By Sudhir Kapadia
India has the potential to be the third-largest economy by 2030. It is well poised to becoming a $5-trillion economy by 2024, powered by several drivers. With India’s demographic dividend set to pay off in this decade, its young working population and a burgeoning middle class will fuel demand, income and savings. The country’s world-class service sector will continue to power growth. Measures like Production Linked Incentives will spur manufacturing and offer an alternative to global companies looking to de-risk their supply chains.FDI is an important catalyst for India’s growth journey. Continued focus on FDI is, therefore, essential.
For multi-national enterprises (MNEs) looking to invest or expand operations in India, tax risk is a key decision variable. EY’s Global Tax Policy and Controversy Outlook, 2022 notes that transfer pricing (TP) related issues are at the heart of many tax disputes. More than half of the Outlook contributors ranked TP as the leading tax audit concern in their jurisdictions for 2022. Providing tax-certainty is central to reinforcing India’s credentials as a preferred FDI destination.
Transfer pricing laws ensure that cross-border transactions between related parties mirror third-party prices (arm’s length principle) and tax rate differences between countries are not misused. By design, these provisions apply to MNEs and have a direct impact on FDI in terms of implementation, resulting controversies and litigation. India has had a fair share of TP controversy. In 2012, following global practices, the Advance Pricing Agreements (APAs) mechanism was introduced to provide tax certainty to MNEs as the transfer prices (and resultant tax outcomes) are determined upfront and cannot be altered in subsequent audits of tax returns for the period of validity of the APAs (typically five years).
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The introduction of APAs was a game-changer. The early years saw as many as 120 APAs signed in a year. However, in the recent years, the APAs have slowed down, resulting in a huge pendency. Government has taken many measures towards bringing tax certainty and ease of paying taxes. However, among the many welcome transformational initiatives, a legacy reform like APA seems to have been somewhat ignored. Since 2016, the number of APA conclusions dwindled to merely two in 2018-19. During 2020-21, only 31 APAs were signed.
At the same time, pendency of APAs is perhaps at its highest ever (estimated to be nearly 1,000 cases. This includes bilateral APAs, many of them with the US. With the pandemic behind us, hopefully, the authorities of the two countries will expedite their meetings and conclude a majority of these pending APAs.
Given the continuing importance of FDI, especially in the current geo-political environment, it is imperative to turbo charge this laudable programme.
Any programme’s success is driven by the people involved. The operational and administrative APA teams have contributed immensely. Their experience and knowledge have been the key to concluding cases. However, the people resources allocated to the APA programme are not commensurate with the caseload. Frequent transfers and change in personnel disrupt the process. Policy-makers should consider creating additional capacity for this programme. Experienced officers can be retained for fixed periods of time to ensure continuity. Cases can be expedited by reducing multiple layers of approval within the chain or embedding time-bound windows at each level for approval of cases.
A large portion of the long pending applications pertain to IT/ ITeS followed by other sectors. Given the extensive experience of the Indian APA teams in dealing with such IT/ITeS cases, efforts could be forged to conclude such low complexity cases through a “framework” (agreeing on a specific rate/margin) approach. This could help tackle a significant part of the inventory. APA renewals could be expedited in cases where facts have remained unchanged from the original APAs. In such cases, site visits could be exempted to achieve faster closure.
The safe harbour rules may be rationalised (based on trends in concluded APAs) to make them more attractive for taxpayers, so that the burden on APAs can be reduced. The current high safe harbour margins should be made more reasonable. Further, safe harbours could be expanded to international transactions involving contract manufacturing and export of pharmaceutical products, investment advisory services, marketing support services, captive R&D services other than those in information technology, and even banks. The definition of ‘low value-added services’ should align with that provided by BEPS Action 10 and the prescribed rate should apply irrespective whether Indian party is receiving or rendering the services.
A taxpayer in APA must potentially contend with TP assessment by the field office simultaneously. This entails expending additional administrative time, resources and money for companies. Assessments should be put on hold for the period when the APA is pending. Such interim period could be excluded for purposes of the statutory assessment timelines if the APA doesn’t fructify. This could further aid ease of doing business in India.
APAs have contributed to the Government’s commitment to a non-adversarial tax regime. Appropriate steps to ensure timely conclusion of cases will be a win-win for all stakeholders.
The author is Partner, Tax & Regulatory Services, EY India