.

Advance Pricing Agreement- An analysis

For an 11 year old coming of age legislation, Indian TP sphere has rather earned a dubious distinction of reaching at the helm of global TP litigation. These increased confrontations between taxpayer and revenue administration seems to have prompted the finance ministry in pre-empting the proposal for APA, which was earlier to be brought as part of DTC bill. This proposal has been welcomed by the industry and is expected to usher a degree of certainty to the TP process.

A. Enactment:

In the words of memorandum 1 to Finance bill 2012:- “Advance Pricing Agreement is an agreement between a taxpayer and a taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future.”

APA draws a parallel from the existing provision relating AAR (Authority for Advance Ruling) .Some of the more pertinent provisions relating to this proposed enactment, as enshrined u/s 92C & 92D are as follows:

– International Transactions: APAs shall provide determination / manner of determination of the arm’s length price of an international transaction. Domestic Transactions stand excluded from APA net.

– Method: The manner of determination of ALP, may include the methods referred to in sub-section (1) of section 92C or any other method, with such adjustments or variations, as may be necessary or expedient.

– Primacy of APA over sec 92C & 92CA: The arm’s length price of any international transaction, which is covered under such APA, shall be determined in accordance with the APA so entered and the provisions of section 92C or section 92CA which normally apply for determination of arm’s length price would be modified to this extent.

– Period: The APA shall be valid for such previous years as specified in the agreement which in no case shall exceed five consecutive previous years.

– Binding: The APA shall be binding only on the person and the Commissioner (including income-tax authorities subordinate to him) in respect of the transaction in relation to which the agreement has been entered into. The APA shall not be binding if there is any change in law or facts having bearing on such APA.

– Agreement obtained by Fraud: The Board is empowered to declare, with the approval of Central Government, any such agreement to be void ab initio, if it finds that the agreement has been obtained by the person by fraud or misrepresentation of facts.

-Scheme: The Board is empowered to prescribe a Scheme providing for the manner, form, procedure and any other matter in respect of the advance pricing agreement.

B. APA- An International Perspective

As CBDT is still to come out with a scheme to administer APA, a peek into international administration of APA mechanism would be a worthy way of looking at the shape of thing to come out in future. Below is a study of class, components, trends and features of APAs prevalent across the globe.

a. Classification:

APAs are globally classified in three categories: Unilateral, bilateral and multilateral APA. Below is a comparison:

Unilateral APA Vs. Bilateral (or Multilateral) APA

  • Meaning:

Unilateral APAs involve agreements between only the taxpayer (MNC) and one government (Tax jurisdiction).

A Bilateral APA is entered into between the taxpayer and both the jurisdictional government with respect to proposed transaction. A multilateral APA is effected where more than two governments are parties to transaction.

  • Risk of double taxation:

Unilateral APAs are not recognized by foreign tax authorizes as they are not party to it and hence possibility of double taxation arises whereas in case of Bilateral APA (where international transaction involves two tax jurisdictions) / Multilateral APA (where international transaction involves multiple jurisdiction) no such loose ends are there.

  • Turnaround Time:

Bilateral / Multilateral APA take more to complete as compared to unilateral as number of parties and complexity of issues are more.

  • Global Presence:

Due to concern over double taxation most of countries prefer bilateral / Multilateral APA over unilateral APA (i.e. US, Canada etc.). Some countries (like Germany, France) provide bilateral APA as rule and would allow unilateral APA only as a exception (i.e. when there is no treaty etc.)

Bilateral/ Multilateral APAs provide certainty to taxpayers in the host as well as home country whereas unilateral APAs are one sided tools addressing issues with bilateral/ multilateral implication

b. APA Process:

A modal APA process shall usually subsume following steps:

• APA strategy and transfer pricing analysis: It shall include gathering data conducting FAR analysis and arriving at a APA strategy

• Pre-filing conference: A pre-filing conference between the taxpayer and authorities allows parties to assess the likely success of the APA and can be conducted on anonymous or named basis

• Formal APA request: Formal APA detailing the scope of APA and addressing the issues identified in the pre-filing phase is placed

• Analysis & Evaluation : It may involve independent experts in reviewing and evaluating enterprise’s transfer pricing methodology

• Negotiation and agreement

• Drafting, execution and monitoring of APA

• Administration and renewal of APA

c. Basic Elements

Following would usually be essential element of an APA as agreed between the tax authorities and the tax payers:

-Transactions covered by the APA

-Transfer pricing method (TPM)

-APA term

-Operational and compliance provisions

-Appropriate adjustments

-Critical assumptions regarding future events

-Required APA records

-Annual compliance reporting responsibility

d. Turnaround Time:

APA completion time varies from case to case. Inter- alia it depends upon category of APA (i.e. unilateral, bilateral or multilateral), complexity of issue involved and efficiency of the tax jurisdiction concerned. The average time to complete APA in Australia is the least (less than one year for unilateral and 18 month to two years for Bilateral). Also Japan, Korea and China are amongst countries with very efficient turnaround time whereas average turnaround time in US and Canada is among the highest (3-4 years).

e. Fees:

World over there are varying practices in this regard. Some countries charge a user fees to file a APA request whereas other do not charge such fees (i.e. US and Canada charge a filing fees whereas china does not charge any such fees)

f. Presence of Clear Guidelines & Transparency (annual Report):

World over for effective administration of APA, proper guidelines, program goals, target audience and standard procedure are invariably defined by the tax jurisdictions. Many Countries like USA, Korea, Japan, Canada, Australia and China release information to the public about their APA programs.

