Effectiveness of Advance Pricing Agreements in India’s Complex Transfer Pricing Environment

This article discusses India’s advance pricing agreement (APA) program, the sector-wise distribution of APAs, and their usefulness given the country’s complex transfer pricing regime.

The question of ascertaining the price at which multinational corporations (MNCs) transact with their associated enterprises in India, called transfer price (TP), is a key area of interest to tax authorities as any profits that are not taxed in India will erode the country’s tax base.

Ever since transfer pricing was introduced in India in 2001, years of audits have also increased the number of tax disputes and litigation, involving major MNCs like Microsoft Corp., Vodafone International Holdings, International Business Machines Corp. etc.

In response, the Indian government decided to launch the Advance Pricing Agreement (APA) program through the Finance Act, 2012 through the insertion of sections 92CC and 92CD in the Income Tax Act, 1961 to supplement appeals and other dispute resolution mechanisms provided in the Income Tax Act, 1961 and double taxation avoidance agreements for resolving transfer pricing disputes.

Goals of India’s advance pricing agreement program

India’s APA program is a voluntary program to not only prevent transfer pricing disputes but also address actual or potential disputes and provide tax certainty to MNCs by allowing them to negotiate how profit margins for India operations will be calculated.

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The APA program provides an alternate and effective dispute resolution mechanism to bring uniformity in laws dealing with transfer pricing in India, as the existing administrative and judicial institutions fail to address specific questions of law while focusing primarily on the questions of facts.

Through the APA program, India aims to deliver a non-adversarial tax regime for foreign investors. Other benefits of an APA include avoiding rigorous and burdensome audit requirements while delivering the tax outcome on the basis of agreed terms of the agreement.

Over time, APAs can lower compliance costs of MNCs and substantially reduce the cost of administration and litigation incurred by the tax authorities.

Status of the advance pricing agreement program in India

An APA can be unilateral, bilateral, or multilateral, and is an agreement between a taxpayer and tax authority determining the TP methodology for pricing the taxpayer’s international transactions for future years. The agreement includes international transactions, agreed transfer pricing policy, determination of arm’s-length price, including the TP methodology to be applied and critical assumptions and the conditions, within its scope.

The methods prescribed for determining arm’s-length price include Comparable Uncontrolled Price (CUP) Method, Resale Price Method (RPM), Cost Plus Method (CPM), Profit Split Method (PSM), and Transactional Net Margin Method (TNMM).

Nearly 12 years after its launch, the increasing popularity of the APA program among foreign investors is evident in the high number of applications received and executed. In April 2024, it was announced that India signed 125 applications in FY2022-23, marking the highest number of APA signings in a single financial year since the program’s inception.

Present status of APAs in India

The number of APAs signed in FY 2023-24 represents a 31 percent increase compared to the 95 APAs signed during the preceding financial year. This brings the total number of APAs signed since the inception of the program to 641, comprising 506 UAPAs and 135 BAPAs. An APA report for 2023-24 is yet to be released.

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During FY 2023-24, India’s Central Board of Direct Taxes (CBDT) also signed the highest number of BAPAs in any financial year to date. These BAPAs were signed following mutual agreements with India’s treaty partners, including Australia, Canada, Denmark, Japan, Singapore, the UK, and the US.

As of the fifth Annual Report, covering FY 2022-23, over 1,600 applications have been filed since the APA program began in India, with 75 percent of these being for unilateral APAs between Indian taxpayers and the CBDT.

Sectoral and industry-wide distribution of APA applicants

The fifth Annual Report notes that the majority of applications resulting in agreements for FY 2022-23 were related to the service industry, particularly businesses engaged in IT-enabled services, software development, contract R&D, engineering design, and knowledge process outsourcing (KPO).

Among the 63 businesses with which the CBDT signed agreements, 14 also engage in manufacturing, while 11 are involved in trading, reflecting the wide range of industries covered by the UAPAs.

The IT sector, banking & insurance, and engineering services accounted for the majority of UAPAs signed in FY23. This highlights India’s status as a prime location for business process and IT outsourcing, with a strong presence of international multinational enterprises in IT clusters like Bengaluru, Hyderabad, Chennai, Gurgaon, and Noida. Specifically, 18 APAs were signed in the IT industry, 26 in the services sector, and 11 in the pharmaceutical and chemical sectors.

Additionally, the cement, packaging, publications, and apparel industries each had one unilateral APA signing, while the automobile and beverage segments recorded two unilateral APA signings each.

Experts estimate that the 516 APAs signed have provided finality to the taxation of approximately INR 190 billion (US$2.2 billion) in revenue, corresponding to around INR 70 billion (US$838 million) in tax payments.

Duration of processing APAs

The average time to complete BAPAs decreased slightly to approximately 62.1 months in FY 23. However, the processing of long-standing BAPAs with treaty partners during this period contributed to an extended average processing time for the year.

India has prioritized the quick resolution of renewals by leveraging the due diligence done during the original application process while also ensuring progress across a mix of cases. As a result, the average time taken for all BAPAs finalized by March 31, 2023, decreased slightly from 58.91 months (as of March 31, 2022) to approximately 58.77 months.

In comparison, for countries such as the U.S., the average time to complete an APA increased to 43.4 months in 2022, up from 35.1 months in 2021.

Conclusion

Ever since its introduction in 2012, India’s APA program has come a long way, equipped to address increasingly complex issues like AMP expenses, payment of royalty, and transfer of intangibles etc., which entail the adoption of transfer pricing methods like profit split and CUP.

By successfully concluding these complex APAs, India is moving forward to adapt to fast evolving realities.

Apart from reducing the compliance requirements as well as forging strategies for dispute prevention, an unplanned positive externality of the program has been assured revenue flow to the Indian treasury, in line with the terms and agreements specified in the APA.

(US$1 = INR 83.49).

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