In a step to reduce transfer pricing disputes, the Indian tax department on Friday signed its first bilateral advance pricing agreement (APA) with Japan.

The APA was signed with a Japanese company, the central board of direct taxes said in a statement, adding that APAs will improve the investment climate in the country and attract more Japanese investors to India.

An advance pricing agreement is an accord between a taxpayer and the tax department on a transfer pricing procedure for a particular set of transactions.

An APA could be a unilateral agreement between the company and Indian tax authorities or a bilateral agreement involving a foreign country or a multilateral agreement between several nations. But bilateral or multilateral agreements with other countries will be based on tax treaties that India has with them.

So under a bilateral agreement, agreements have to be signed at various levels—between the tax authorities of both the countries and between the tax authorities and the respective company.

Advance pricing agreement rules were notified in August 2012 as the Indian tax authorities sought to reduce long-drawn litigation in transfer-pricing and provide some certainty to multinational companies operating in India.

Transfer pricing is the practice of arm’s length pricing for transactions between group companies based in different countries to ensure that a fair price—one that would have been charged to an unrelated party—is levied.

Transfer pricing has been an area of increasing dispute in India with the most recent assessment of such pricing by the tax department seeing increased claims of more than $9.5 billion.

S.P. Singh, senior director with Deloitte Haskins & Sells LLP said bilateral APAs can reduce double taxation and protracted litigation and provide certainty. “Unless and until the whole process of transfer pricing audit is substantially changed there will be unjustified additions and litigation. The government must encourage APAs and at the same time must attend to the root cause of undesired litigation.”