On August 30, 2012, the Central Board of Direct Taxes ("CBDT") issued guidance on its advance pricing arrangement ("APA") program. This release provides critical guidance to taxpayers and brings in much needed rules to introduce the APA program in India. The introduction of the APA program is designed to give taxpayers greater certainty on international transactions between related parties operating in two or more tax jurisdictions. Much of the guidance discusses provisions that, in name, are similar to those implemented in countries where transfer pricing legislation is more developed, such as Canada. The release of this guidance is welcomed. The news signals that India is serious about providing taxpayers with a clear framework for gaining tax certainty.
The CBDT can expect to face a steep learning curve when developing the APA program, as it relates to how it will provide the benefits that multinationals need and expect. Given I was involved in the Canadian APA program from its early inception and witnessed how it evolved over the years, I will draw on my 17-years of APA experience from both the Government and private sector to illustrate how the APA program in India should evolve and the problems it may face.
Why an APA Program is Important
India has been an economic wonder over the last decade. The country has achieved astonishing economic expansion while simultaneously keeping inflation in check. As the world economy becomes increasingly globalized, countries need to ensure that their international tax laws and practices are seen as transparent. Failure to institute legislation that is deemed transparent by international investors serves to increase uncertainty and helps drive investors away. Generally speaking, tax systems that allow firms to understand what is expected of them, and the consequences associated with not complying with tax laws, serve to improve the economic climate for international investors.
Transfer pricing can serve as a tool used by companies to reasonably assign profits to lower tax jurisdictions by strategically locating functions, assets, and risks. India is viewed by many foreign nationals with suspicion. In relation to the current transfer pricing climate in India, many taxpayers view the Indian tax authorities and the transfer price adjustments they generate as inconsistent, viewing the tax authority with much precaution. Adjustments vary from state to state, and the size and scope of such adjustments do not seem to make economic sense. Consequently, firms should know what to expect and how to gain tax certainty as they relate to transfer pricing.
Given an APA is a formal arrangement between a particular taxing authority and a taxpayer involved in cross-border transactions with a foreign related entity to gain tax certainty on one or more international transactions, gaining some degree of tax certainty for firms operating within India becomes a welcomed feature of the Indian tax code. The recent guidance for the APA program demonstrates that the Indian Governments want to find a way for taxpayers to achieve this certainty, as they relate to international transactions. While this may be deemed as good news by the international community, and may increase foreign direct investment, much time will be needed to ensure that the skill required to generate tax certainty (through the determination of arm's length prices) and the culture required of the CBDT to apply the arm's length standard consistently is met. While the arm's length standard is enshrined in current Indian legislation, ensuring the arm's length result is applied is a different matter.
Indian APA Program
The guidance provided in Notification No. 35 contains many issues that taxpayers need to consider. Key provisions include:
1. Taxpayers are allowed to conduct pre-file meetings in person and on an anonymous basis.
2. A basis for completing a bilateral, multilateral and unilateral APA and allowing for the completion of a renewal.
3. APA may be applied to existing and future transactions.
4. Guidance on the application process and the manner in which applications can be modified or withdrawn.
5. A requirement that the APA team have employees experienced in a wide range of disciplines including economics and law.
6. No provision provides for the use of rollbacks.
Concerns with the Current APA Program
The above guidance overview, as it relates to the APA program in India, seems encompassing and the business community should be pleased with the efforts the CBDT has taken to make the APA program viable. However, some concerns remain:
Lack of timelines for completion: Guidance on APAs do not tell perspective firms entering the APA when their APA will be completed. This is problematic given the APA program is designed to gain tax certainty, and resolution is not assured. This does not create an environment that enhances the level of certainty firms are seeking when entering into the APA program.
Sharing of Information: India is a developing economy. Given the lack of experience in transfer pricing, many adjustments involving the same issues vary across Indian states. This has created a lot of precaution amongst taxpayers related to the Government's ability to apply transfer pricing rules fairly and consistently. The current guidance provided by the CBDT fails to adequately address the issues of safeguards with respect to sharing of information between the APA program and other areas of tax administration. While the provisions allow for taxpayers to come forth anonymously, they do not clearly articulate how such consultations will be carried out.
