The Indian tax administration has been proactive in the past few years in its attempts at reducing tax litigation. Monetary thresholds for filing of appeals by tax authorities have been enhanced and a number of circulars have been issued to clarify disputed tax issues.
However, the major source of disputes in direct taxes is transfer-pricing (TP). India first introduced TP provisions in FY01 and tax authorities (such as transfer-pricing officers) slowly began experimenting with TP provisions, the procedure and the interpretation of the legislation. TP adjustments increased progressively year-on-year in numbers and in quantum. They reached a peak of R70,000 crore in FY14. Though the total quantum of such adjustments have witnessed a reduction since FY14, the number of cases in which adjustments are made have gone up year-on-year and transfer-pricing litigation still outstrips other litigation in direct taxes.
Transfer-pricing litigation clogs up appellate channels and takes much more time to resolve since, in many cases, the appellate tax tribunals restore the disputed issue back to the transfer-pricing officer as a number of facts and nitty-gritty need further re-examination. This starts another chain of appeals, further delaying an already fraught process. Transfer-pricing disputes need a targeted approach in order to reduce the onerous litigations which impact the ease of doing business in India.
The introduction and efficient implementation of an advance pricing agreement (APA) scheme, in which the taxpayer enters into an upfront agreement with the tax administration regarding the arm’s length price of its international transactions with related parties, has been a successful initiative in preempting transfer-pricing litigation. The tax administration has entered into 77 bilateral APAs since the scheme was introduced in 2012, of which the bulk (70) have been signed last year and in the current year. The efficient implementation of the APA programme in recent years has helped corporates attain certainty regarding their related-party transactions for up to five years in the future with an option to roll it back to cover four earlier years. Tax tribunals have also started adjudicating taxpayers’ pending transfer-pricing litigation based on the agreed principles embodied in the APA even though the APA may not cover the period in question. Every APA agreement represents tax certainty for a taxpayer and avoidance of resources spent on litigation by both the taxpayer and the tax administration. There are, however, more than 600 APA applications pending and it will be a challenge for the tax administration to arrive at agreements on these in a reasonable time-frame. Also, the bulk of transfer-pricing cases will still go through the normal cycle of audits and assessments by field authorities.
Transfer-pricing is a fact-intensive exercise and guidance issued by the tax administration can help nip many potential disputes in the bud. The introduction, by the tax administration, of the range concept instead of the mean and the use of multiple year data for selecting comparables has the potential to reduce recurrent TP litigation. However, currently, there is very little guidance in the form of circulars or guidelines issued by the tax administration on commonly litigated transfer-pricing issues. This passive outlook is a breeding ground for disputes and litigation.
Using the APA regime, the tax administration has been able to arrive at mutually acceptable resolutions with taxpayers on a number of issues. The APAs cover industry segments such as software development services, IT-enabled services, investment advisory services, telecommunication, oil exploration, pharmaceuticals, finance and banking, media, engineering design services and administrative and business support services. The international transactions covered in the APAs include pricing of corporate guarantees, royalty, and software development services, IT-enabled services and inter-group expenses.
The learnings from the APA negotiation exercises can be used to preempt disputes in other cases also. While the individual details of an APA remain confidential, guidance from the tax administration by using the principles and methodology from APAs signed with taxpayers can be a quick and efficient way to preempt litigation on major transfer-pricing issues. These should be used to bring out comprehensive guidance on issues such as the most appropriate method to be followed, the selection of comparables, the selection of the foreign associated entity as a tested party if it has the less complex functions, and the margins charged on routine inter-group functions. A number of such potential disputes would be avoided at the level of transfer-pricing officers if they have uniform guidance on the approach to be taken for the TP exercise on issues such as these.
The author is Of-counsel, BMR & Associates LLP and, formerly, joint secretary, ministry of finance, Government of India