Transfer Pricing – Alternative Dispute Resolution Mechanisms
March 2012
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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Contents
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Transfer Pricing - Background and recent trends
Normal Dispute Resolution Mechanisms
Alternate Dispute Resolution Mechanisms
Dispute Resolution Panel
Mutual Agreement Procedure
Advance Pricing Agreement
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Transfer Pricing - Background and Recent Trends
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Transfer Pricing - A Global Overview
New and expanding transfer pricing legislation and rules are in vogue in many countries
Stepped up enforcement globally in the form of: More auditors, better training Increasingly sophisticated Change in scrutiny mechanism
Complex issues and transactions are picked up for scrutiny and increasingly challenged
India, China, Australia, Korea and Japan have all recently seen an increase in number of cases picked up for scrutiny
Singapore and other tax authorities have signaled intent to step up Transfer Pricing (TP) compliance and field audit work.
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© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Ten most aggressive tax authorities for Transfer Pricing
Country Rank in 2010 Rank in 2007 Change
Japan 1 1 -
India 2 6 Up 4
China 3 8 Up 5
Canada 4 9 Up 5
United States 5 3 Down 2
France 6 5 Down 1
Germany 7 2 Down 5
Australia 8 4 Down 4
Korea 9 7 Down 2
United Kingdom 10 10 -
Asian Countries aggressive tax authority poll - India ranks second following Japan and preceding China (source -TP Week)
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Transfer Pricing - Scrutiny Trend
Since introduction of the Transfer Pricing regulations in India in 2001, the Directorate of Transfer
Pricing has made adjustments of approximately INR 45,000 cr (approximately US $ 10,000 million)
(source - Extract of Finance Minister’s speech made at a press conference on January 25, 2011 on prevention of
money laundering)
Transfer Pricing additions touch INR 44,500 cr in the recently completed round of Transfer Pricing
Audits ended 31 October 2011 (approximately US$ 9,271 million) (source - DNA Money newspaper
publication, November 15, 2011)
On an average, Transfer Pricing adjustments are made on 54%* cases picked up for scrutiny
*Estimates based on various sources
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Key Triggers and Contributors for Transfer Pricing Audits
Contributors to Aggressive Audits:
Mounting fiscal demand on Government
Need to preserve tax base
Unprecedented sharing of information between revenue authorities
Key Triggers for Aggressive Audits
Consistent losses / low margins of the taxpayer attributable to inter-company transactions
Significant changes in profitability of the taxpayer and its Associated Enterprises
High Royalty / Technical fee payouts, Cost recharges, Management Fees, Cost allocations
Net losses incurred by routine distributors
Low mark-ups for services
Significant Advertisement and marketing spends by manufacturing / distribution companies
Substantial increase in transfer pricing audits and disputes across the Globe , India is no exception….
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© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Normal Dispute Resolution Mechanism
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Dispute Resolution Mechanism – Traditional Route
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Supreme Court
High Court
Tribunal
Commissioner (Appeals)
Tax
officer
• Most direct tax disputes are
dealt under traditional dispute
resolution avenues
• Each level of hierarchy involves
substantial period of time
• At times, cases at lower levels
are passed in favour of revenue
Timelines to achieve any possible certainty in tax positions – Years !!!!
