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Indian TP regulations - Aligning with global practices?
APA rollback provisions
In the backdrop of a huge volume of TP adjustments made by the Revenue authorities, the APA programme was introduced in the year 2012 to reduce litigation and provide certainty to taxpayers. To make APAs more effective, the rollback provisions were introduced in July 2014 by the Finance Minister’s maiden budget and were finally notified in March 2015, wherein it was provided that the applicant could rollback the APA agreement entered into for 4 preceding years.
In another welcome move, in May 2015 the Finance Ministry issued a draft scheme for public comments with regard to the use of ‘range concept’ and ‘multiple year data’ for the computation of arm’s length price (ALP) which is intended to add flexibility to the application of the Indian TPR which currently prescribes the use of arithmetic mean and mandates use of current year data for determining the ALP.
The rules for rollback notified in March 2015 provide for key rollback provisions, the procedure for filing a rollback application, eligibility criteria/ conditions under which rollback would be allowed or would lead to cancellation of the agreement and procedure for giving effect to rollback.
The rollback provisions are applicable for 4 years prior in respect of the same international transactions for which taxpayers file forward looking APA i.e. in case an APA is being applied for the period starting 1 April 2015, rollback years would cover the period of 4 preceding years starting from 1 April 2011 to 31 March 2015. This would give taxpayers a total of 9 years certainty i.e. 5 prospective and 4 prior years.
One of the key conditions for application of the rollback provisions include that the rollback provisions shall be applied for all the rollback years in which the international transaction has been undertaken.
Interestingly, the rollback provisions would not be applicable to a particular year where the Appellate Tribunal (second appellate authority) has passed an order disposing of the appeal prior to the date of signing of the APA or if they result in a reduction of the total income or an increase in the loss of the applicant as declared in the return of income.
Additionally, the mandatory provision of pre-filing consultation with the APA authorities is done away with and, it has been made optional for the taxpayer.
Range concept and use of multiple year data
The draft scheme containing provisions on application of ‘range concept’ and ‘use of multiple year data’ are applicable only for transactions undertaken on or after 1 April 2014 i.e. applicable for financial years 2014-15 and onwards subject to finalisation of the scheme.
Introduction of Range Concept
The Indian TPR, until now, mandated the use of arithmetic mean for determination of ALP with a tolerance band of 3 percent (1 percent for wholesale distributors) to justify the transfer price. However, this concept of arithmetic mean is different from the global practice of using the ‘inter-quartile range’.
Arithmetic mean has an inherent shortcoming and distorts the results as it does not exclude the effect of outliers. This leads to pushing up the ALP and thus invites an unwarranted TP adjustment in the hands of taxpayers.
The government has recently issued a draft scheme for the introduction of the ‘range concept’. It has been proposed that the range concept can be used for determining ALP only in cases where Transactional Net Margin Method (TNMM), Resale Price Method (RPM) or Cost Plus Method (CPM) has been selected as the most appropriate method to benchmark the international transaction.
The draft scheme prescribes a minimum of 9 comparables to be selected for application of range. Further, it states that the data points lying within the 40th to 60th percentile of the data set or series would constitute the range (unlike the international practice of inter-quartile range). If the transfer price of the tested party falls outside the range, it shall be adjusted to the median of the range and if it is within the range, no adjustment shall be made. As mentioned earlier, public comments have been provided on this draft scheme and the final rules are awaited.
Use of multiple year data
The Indian TPR recommend use of current year’s data for comparability analysis, unless a taxpayer demonstrates that prior years’ data (last two years) had an influence in setting up of transfer prices. The majority of companies do not have current year data available in public databases. Thus, while preparing the TP documentation, the taxpayers had no choice but to use data for multiple years. However, the Revenue authorities at the time of tax audits invariably consider current year data (i.e. data for the year in which the intercompany transaction has been undertaken) which at that point of time is available and accordingly make adjustments to the income of taxpayer.
To curb litigation, it has been proposed to allow multiple year data for determination of ALP. The draft scheme proposes the use of 3 years data including the current year (i.e. year in which the transaction has been undertaken). The use of prior 2 years data is permitted in certain circumstances which include non-availability of current year data or if it fails a quantitative filter in one of the years. However, it has been proposed that the data for the current year can be used during a TP audit both, by the taxpayer and the Revenue authorities, if it becomes available at the time of audit.
India’s APA programme has received an overwhelming response from our taxpayers’ fraternity which is evidenced by nearly 600 unilateral and bilateral applications filed in the first three years. The rollback provisions are likely to be an effective way to reduce pending litigation and make the APA programme even more effective. Rollback provisions have been welcomed with open arms by taxpayers with a sizeable number of rollback applications being filed from March to May 2015. The key would be how the APA authorities prepare themselves to manage the large number of cases which are pending. The amount of work will have increased substantially, given that taxpayers have applied for rollback in many cases of pending applications.
Further, the draft scheme on the application of range concept and use of multiple year data introduced by the government is certainly a step in a positive direction.
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Before finalising the draft scheme, emphasis must be placed on the practices followed internationally to ensure that the Indian TPR are consistent with global TP practices.) Broadening the range, not prescribing a minimum number of comparables, and allowing application of the rules for any method used by the taxpayer to determine ALP, would pave the way in meeting the objective of the Government to reduce unwarranted litigation.