1. Advance Pricing Agreement / Safe Harbour / Thin Capitalisation
27 October 2012
Date
Presentation by:
CA Yashodhan D. Pradhan

2. Presentation Overview
Advance Pricing Agreement (APA) – Introduction
APA: International Scenario
APA Scheme in India
Safe Harbour Provisions
Thin Capitalisation

3. Advance Pricing Agreement (APA)
Date
Advance Pricing Agreement (APA)

4. Introduction to APA... An APA is a contract Usually for multiple years
Date
Introduction to APA...
An APA is a contract
Usually for multiple years
Between a taxpayer and at least one tax authority
Mainly to prospectively resolve real or potential transfer pricing issues
Involving transactions between related parties
Cross-Border Trade By/Between Multinationals is Arguably Single Most Important Catalyst of global economic development.
Evidenced by fact that cross-border trade by multinationals currently account for 60% of global trade;
With the estimates for those figures to increase to as high as 80% in the next years.
Yet, Cross border trade among multi-nationals often carries uncertainly in the areas of Customs and TP because of administrative inconsistencies

5. Date
...Introduction to APA
Agreement
Once APA has been entered into, the ALP will be determined only in accordance with the APA
The APA process is voluntary
Supplements appeal and other DTAA mechanism for resolving transfer pricing disputes
Provides greater certainty on the transfer pricing method adopted
Mitigates the possibility of disputes
Facilitates the financial reporting of potential tax liabilities
Reduces the incidence of double taxation, and the costs associated with both audit defense and documentation preparation
Cross-Border Trade By/Between Multinationals is Arguably Single Most Important Catalyst of global economic development.
Evidenced by fact that cross-border trade by multinationals currently account for 60% of global trade;
With the estimates for those figures to increase to as high as 80% in the next years.
Yet, Cross border trade among multi-nationals often carries uncertainly in the areas of Customs and TP because of administrative inconsistencies

6. Types of APA Type Nature Unilateral APA
Date
Types of APA
Type
Nature
Unilateral APA
APA entered into between a taxpayer and the tax administration of the country where it is subject to taxation
Bilateral APA
APA entered into between the taxpayers, the tax administration of the host country and the foreign tax administration
Multilateral APA
APA entered between the taxpayers, the tax administration of the host country and more than one foreign tax administrations

7. Date
Advantages of APA
Provides certainty of tax treatment by relevant tax authority
Investment decisions regarding overseas operations clarified: Projection of future tax liabilities possible
Mitigates risk of a difficult potential TP audit/ future litigation
Substantially reduces possibility of future double taxation (bilateral or multilateral APA)
APAs have the potential to cover most TP issues including:
Tangible goods pricing.
Services
Intangibles issues involving royalties
Cost-sharing issues
Taxpayer has participation in the process (unlike MAP)
Cross-Border Trade By/Between Multinationals is Arguably Single Most Important Catalyst of global economic development.
Evidenced by fact that cross-border trade by multinationals currently account for 60% of global trade;
With the estimates for those figures to increase to as high as 80% in the next years.
Yet, Cross border trade among multi-nationals often carries uncertainly in the areas of Customs and TP because of administrative inconsistencies

8. Date
Disadvantages of APA
Increases the risk of audits and adjustments in the related party country (in case of unilateral APA)
Cost of implementation is high
However, it’s likely that APA costs ≦ audit defense fees
However, high cost involved in preparing APA application makes it economically justifiable only when there is large volume of transactions
May reduce tax planning opportunities
Immediately draws attention to an entity’s tax planning in different nations
Usefulness of APA diminished if no agreement reached until period proposed to be covered almost expires
Potential reluctance of taxpayers to disclose information unless confidentiality is assured
Cross-Border Trade By/Between Multinationals is Arguably Single Most Important Catalyst of global economic development.
Evidenced by fact that cross-border trade by multinationals currently account for 60% of global trade;
With the estimates for those figures to increase to as high as 80% in the next years.
Yet, Cross border trade among multi-nationals often carries uncertainly in the areas of Customs and TP because of administrative inconsistencies

9. Date
Example
Indian subsidiary engaged in machinery distribution, had very high profits over a number of years
Concern about exposure of foreign parent to adjustment by its tax authority
Earlier assessment: both foreign parent tax authority and Indian TP authorities adjusted income, resulting in double taxation
Goal: Obtain tax authority approval for resetting transfer prices
Strategy: Obtain bilateral APA, adjust to closest point in the range (high end)