Lack of Rollback Provision: The guidance provided in Notification No. 35 does not mention anything about the rollback of results obtained in the APA to previously unaudited years. The failure to include such a provision will diminish the level of tax certainty the APA program provides to taxpayers. Many companies apply for an APA in order to resolve contentious issues they have with the field auditor. Not allowing the taxpayer to apply the results gained by an APA to unaudited years, where the facts are comparable to those in the APA, allows uncertainty to remain for the taxpayer (as will be discussed in more detail below).
Comparing and Contrasting The Canadian and Indian APA Programs
An APA is an arrangement between a taxpayer and a tax administration to confirm the appropriate transfer pricing methodology for a non-arm's length transaction. The Canadian APA program began in December 1994, with the release of IC94-4.1 Much like the directives released by the CBDT that the APA be multifaceted in India, the Canadian competent authority and those that make up the APA team include a wide range of people with varying backgrounds.
The Canada Revenue Agency ("CRA") has recognized that transfer pricing is clearly not an exact science. As such, it relies on auditors with many years of experience and economists who have been trained to treat economic aspects of transfer pricing in a robust manner. The typical APA team is composed of a lead analyst, an economist from the Competent Authority Services Division and an auditor from the taxation services office. The CRA has learned that a team that is multifaceted will likely result in the deployment of expertise needed to achieve the arm's length standard in a reasonable amount of time. In addition to the technical skill required to determine an arm's length price, the APA program is also designed to ensure and foster consistency with the field. At the pre-filing stage, the Chief Economist (who is responsible for providing advice to the field officers) attends meetings to ensure consistency is being met between transfer pricing methodologies used in the field and those that apply within the APA program. This mechanism ensures that transfer price determination is consistent at various levels of the CRA.
The need for skillful APA officers to routinely participate in site visits is another area the CBDT should incorporate into their APA program. It has been my experience that when both APA teams participate in site visits, when completing a bilateral APA for instance, less contention exists over the functions, assets, and risks assumed by related parties. When only one APA team attends a site visit, however, their development and interpretation of facts may differ substantially from those of the other APA team. Ensuring that site visits occur as a normal part of an APA program should therefore be fostered. This should result in less contention existing between APA teams, which should decrease the time required to complete an APA.
An important aspect that arises when considering whether to perform site tours surrounds the issue of costs. Fees charged by Governments offering an APA program can include "APA filing fees" or fees that cover all or part of the cost of site tours. It has been my experience that countries that do not require fees dedicated to travel costs (and thus only charge filing fees for instance) resulted in their APA teams performing little, if any site tours. Countries that did charge fees specifically associated to cover costs of travel (such as Canada) did result in those APA teams engaging in more site tours.
Within the Indian context, those applying for an APA need to pay a filing fee based on the size of the international transaction entered into or proposed. The fee can range from 10 lakhs to 20 lakhs. It is not entirely clear if any part of this will be devoted to incurring travelling costs related to site tours. In order to improve the fact gathering capability of the Indian APA team, some part of this fee should be devoted to travel, or a separate additional fee should be considered to pay for travel, in order to enhance the team's ability to gather facts and settle files. Lastly, a system that allows senior auditors and accountants to train new professionals coming into the program is key to ensuring that enough knowledgeable staff exists to complete APAs. The inability of the CRA to complete files in the past were largely the result of not having enough qualified staff.
The Indian tax authority can gain from implementing similar procedures as those discussed above that would ensure both consistency and the completion of APAs in a timely fashion.
Mechanisms for Achieving Double Tax Avoidance
The APA program is designed to avoid the incidence of double taxation by agreeing on an intercompany price that is acceptable to one or more tax authorities. The benefits that an APA brings include prospective avoidance of double taxation, penalty protection, and efficient resolution of recurring complex transfer pricing issues (less taxpayer time and audit resources). APAs provide long term savings as well. APA renewals are usually less time consuming. However, one area where the two APA programs differ materially involves the potential application of APA findings to past unaudited years. CRA will usually agree to accept a request to "rollback" the terms and conditions of an APA to open tax years if facts and circumstances are substantially similar.
