transfer pricing – alternative dispute resolution mechanisms march 2012

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


Transfer Pricing - Background and Recent Trends


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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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


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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Normal Dispute Resolution Mechanism


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 !!!!


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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Alternate Dispute Resolution Mechanism


• Dispute Resolution Panel (DRP)

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Mechanisms to resolve Disputes - Practical Experiences

• Mutual Agreement Procedure (MAP)

• Advance Pricing Agreements (APAs)


Dispute Resolution Panel (DRP)


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



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)


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


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


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


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…….


(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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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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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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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


Q & A

Questions

&Answers

Kishore NairSenior Manager, B S R & CoEmail: [email protected]

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transfer pricing – alternative dispute resolution mechanisms march 2012

Documents

transfer pricing adjustments

transfer pricing legislation

transfer pricing regulations

transfer pricing tp

transfer pricingcountryrank

indian partnership

swiss entity

aggressive tax authorities