Also standards of procedure of compliance by the taxpayers need to be set. In most of the TP jurisdiction an Annual report of such compliances is required to be filed by the taxpayer.

g. Rollbacks:

In some countries (i.e. US, China etc.), APA also comes with rollback provision, wherein a TPM developed in an APA could be used to resolve past open TP cases. Availability of this benefit would usually require consistency of current state of affairs with facts, laws and records of previous periods.

h. Renewals:

Several jurisdictions provides for more streamlined and expedited processing of renewal of an APA application, when the facts and circumstances have not changed significantly. In such circumstance and under such jurisdiction renewals result in time and cost efficiency.

i. Trends:

– Increasing Spread: Over 30 countries have adopted APA and the number of completed APA has been increasing every year. Japan and USA, being the first countries to implement APA, accounts for most number APA (In 2011 Japan completed close to 100 and USA completed close to 45 APAs)

– Nature of International Transaction: APA covers variety of international transactions. However transactions relating to tangible property are the subject matter of majority of APAs followed by service transaction and intangibles.

– Method applied: TNMM has been the most preferred method for APAs across the globe where as the transactional methods (i.e. CUP, resale price and cost plus method) are being scarcely applied.

C. Benefits of APA:

a. Certainty and unanimity of approach: Through forging agreement amongst the all stakeholders of an international transaction, APA process brings out unanimity and certainty as to mode of determination of transfer price.

b. Time & Cost Savings: APA process usually involves considerably lesser time and cost than TP examination.

c. Rollbacks: APA could be a cost effective way of resolving a continuing TP dispute.

d. Reduced Litigation: A prior agreement with revenue authorities through APA process minimizes chances of future litigation and wastes associated with such litigations.

D. Issues / Suggestions related to Indian APA:

In this background above discussion, CBDT would be well advised to take into consideration following factors while drafting the APA scheme:

– Bilateral / Multilateral APA: The current wordings of enactment seem to imply unilateral APA to be the intent of law making authorities. However Bilateral/ multilateral APA are more effective and combat the possibility of double taxation by bringing in unanimity. Also most of the APA jurisdictions emphasize this fact and a step towards bilateral/Multilateral APA would go long way towards achieving the APA objectives.

– Principled and Co-operative approach by revenue administration: Success of APA depends on enthusiastic participation by the taxpayer. Administration must ensure that taxpayer perceive APA program benefits them. APA must not be construed as synonymous to normal audit proceedings by revenue authorities.

– Independence: Independence and the relevant competence of the APA committee is of paramount significance. Bringing together the representative from suitable disciplines would be helpful.

– Maintaining Confidentiality: APA shall be approached as a trust building process. There would be an obvious apprehension in taxpayers mind that if an APA is not completed the information exchanged during the unsuccessful process might as well be used against them. Board shall incorporate significant safeguard in this regard otherwise it as well work as a deterrent.

– Assumptions: All APA contain a set of premises that shall be kept intact for the subsistence of APA. However in the interest of longevity of APA these important assumptions shall provide a room for small and immaterial changes.

– Turnaround time: As discussed above turnaround time for a APA varies across the world and depends on various factors. A shorter turnaround time would make this mechanism more effective.

– Rollbacks: Rollback might as well be used as means to resolve pending TP disputes given the facts, records and circumstance continue to be consistence.

– Renewals: Incorporating renewal provision shall improve the efficiency of APA mechanism.

– Guidelines & Compliances: For effective administration the CBDT shall frame proper guidelines and establish standard procedure. Board shall also specify the standard compliance standard to be followed by the taxpayer (in most of the TP jurisdiction an Annual report of such compliances is required to be filed) and authority and practices for its verification.

– Defining Target Audience: In view of the initial paucity of the relevant skill and resources, it might serve to define a target audience/ case / transaction or a priority policy (i.e. UK prefers APA for complex rather than straightforward cases, China gives priority to the Company’s that has been subject to TP audits etc.).

The clouds of apprehensions stemming from aggressive and adversarial approach adopted by revenue department and further accentuated by apathetic administration and enactments (i.e. DRP has failed to meet the expectation, safe harbor is long impending, Retrospective amendment are creating confusions etc.) can’t be underplayed. So it might be apt to say that, though industry has welcomed the arrival of APA, it has it’s fingers crossed.


CA Rahul Kumar, Partner
AVA & Associates
About AVA – AVA & Associates is a Chartered Accountant firm with an experience of more than two decades in providing contemporary services to clients of varying nature, business line, size, scale and geography. AVA inter-alia specialize in to the discipline of accounting, taxation, audit & assurance, financial management and corporate law.

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0 responses to “Transfer Pricing – In Realm of evolution – Part II”

  1. Shubhankar Watsa says:

    Gone through with this article..a nice piece of work…keeep updating us Mr rahul

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