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Dispute Resolution Mechanism - Issues
Tax uncertainty coupled with substantial period in litigation process
Huge number of pending cases before the various dispute resolution fora
Aggressive approach in tax collections and tedious tax refund process dents taxpayers confidence
Conflicting decisions at various levels of dispute resolution fora adds to the complexity of the Indian tax laws
Possibility of further litigation
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© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Alternate Dispute Resolution Mechanism
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
• Dispute Resolution Panel (DRP)
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Mechanisms to resolve Disputes - Practical Experiences
• Mutual Agreement Procedure (MAP)
• Advance Pricing Agreements (APAs)
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Dispute Resolution Panel (DRP)
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
DRP Process
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TP Order prejudicial to taxpayer
Draft Order by tax officerReceipt of draft order by
taxpayer
Taxpayer files objections to
variations to the DRP
Taxpayer intimates to tax officer of
acceptance of variation
No action taken by taxpayer
DRP to issue directions binding on
the tax officer
Tax officer to pass final order
Tax officer to pass final order
Tax officer to pass final order
Taxpayer to file appeal with CIT within 30 days of receipt of final
order from AO
(Within 9 months from the end of the month in which draft order is issued)
(Within one month from end ofmonth of receiving bindingdirections from DRP)
(Within one month fromend of month in whichacceptance received)
(Within one month from end of month in which period for filing objections with DRP expires)
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Dispute Resolution Mechanism
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Perceived Benefits Specialist Panel - Three views instead of one
Speedy Resolution - Time bound
Direct Appeal to the ITAT by the taxpayer
Department cannot appeal against the DRP directions
No demand till AO issues final order based on DRP directions
Experiences
Over 1,000 cases filed across 8 cities - strain on 9 month timeline
Frequent and numerous adjournments consequent to absence / transfer
of panelists
Very short hearing notices and time limit set for hearing
Absence of independent institutionalized form of Dispute Resolution
Legal issues not dealt with by DRP
On a writ petition filed by Vodafone, the Delhi HC held that DRP should pass a reasoned order
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DRP vs. CIT(A)
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Depending upon the facts and circumstances of each case, the
CIT(A) route may be preferred in cases where:
No compelling reasons for a fast track to ITAT hearing
Covered matter – ITAT / Higher authorities’ orders are in favor
Directions of DRP are non-speaking
– If CIT(A) has ruled in favor of taxpayers on similar issues in
preceding years
– If no favorable order exists, possibility that the CIT(A) could
exercise flexibility / independence in approach
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Mutual Agreement Procedure (MAP)
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MAP Procedure
Mutual agreement is reached Mutual agreement is reached
Success
Tax DisputeTax Dispute
Taxpayer approach CA of the contracting state of his residence
Taxpayer approach CA of the contracting state of his residence
CA of home country rejects application
CA of home country rejects application
CA of home country accepts application for MAP
CA of home country accepts application for MAP
CA of home country unilaterally resolves
CA of home country unilaterally resolves
Should be resolved by consultationShould be resolved by consultationNo Agreement is reached
No Agreement is reached
Dispute capable of Unilateral resolution
Dispute capable of Unilateral resolution
Yes
NoNo Success
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How long is a MAP process
Confirmation of receipt of MAP application by
other CA within 1 month
Acceptance of MAP application and notification to
taxpayer within 1 month
Analysis & Evaluation by the CA and issuance of position paper
within 4 to 6 months
MAP application filed within 3
years of being aggrieved
Confirmation of MAP application and advising to
other CA within 1 month
Review of position paper
and determination response on it
within 6 months
Negotiation between CAs within
6 months
Mutual agreement between CAs and drafting of MoU within 6 months
Approval of mutual
agreement by the taxpayer
within 1 month
Exchange of closing letters within ASAP
Implementation of mutual agreement
within 3 months
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MAP vs. Indian Judiciary
MAP Commissioner Appeals Appellate Tribunal
Parallel process with domesticappeals
Chance of success greater thanDRP, but still limited
Greater chance of success ascompared to CommissionerAppeals
Approach of negotiation/compromise Legalistic approach/ no negotiations Legalistic approach/ no negotiations
Taxpayer likely be asked to assist Competent Authority
Documentation will need to be produced to substantiate the facts
Documentation will need to be produced to substantiate the facts
Taxpayer can influence how thecase progresses. However, not a party to the actual negotiations
Proceedings take place in presence of taxpayer and its Representatives
Proceedings take place in presence of taxpayer and its Representatives
Time period - 20 to 30 months for resolution
24-30 months 20-24 months after Commissioner (Appeals)
Complete stay on tax demandsuntil agreement reached
Generally demand is not put in abeyance fully. 50%-75% taxes are to be paid upfront
Decision of CA is binding on Revenue, not binding on taxpayer
Binding but sequential appeals can be made to higher judicial authorities
Binding, but question of law appealable to judicial authorities
Rejection of resolution can limitfuture access
Long-drawn time consumingProcess
Quality of “representation” and“Court-craft” key in winning cases
Significant case backlog High cost of litigation
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MAP – Current Updates
Indo-US Competent Authorities recently arrived at a mutual agreement in respect of US captive providing software\ IT enabled services
Margin of 18 percent for fiscal year 2003-04 and 17.5 percent for fiscal year 2004-05 concluded as opposed to 24% to 26% proposed by Indian Revenue
This settlement results in a gross relief of approximately 9% and would also entail a correlative adjustment, and thereby eliminating double taxation
Based on the above conclusion the 5% relief, working capital / idle capacity adjustments would not be available.
