Recent initiatives to contain tax disputes Indo American Chamber of Commerce

 Transfer Pricing (TP) adjustments have become highly contentious in recent times  Over 51% cases taken for TP audit result in adjustments to declared incomes (Annual report of Ministry of Finance,2013) For the figure is reported to be of the order of INR 671 billion  Variety of reasons for this situation YearNumber of cases taken for TP audit Adjustments made ( billion INR)

 Two major initiatives by Government to address the situation 1. Advance Pricing Agreements (APA) Scheme 2. Safe Harbour Rules 3

 APAs are agreements between Tax department and the taxpayer determining agreed price for ‘related party’ transaction(s)  These inter-alia -  Lay down the manner of its determination Arm Length Price (ALP) of an “international transaction” OR Determine the ALP  Bind the taxpayer and the ITD to adopt the agreed price  For a defined period not exceeding 5 consecutive years  Under certain clearly stated critical assumptions  Scheme applies to all sectors and there is no minimum threshold  APAs can be Unilateral, Bilateral or Multi lateral 5

 Bilateral APAs  Entered into between Board & the taxpayer based on agreement between Competent Authorities (CA) of two countries  Multilateral APA  Entered into between Board and taxpayer based on agreement between CAs of more than two countries  These ensure certainty at both ends of the transaction  However, bilateral/multilateral APA can be entered only if -  There are provisions in domestic law of the other country to enter into APAs  The concerned countries have DTAA with each other  The AE(s) situated outside India initiates the process in the other country 6

1. Pre-filing application and consultations with a special Team of Board to -  Determine scope of proposed APA  Identify transfer pricing issues and past history  Determine suitability of the ‘international transaction’ for APA, and the critical assumptions behind the proposal Transactions can be relating to transfer of tangible / intangible properties, cost sharing, provision / receipt of services, etc.  Discuss broad terms of understanding including time lines The terms are recorded but are not binding  Anonymous pre-filing consultation permissible 7

2. Filing of APA Application  Prescribed proforma, Application fees  For ongoing transactions - before 1 st day of the year  For new transactions - before undertaking the transaction  Business structure, financial analysis, comparables etc  Functional analysis Functions performed by the taxpayer in relation to the controlled transactions, assets used to perform these and related business/ commercial risks  Critical assumptions – Facts the continued existence of which is critical to support the agreed ALP - such as industry, business, economic conditions, etc 8

3. Evaluation and Negotiation stage  Examination of documents by the Team,  Removal of defects,  Calling of additional information  Site inspection, if necessary  Negotiations with taxpayer  Negotiations with other jurisdictions where necessary  Preparation of draft report  Drafting of proposed agreement in case consensus is reached  Possible to withdraw from the process at any stage 9

4. Finalisation of APA with approval of GoI, laying down -  Particulars of the ‘international transaction’ covered  Definition of relevant terms, the business model, functional and risk profile etc  Critical assumptions – Factors and assumptions that are so critical and significant that neither party entering into an agreement will continue to be bound by the agreement if any of those is changed May be Operational or Legal or Financial or Accounting May be about the taxpayer or an affiliate or a third party or industry or general economic conditions. Agreement not to be binding in case of change in any critical assumptions or failure to meet conditions subject to which the APA has been entered into  Agreed transfer pricing methodology or the ALP 10

5. Post APA compliance  For years covered under APA all completed or pending, assessments have to be completed in accordance with the APA  Regular TP audit will not be carried out for transaction(s) covered under APA  Annual compliance report to be filed for the covered transaction(s) to certify - Compliance with the terms of the agreement Satisfaction of critical assumptions Correctness of supporting data/ Information 11

 Process is non adversarial  Mandatory pre-filing allows taxpayer to assess department’s view beforehand  Flexibility in determining ALP  Provides legal certainty regarding covered transaction(s), reducing cost of compliance  Elimination of potential double taxation in cases of bilateral or multilateral APA  APA can also provide guidance to the past litigation 12

 High upfront cost – may not be suitable for mid size companies  Lengthy and elaborate process  Extensive information required to be shared Issues of confidentiality in case of withdrawal from APA process  Time limit for completing the process not prescribed  No provision of roll back of APA terms to past disputes  Processes are still in nascent stage 13

 Best suited in cases of c omplex controlled transactions with high TP risk  Revenue impact of possible TP adjustments is large  The Associated Enterprises are so deeply integrated in the business that a prudent businessman cannot assign functions and risks unambiguously to either entity  The value of intangibles contributes significantly to the business value of the transaction  Comparables do not exist for the type of transaction  Taxpayer needs legal certainty for strategic business decisions 14

 “ Safe Harbour” in relation to computation of ALP means the circumstances in which tax authorities shall accept the transfer price declared by the taxpayer  Safe Harbour Rules (SHR) notified on  These are applicable only to ‘eligible taxpayers’, and for ‘eligible international transactions’  If an eligible assessee opts for SHR then the transfer price declared by him in respect of eligible international transactions will be accepted, provided the safe harbour conditions are fulfilled 16

 Persons engaged in international transactions relating to -  Software development services,  IT-enabled services,  KPO services,  Contract R&D services relating to - Software development Generic pharmaceutical drugs  Manufacture & export of auto components,  Intra-group loan to a non-resident wholly owned subsidiary (WOS),  Corporate guarantee provided to a non-resident WOS. 17

Eligible International TransactionSafe Harbour Software development and IT enabled services (i)transactions < INR 5 billion (ii)transactions > INR 5 billion (i)Operating profit Margin (OPM) 20% or more (ii)OPM 22% or more KPO servicesOPM is 25% or more Contract research and development services (i)relating to software development (ii)relating to generic drugs (i)OPM is 30% or more (ii)OPM is 29% or more Manufacture and export of core auto componentsOPM is 12% or more Manufacture and export of non-core auto componentsOPM is 8.5% or more Advancing intra-group loans (i)Aggregate value of transactions < INR 500 million (ii)Aggregate value of transactions > INR 500 million Interest rate is not less than Base SBI rate+150 basis points Base SBI rate+300 basis points Providing corporate guarantees (i)does not exceed INR 1 billion (ii)exceeds INR 1 billion Commission or fee is (i)not less than 2% (ii)not less than 1.75% 18

Thanks 19 S.S Khan Senior Partner Kochhar & Co kochhar.com

 Particulars of applicant including  Global structure,  Particulars of AE,  Prior 3 years’ overview of an operation,  Functional and Risk Profile,  Covered International transactions,  Value of covered under TP audits for prior 3 years,  type and duration of proposed APA,  Proposed TP methodology, Identification of third party comparable,  Details of ALP, PLI,  Critical Assumptions,  Agreement with AE, Reasons for covering international transactions in APA 20

 Details of proposed covered transactions  Disclosure of other controlled transactions  Transfer pricing background  Financial statements, for past years and forecasts  Industry analysis  Business structure  Functional analysis (functions performed by the taxpayer in relation to the controlled transactions, assets used to perform these and related business/commercial risks)  Relevant economic analysis including impact of the proposed TPM 21