Almost each month, there is a press release issued on the number of advance pricing agreements, signed by the Central Board of Direct Taxes (CBDT). Earlier, when this news was shared with Zenobia Aunty, it often made her day.

At least one mechanism was functioning properly, she felt. There were many that were broken such as Advance Rulings – owing to the non-appointment of a chairperson in a timely fashion, there would be no sitting for months on end. Imagine, the plight of foreign investors who were assured of an order within six months as per the Income-tax (I-T) Act. Yet many had to wait endlessly before transacting with India, because they wanted to be sure on the tax outcome of their transaction and preferred to have an order from the Authority of Advance Rulings (AAR) in hand.

Compared to this, things had improved in the arena of transfer pricing, advance pricing agreements (APAs), which were regularly settled, provided certainty for up to nine years. APAs settle transfer prices and transfer pricing methods for transactions entered into by an Indian company with its overseas affiliates, in advance and avoid transfer pricing litigation. A rollback provision, which was introduced in October 2014, enables taxpayers to retrospectively apply the APA agreed upon for a period of past four years, thus providing transfer pricing certainty for a nine-year period.

JaitleyFinance minister Arun Jaitley

India had become notorious for its transfer pricing litigation, especially on contentious issues like bringing issue of share capital within the transfer pricing ambit. Many such issues, over the years had settled, even as transactions in the nature of advertising, marketing and promotion expenses continued to be in the harsh spot light of the transfer pricing officer (TPO).

However, when her favourite niece shared the last press release of the CBDT issued in early February that the CBDT had signed four more unilateral APAs, Zenobia Aunt’s frown deepened. The reason is quite simple, she feels that the mechanism of APAs is popular largely because of the provisions relating to safe harbours are not attuned with the needs of India Inc.

The number of APAs (in total) entered into by CBDT has crossed the 100 mark, to reach 130. This includes 8 bilateral APAs and 122 Unilateral APAs. In the current financial year, a total of 66 APAs (5 bilateral APAs and 61 unilateral APAs) have already been entered into. The CBDT expects more APAs to be concluded and signed before the end of the current fiscal, stated the press release.

This press release went on to add: Since its inception, the APA scheme has evinced a lot of interest from taxpayers and that has resulted in more than 700 applications (both unilateral and bilateral) being filed so far in about five years. The progress of the APA Scheme strengthens the government’s resolve of fostering a non-adversarial tax regime. The Indian APA program has been appreciated nationally and internationally for being able to address complex transfer pricing issues in a fair and transparent manner.

“Hmmm..,” went Zenobia Aunty. “All this is fine, but do you realise APAs are proving to be the only recourse?” she asked. India also has in place, safe harbor mechanism, which companies are not opting for, added my Aunt.

Under the safe-harbour mechanism, by adopting the profit margins prescribed for various kinds of outsourced services (such as R&D, IT, ITeS to name a few) rendered by an Indian company to its overseas affiliates, the Indian company gets transfer pricing certainty for a five-year period. These profit margins are typically on the slightly higher side, for example: the operating profit margin prescribed for a KPO is 25% or more, and for an R&D service provider, it is 30% or more. However, by accepting such higher margins, which translate into higher tax in India, the Indian company benefits from simplified transfer pricing compliance and no litigation.

As the prescribed profit margins were perceived to be high, Indian companies opted for filing applications for APAs. The situation is no different today. In fact, with outsourcing emerging as a ‘bad’ word in USA, profit margins could shrink further for India Inc., especially for those companies operating in the IT-ITeS sector.

It is high time that the profit margins prescribed under the safe harbour provisions are recalibrated downward. This alone will ensure that India Inc. opts for it and eases the burden on APA mechanism.
Ideally, only complex cases, should be dealt with under APAs, sadly in India this isn’t the case. Instead of continuing to applaud ourselves on the popularity of APAs it is time to look deeper and fix the scene.