Would the 17.5% be a guiding factor while arriving at the mark-up for safe harbour???
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Advance Pricing Agreements (APA)
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APA – An Overview
The OECD transfer pricing guidelines Chapter IV, Section F define Advance Pricing Arrangement (‘APA’) as:
“An arrangement that determines, in advance (emphasis added) of controlled transactions, an appropriate set of criteria (e.g. method, comparables and appropriate adjustments thereto, critical assumptions as to future events, etc.) for the determination of the arm’s length price for those transactions over an agreed period of time.”
APA provides win-win situation for all the parties involved
APA’s are of 3 types:
Unilateral APA – APA between taxpayer and tax authority of domestic country
Bilateral APA – APA between taxpayer and two tax authorities
Multilateral APA – APA between taxpayer and multiple tax authorities
Although simpler to implement than a bilateral/multilateral APA, unilateral APAs not
recognized by theforeign tax authority…….
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
(2) Pre-filing
(4) Post
Submission
(3) APA
Submission
(1) Planning
APA Administration
(5) Dispute Resolve
APA Process
• APA Strategy• Fact gathering and analysis• Economic analysis
• Prepare pre-filing docs
• Pre-filing meetings• US fee payment
• Prepare and file APA request/submission
• Acceptance Letter
• Receive/ reply to tax authority questions
• Meeting with the Authorities
• Site visits • Recommended
negotiating position• CA negotiation
• Finalise APA and sign agreements
• Adjustments and APA annual reports
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© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Advance Pricing Arrangement – Indian Context
The Board may enter into an APA with a taxpayer for determination of
the ALP in respect of an international transaction
Determination of ALP by any method including one of the prescribed
methods
APA term would be limited to a maximum term of five consecutive
financial years – No provision for roll back
The APA would be binding on the taxpayer and the Tax Authorities, and
only in respect of the international transactions for which the
agreement is sought
The DTC provisions appear to cover only Unilateral APAs
The Board to frame rules for APAs
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© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
APAs – Potential Benefits & Challenges in the Indian Context
Potential Benefits
– Certainty on Tax Issues (Particularly in case of complex high risk transactions)
– Avoidance of protracted litigation (time consuming and expensive)
– Facilitates Transfer Pricing planning
– Could provide opportunity to apply agreed methodology to resolve similar issues in open prior years
Challenges
– Costs could be significant and could take multiple years to finalize
– Creating knowledge/ research base, appropriate resources, databases and other infrastructure
requirements
– Extent of information required - exposes all aspects of the business due to voluntary nature of the process
– Reliable prediction about the future outcomes would be difficult to make - assumptions initially made may
not adequately reflect changing market conditions
– Considering that the DTC proposes what appears to be a Unilateral APA - whether this will be able to
resolve issues associated with double taxation
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© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
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APAs in India – The Way Forward
Provision for Bilateral / Multilateral APA mechanisms
Clearly defined goals and responsibilities for the APA program, including strong legal framework incorporating APA mechanism into domestic tax law
Dedicated APA team, separate from Transfer Pricing Officers associated with the audit - to ensure consistency in interpretation of critical assumptions and enhance effectiveness
Availability of specialist resources with industry knowledge for the APA team along with requisite database
Formulate position on rollbacks - taxpayers must have assurance that past closed years will not be reopened for audit based on the transfer pricing agreed in the APA
© 2012 B S R & Co., an Indian Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
Q & A
Questions
&Answers
Kishore NairSenior Manager, B S R & CoEmail: [email protected]
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