10. APA: International Scenario
Date
APA: International Scenario
More than 30 Countries allow APA
Almost 20 years ago, only a few countries (e.g. the United States, Canada and Australia) were front-runners in the implementation of formal APA schemes
Up to 2010, the United States had signed the highest number of APAs (over 950) in the world
Following the introduction of the OECD guidelines on APAs in 1995, a number of countries began to enter into APA schemes
The experiences of these countries (especially the Asian countries due to economic similarities) in the implementation of APA schemes, can be used by India to implement a robust APA regime

11. APA: International Scenario
Date
APA: International Scenario
Country
Year of introduction
Type of APA
Term of agreement
Pre-filing
Japan
1987
Unilateral & Bilateral
3-5 years
Optional
USA
1991
Unilateral, Bilateral & Multilateral
Mandatory UK
1999
Unilateral, Bilateral (No distinction in bi and multilateral
18 to 21 months
China
2004
India
2012
Upto 5 years

12. Date
APA Scheme in India…
The APA regime was initially slated to be a part of the Direct Taxes Code
However, the scheme has been released in advance with its introduction through the Union Budget , and has been woven into the existing set of Regulations
Although the operating guidelines were spelled out very recently i.e. on 30 August 2012, the Finance Ministry had already taken some administrative steps, including the appointment of an APA team, for the implementation of the scheme
Introduced through sections 92CC and 92CD and Rules 10F to 10T

13. Date
…APA Scheme in India
At present, a parallel mechanism exists i.e. advance rulings from the Authority for Advance Rulings (AAR)
AAR is empowered to examine a prospective contract of a resident taxpayer with a non-resident in order to determine the taxability thereof
The main difference: under the APA scheme, the tax authorities may determine/quantify the value of the international transaction or profits, whereas the Authority for Advance Rulings does not have a power to do so

14. Significant Features of the APA Framework in India…
Date
Significant Features of the APA Framework in India…
The use of existing prescribed methodologies with necessary adjustments/variations or any other method to determine the arm's length price
One may choose any method in addition to the methods prescribed in the Regulations
This gives flexibility to agree upon a method that may be more suitable
This also makes the APA regime more attractive to those MNEs that are dealing with difficult scenarios where the prescribed methods may not best reflect an arm’s length outcome

15. …Significant Features of the APA Framework in India…
Date
…Significant Features of the APA Framework in India…
The duration (i.e. term) of an APA would be limited to a maximum of five consecutive fiscal years
Coverage of five years is consistent with the coverage of APAs in other countries
A period of three to five years is considered adequate as regards the cost of the APA process, expected changes to the business and various conditions affecting the transactions covered

16. …Significant Features of the APA Framework in India…
Date
…Significant Features of the APA Framework in India…
APAs are binding on the taxpayer and the tax authorities unless there is a change in the law or facts of the case
This will give certainty to both taxpayers and the tax authorities.
However, care should be taken to ensure that minor changes in the course of business due to market dynamics do not render the APA void.

17. …Significant Features of the APA Framework in India…
Date
…Significant Features of the APA Framework in India…
Approval of the Central Government will be necessary
This suggests that the government intends to monitor and possibly even control the APA process
Other than its obvious effects, this will ensure that the APA process is completed within a reasonable time frame

18. …Significant Features of the APA Framework in India…
Date
…Significant Features of the APA Framework in India…
An APA applies to the determination of the arm's length price in respect of prospective transactions only even if the transaction is a continuing one
The APA process is a forward-looking exercise and is applicable only with regard to prospective transactions that are either being contemplated to be undertaken or those which are continuing transactions that will be carried out in the following year by the taxpayer
Further, as APA will involve the determination of the arm’s length price, a detailed transfer pricing audit by a transfer pricing officer will not be undertaken for the term of the agreement, however, the taxpayer will need to satisfy the transfer pricing officer as regards the compliance with the terms of the agreement, critical assumptions, correctness of the supporting data and consistency of the applications of the transfer pricing method

19. …Significant Features of the APA Framework in India…
Date
…Significant Features of the APA Framework in India…
The fees prescribed for the APA ranges from INR 1 million to INR 2 million depending upon the amount of international transactions under consideration
Amount of International Transaction entered into or proposed to be undertaken in respect of which agreement is proposed during the proposed period of agreement
Fee (INR)
Amount not exceeding Rs. 100 Crores
10 lacs
Amount not exceeding Rs. 200 Crores
15 lacs
Amount exceeding Rs. 200 Crores
20 lacs

20. …Significant Features of the APA Framework in India
Date
…Significant Features of the APA Framework in India
APA shall not be binding if there is a change in law or facts relating to the agreement
Void-ab-initio if agreement is obtained by fraud or misrepresentation of facts
If ROI already filed, the same can be modified after APA is entered into
Assessment if already completed , the officer should assess or reassess as per the APA

