Rules for advance pricing arrangements are likely to be introduced in India with an eye on reducing transfer pricing litigation between corporations and tax authorities.
An announcement to this effect is expected either in Budget 2008-09 or in the direct tax code that is likely to be introduced later.
Transfer pricing legislation was introduced in India in 2001 and has emerged as the single biggest source of courtroom battles between Indian tax authorities and companies, a large number of which are multinationals with operations in India.
Tax specialists and industry have been demanding clear-cut advance pricing mechanisms that will allow them to determine the valuation of related party transactions.
However, moves to come out with advance pricing arrangements have not been spelt out so far principally because of a lack of experience of such transactions in the official tax administration
"Having completed transfer pricing audits on several transactions for four years now, this is the right time to introduce advance pricing arrangements in India," said official sources.
Indian income tax authorities have done transfer pricing audits of a number of cases with substantial adjustments, many of which are pending in tribunals or courts.
To implement this arrangement, the government will have to create a statutory framework that would include the process of filing applications for such cases, pre-filing conferences, evaluation and negotiations with tax officials and drafting of the arrangement. This process will also involve setting up an authority to issue rulings on valuations.
An advance pricing arrangement will provide tax payers an opportunity to reach an early agreement with tax authorities on the future application of the arms-length principle in their international transactions with related parties.
The agreement means that the tax administration provides a commitment not to make any adjustment to the transfer price so long as the tax payers stick to the principles agreed in the arrangement.
Most developed countries have provided an alternative dispute resolution forum for settling transfer pricing issues amicably as the normal appellate process proves to be quite lengthy.
What is an advance pricing arrangement?
An advance pricing arrangement settles the transfer pricing methodology and the range of profit margins to be adopted for an agreed number of years. The arrangement will be reflected in the return of income of the tax payer, which will not be disturbed as long as tax payer sticks to the principle agreed upon.
The main advantage of such an arrangement is that it enhances the predictability of tax treatment of international dealings, provides certainty to foreign investors and fosters a better investment climate.