As transfer pricing audits increase and the issues identified by auditors become more complex, the APA program may be appropriate. However, all potential issues must be considered before applying for an APA. As part of a strategy in applying for an APA in Canada, many firms consider the application of a rollback. Rollbacks are relevant where adjustments in previous (and often contentious) years are significant.
In Canada, a rollback, requested as part of a bilateral APA, will no longer be considered for a taxation year where the CRA has issued a letter to the taxpayer requesting documents from the taxpayer regarding the taxation year in question for the purpose of an audit. However, if a taxpayer requests a rollback before the audit letter has been issued, it is equivalent to a voluntary disclosure. The rationale for this resides in the fact that a rollback is not intended to replace an audit or as a mechanism for avoiding an audit. If audit letter has not been issued, an auditor will not make a referral to the Transfer Pricing Review Committee if an upward adjustment in a rollback year exceeds the penalty threshold. This may create an incentive to apply for an APA in situations where contemporaneous documentation was not prepared for prior years, as it reduces exposure to transfer pricing penalties that could come about in a random audit.
Applying rollbacks allow the taxpayer to receive more tax certainty at no additional cost to those involved. Given the use of a rollback is only applied in situations where the facts found within an APA period are similar to those in the unaudited years, an APA rollback is a win for the taxpayer at no cost to the APA team. The application of rollbacks are important and the CBDT should consider instituting such rollbacks to its current rules with accompanying guidance.
Realities of an APA
The success of the Canadian APA program resides partially in the fact that when all parties understand how files are resolved, all parties can do their part in securing an APA. It has been my experience that the presentation of facts is critical. As a result, all important information must be provided at the time of filing a submission. Information provided later carries less weight and is often met with some skepticism from the tax authorities. Indian tax authorities must ensure that submissions accepted meet a high standard. Although APA negotiations are generally principled, results are important. Therefore, information that justifies a particular result becomes fundamental.
The procedures outlined in completing an APA in India are similar to those found in Canada. Within the Canadian APA program, the following steps are taken to complete and renew an APA:
- Prefiling meetings
- Formal acceptance letter and user charges
- APA submission
- Review and evaluation phase
- Finalization phase including negotiations
- Compliance phase
- APA renewal
There are some concerns with certain administrative aspects related to securing an APA in India. For example, the CBDT does not provide any guidance on the length of time it will take to complete an APA. In the Canadian APA program, the policy is to complete a bilateral APA in two years. Another issue deals with privacy and how taxpayer information is dealt with. While the APA process in India provides for anonymous prefiling meetings, the guidance does not provide information on how this would occur. Also, no guidance is given that assures taxpayers their information will not be shared with other members of the tax agency. While no guarantees exist in the Canadian APA program, Canadian taxpayers are assured that this information is not abused (given that many safeguards exist within the Agency that prevents abuse). The CBDT must ensure that safeguards and firewalls are clearly in place to ensure that no abuse related to APA information takes place.
The tax efficiencies the Indian APA program will create, and the impact that the newly-issued guidance will have on taxpayers, will depend on a number of factors, including the level of experience developed by the CBDT and whether the existing rules found in Notification No. 35 are applied consistently across all taxpayers who seek tax certainty within the APA program. Time will be required to get the CBDT "up to speed" on how to implement the rules fairly and consistently across various regions and sectors, in a way that meets the arm's length standard. At the same time, the CBDT must gain the trust of taxpayers to make them feel comfortable that they can achieve real tax certainty when going through the APA process and trust their dealing will be professional. Despite the potential hurdles that await the CBDT, this new guidance is certainly a welcome first step to providing taxpayers a practical avenue to gaining tax certainty.
1. APAs are completed within the Canadian Competent Authority Services Division and is found with the International and Large Business Directorate of the CRA.
Originally published in International Taxation -Vol. 7 -October 2012 77
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