21. APA Rules… Rule Description 10F Meaning of expressions 10G
Date
APA Rules…
Rule
Description
10F
Meaning of expressions
10G
Person Eligible to apply
10H
Pre-filing Consultation
10I
Application for advance pricing agreement
10J
Withdrawal of application for agreement
10K
Preliminary processing of application
10L
Procedure
10M
Terms of the agreement
10N
Amendments to Application
10O
Furnishing of Annual Compliance Report
10P
Compliance Audit of the agreement
10Q
Revision of an agreement
10R
Cancellation of an agreement
10S
Renewing an agreement
10T
Miscellaneous

22. …APA Rules… Rule / Form Description 44GA
Date
…APA Rules…
Rule / Form
Description
44GA
Procedure to deal with requests for bilateral or multilateral advance pricing agreements
Forms
3CEC
Application for a pre-filing meeting
3CED
Application for an Advance Pricing Agreement
3CEE
Application for withdrawal of APA request
3CEF
Annual Compliance Report on Advance Pricing Agreement

23. …APA Rules… Eligibility: Pre Filing Consultation: Application for APA:
Date
…APA Rules…
Eligibility:
applicable to all “persons” undertaking international transactions or
contemplating to undertake international transactions
Pre Filing Consultation:
Mandatory
Detailed information required
Option to keep the names ‘anonymous’
Request to DGIT in form no. 3CEC
Neither binding on the Board nor the taxpayer to enter into an APA
Objective is to enable both parties to:
determine the scope of the agreement
identify transfer pricing issues
determine the suitability of international transaction for the agreement
discuss broad terms of the agreement
Application for APA:
To be filed in Form no. 3CED

24. …APA Rules… Withdrawal: Preliminary processing and procedure:
Date
…APA Rules…
Withdrawal:
Applicants can withdraw any time before the finalisation of the terms
However, the fee which has been paid would not be refunded
Form 3CEE prescribed
Preliminary processing and procedure:
includes vetting the application for any deficiencies
If the application is allowed in the preliminary processing phase, the main processing of applications would be conducted by the APA team in the following manner:
holding meetings with applicant
calling for additional documents/ information/material from the applicant
visiting applicant’s business premises
making inquiries as may deems fit in the circumstances of the case
Agreement and terms:
Approval of the Central Government required
Should include – International transactions covered, agreed methodology, ALP if any, critical assumptions, time period, definition of terms and other conditions if not covered in the prescribed APA scheme

25. …APA Rules… Annual Compliance Report: Compliance audit:
Date
…APA Rules…
Annual Compliance Report:
To be furnished in quadruplicate to DGIT for each of the years covered in the agreement
One copy each would be sent by the DGIT to the CA India, to the jurisdictional CIT and one copy to the TPO
To be filed within thirty days of the due date of filing the income tax return for that year, or within ninety days of entering into an agreement, whichever is later
Compliance audit:
The TPO to carry out the compliance audit of the APA for each of the year covered in the agreement
required to furnish his report within six months from the end of the month in which the annual compliance report is received by him
Covered transactions under the APA scheme would not be audited by the TPOs under the routine transfer pricing assessment procedure
The compliance audit is not a general feature internationally

26. …APA Rules Revision of an APA: Miscellaneous:
Date
…APA Rules
Revision of an APA:
An APA can be revised in case of:
change in critical underlying assumptions
change in such law other than that which renders it non-binding
request from CA in the other country
The revision order is required to be in writing citing reasons of revision required and:
revisions can be initiated by the Board / DGIT/ CA/ taxpayer
opportunity of being heard to be provided
non-agreement by the taxpayer on the proposed revisions may result in cancellation of the APA
Miscellaneous:
Mere filing of a application for an agreement under these rules shall not prevent the operation of Chapter X of the Act for determination of arms‟ length price under that Chapter till the agreement is entered into

27. What is Lacking? or What is Just Not Right?
Date
What is Lacking? or What is Just Not Right?
No provisions for rollbacks
No mention of timeframe to conclude
No provisions re confidentiality safeguards
Cancellation of agreements may not work in bilateral / multilateral scenario
Provisions regarding critical assumptions need to be explained further

28. Bilateral / Multilateral
Date
Processes
Unilateral APA
Bilateral / Multilateral
APA
CBDT Approval
CBDT Approval
DGIT
Competent Authority
in India
Discussions
Competent Authority
Of AE’s Country
Agreement
Agreement
APA Team
APA Team
Agreement AE
Discussions
Taxpayer
Taxpayer
India
Outside India

29. Date
Way Forward
Obtaining an APA involves extensive negotiation between the taxpayer and the tax authorities in a mutual environment
Indian tax authorities need to develop an environment conducive to the success of a continuous negotiation process
An APA scheme has the ability to deliver significant benefits including savings in compliance and administrative costs
However, the law must clarify certain aspects such as secrecy of business information to safeguard the interests of the taxpayer

30. Date
Safe Harbour

31. Introduction to Safe Harbour
Date
Introduction to Safe Harbour
Safe Harbour Rules are the circumstances under which tax authorities automatically accept the transfer prices declared by the taxpayer
Provides certainty and compliance relief
Could be in the form margin threshold or exclusion of certain classes of transactions from TP regulations
Safe Harbour and Presumptive Taxation provisions (Similar in nature)

32. Why are Safe Harbour Rules so Important to India?
Date
Why are Safe Harbour Rules so Important to India?
India is a globally preferred country for outsourcing of services
However, the outcomes of the TP assessments concluded in the last couple of years have increased the uncertainty over taxation issues
Safe Harbour Rules once introduced, will provide some certainty to MNEs
Captive service providers in India to benefit

33. Industries / Transactions that Need Immediate Attention
Date
Industries / Transactions that Need Immediate Attention
Indian IT/ITeS industry
Management Service Charges
Royalties

34. Date
Global Scenario
Safe Harbour provisions are being practiced by several mature practices across the globe
in Australia and New Zealand, a 7.5 per cent markup on cost is generally accepted as an arm’s length margin for the non-core services
US has prescribed a Safe Harbour for routine services. Here the services charged at cost (without mark-up) are considered to be at an arm’s length
Brazil have introduced safe harbour provisions in respect of exports

35. Safe Harbour Provisions in India
Date
Safe Harbour Provisions in India
Contained in Section 92CB
No Rules prescribed by CBDT yet and hence, no clarity
Awaited since 2009
Risky from double taxation perspective
Harmful in case of genuine business losses and downturns

36. Advantages and disadvantages of Safe Harbour Rules
Date
Advantages and disadvantages of Safe Harbour Rules
Reduces litigation burden
Provides a measure of predictability
Significantly reduced compliance
Administrative simplicity
Risk of double taxation
Difficult balancing act

37. Date
Thin Capitalisation

38. The Concept of Thin Capitalisation
Date
The Concept of Thin Capitalisation
A company is said to be thinly capitalized when its capital is made up of a much greater proportion of debt than equity
In other words, when its gearing or leverage, is too high
This is perceived to create problems for two classes of people
consumers and creditors bear the solvency risk of the company, which has to repay the bulk of its capital with interest; and
revenue authorities, who are concerned about abuse by excessive interest deductions

39. The Concept of Thin Capitalisation
Date
The Concept of Thin Capitalisation
Specific rules aimed to discourage thin capitalization often require that the debt-to-equity ratio meet a specific ratio in order for the company to be allowed to deduct interest expenses
Thin capitalization refers in some countries to the situation where a company has excessive debt in relation to its arm’s length borrowing capacity
Here, the rules do not specify the debt-to-equity ratio, but do specify that in order to claim interest deductions, a company must ensure – and be able to document from a transfer pricing perspective – that the terms and conditions of its intercompany financing are comparable to those it could have obtained from third-party lenders (for example, in the United Kingdom)

40. Why is Thin Capitalisation Considered as a Problem?
Date
Why is Thin Capitalisation Considered as a Problem?
Thin capitalization is a problem from a tax perspective because the returns on equity capital and debt capital are treated differently for tax purposes
Returns to shareholders on equity investments are not deductible for the paying company, being distributions of profit rather than operating expenses
On the other hand, returns to lenders on debt – most commonly in the form of interest – are normally deductible for the payer in arriving at profits assessable to corporate tax
This can result in attempts by multinational enterprises to present what in substance is equity investment in the form of debt, and thereby receive more favourable tax treatment

41. Why is Thin Capitalisation Considered as a Problem?
Date
Why is Thin Capitalisation Considered as a Problem?
As of now, India does not have any Thin Capitalisation Rules
Direct Taxes Code proposes to introduce this concept
Income tax department is seriously thinking of applying thin capitalization rules in India
This will allow them to classify some parts of the interest paid as dividend

42. Date
Conclusion
APA is a step in a right direction, however, concerns relating to confidentiality of information etc. need to be addressed
Safe Harbour Rules are eagerly awaited by MNEs. However, the taxpayers are wary of possible double taxation issues
Thin Capitalisation is yet to be formally introduced in India. Its introduction will depend on the adoption of Direct Taxes Code

43. Vispi T. Patel & Associates
Yashodhan D Pradhan
Principal Consultant
Vispi T. Patel & Associates
Contact No.: