There’s never really a phase in life where we aren’t awaiting some sort of results. We give some sort of test and await results while someone else is assessing our performance. It’s anerve-racking phase where we travel the world of possibilities with too many questions on mind, and absolutely no answers, only likelihoods.This happens because our plans and course of actions are dependent on these results – it’s more about what is at stake rather than how we performed. Wouldn’t life be more certain and less stressful, if our results were more certain? Probably yes, however, the more important question is, how? And there’s only one way to do it – “Fix the results”, which is illegal everywhere, except when it comes to Transfer Pricing. One may assess the arm’s length price as independently as possible, however, there’s still subjectivity involved which needs to be reconciled with the tax officer. These reconciliation stake the form of tax litigations and tax assessments which involve hefty consultation fees and a lot more at stake. However, this can be done away if you ‘fix your results’ and there’s an absolutely legal procedure to do the same – Advance Pricing Agreements, where you can sit and discuss the transfer price with the tax authorities, even before the transaction shave occurred and agree on the methodology to be followed. Alas!Why fight later, when you can discuss it now?
What is an Advance Pricing Agreement of Transfer Pricing?
An Advance Pricing Agreement (also referred to as ‘APA’) is a legal agreement between tax authorities and taxpayers on the transfer pricing policies – to be applied in future years, to value international transactions with associated enterprises. It is an effective measure for many enterprises to mitigate the risks involved in transfer pricing by ensuring their methodology of calculating arm’s length price is accepted as reasonable by the tax departments. It lays down the methodology to be applied for a certain future period, based on specified terms and conditions. This brings in certainty to the valuation and the results, turning transfer pricing compliance into a cakewalk, once the agreement is entered into. The number of transfer pricing litigations are always on the higher side and therefore, to alleviate the same, the Advance Pricing Agreements were introduced. Thus, Advance Pricing Agreements results in –
- the certainty with respect to the outcome of the international transactions, by agreeing in advance the transfer pricing methodology be applied to the transactions covered by the agreement
- removal of the threat of audit or minimizing these verity of audit
- substantial savings in compliance costs over the period for which the Advance Pricing Agreement is applicable and
- also, for tax authorities, reduces the cost of administration and makes resources available for other tasks.
Thus, the Advance Pricing Agreements provide a win-win situation for both the taxpayers and the tax authorities.
What is the scope of an Advance Pricing Agreement?
An Advance Pricing Agreement aims to agree on the transfer pricing methodology for particular international transactions. Thus, an agreement would typically include a pact on the following points:
- international transactions covered
- period for which the transactions would be covered
- transfer pricing policy
- the methodology to be adopted for determination of arm’s length price
- definition of all relevant terms which may be significant or have a bearing on the pricing
- critical assumptions about the transactions
- terms and stipulations of the agreement, other than those mentioned in the income tax law
The Advance Pricing Agreement defines all the critical assumptions in relation to the international transaction in advance and the agreement will be valid for a particular transaction only if the assumptions hold. These assumptions lay down all factors which affect the pricing including those which are not controlledby the enterprise or the tax authorities such as factors relating to an affiliate or a third party, industrial policies, general economic conditions, etc. In case there is a change in any of the terms or failure of a critical assumption, the agreement can be revised or cancelled. (Rule 10M)
What are the types of Advance Pricing Agreements?
There are three types of Advance Pricing Agreements –
- Unilateral APA– Such agreements involve only two parties – the enterprise and the tax authority of the country in which the enterprise is located.
- Bilateral APA– The bilateral agreements involve four parties – the enterprise, the associated enterprise in a foreign country, the tax authority of the country in which the enterprise is located and, the tax authority of the country in which the associated enterprise is located.
- Multilateral APA – The multilateral agreements involve more than four parties – the enterprise, two or more associated enterprises in a foreign country, the tax authority of the country in which the enterprise is located and, the tax authorities of the country in which each associated enterprise is located.
Who can enter into an Advance Pricing Agreement?
Any enterprise who has undertaken an international transaction or is contemplating to enter into an international transaction can enter into an Advance Pricing Agreement. There is no restriction on the type of international transactions that can be covered. There is also no threshold as to the value of transactions or turnover of the enterprise.
One application can cover multiple transactions with multiple associated enterprises. There is no need to file different applications for each type of transaction. An enterprise can opt to enter into bilateral or multilateral agreements to include tax authorities of the country in which the associated enterprises are located.
Procedure for Advance Pricing Agreement
Self-study of the case
Application for an Advance Pricing Agreement requires information such as –
- particulars of the enterprise, particulars of associated enterprises, particulars of the parent enterprise
- type of agreement applied for
- period for which the agreement is proposed
- the history and background of enterprise, general description of the business and the transactions
- the proposed method, details of the analysis of methodology, proposed secondary method
- details of functional analysis, industrial and market analysis
- impact of the proposed agreement
Thus, before filing an application, the applicant has to conduct a detailed study of the case to be submitted and the methodology proposed.Once an application is made, all discussions and the contents of agreements are restricted to the extent of transactions and details proposed in the application.Thus, the application has to be filed carefully after gaining clarity over the proposition.
Pre-filing consultation with tax authorities
There may be concerns about the details of transactions or lack of clarity on certain issues. In such cases, the entity can also request a ‘Pre-filing consultation’ to gain clarity about the agreement they propose to enter into. This will help to determine the scope of the agreement, identify the transfer pricing issues, determine the suitability of agreement and discuss the broad terms. Accordingly, they can proceed with the application for Advance Pricing Agreement. This does not bind the board or the entity to enter into a transaction and also does not necessarily needs to be followed up with an application for agreement.An application for pre-filing consultation can be made by submitting Form 3CEC. This application can also be filed in anonymity i.e. without specifying the name of the parties involved. (Rule 10H)
Application for Advance Pricing Agreement
To apply for an Advance Pricing Agreement, an application has to be made by filing Form 3CEDalong with the fees. If the application is for ongoing transactions, the same has to be filed before April 1 of the year in respect of which the agreement is proposed. In other cases, where the application is being filed for a contemplated transaction, it has to be filed before such transaction is undertaken. (Rule 10I)
Amendment or Withdrawal of Application
Amendment can be made in application by requesting in writing, at any time before the agreement is finalised, if the same does not fundamentally alter the nature of application filed originally. Such an amendment would require additional fees. (Rule 10P)
The application can be withdrawn at any time before the agreement is finalised. However, the application fees would not be refunded. Application for withdrawal has to be made by submitting Form 3CEE. (Rule 10J)
Procedure after Application
Once the application has been submitted, it would be scrutinised for defects. If any defect is found, the same has to be rectified within 15 days. If not complied with, the application will be rejected and fees refunded. (Rule 10K)
After acceptance of the application, the tax authorities shall conduct meetings, call for additional document or information, visit the applicant’s business premises, or make inquiries, as necessary, until the final agreement is drawn. (Rule 10L)
There is no time frame specified for completion of the negotiation or finalisation of the agreement.Once the agreements are finalised, the same will be shared with the enterprise only, and would not be shared in the public domain.
Annual Compliance Report and Compliance Audit
After entering into an agreement, the enterprise has to annually file a compliance report to the tax officers. This report has to be filed by submitting Form 3CEF. This form has to be submitted within 30 days from filing an income tax return for the year or within 90 days from entering into an agreement, whichever is later. (Rule 10O)
The tax authorities shall conduct a compliance audit for each year covered by the agreement to ensure the terms of the agreement have been complied with. The regular transfer pricing audits conducted by tax officers would not be applicable for transactions covered by the agreement. (Rule 10P)
Revision, Cancellation or Renewal
An agreement can be revised if there is a –
- change in the critical assumptions or failure to meet the conditions mentioned in the agreement
- change in the law that modifies the matter covered by the agreement
- request from an authority in another country, in case of a bilateral or multilateral agreement (Rule 10Q)
An agreement can be cancelled if the –
- compliance audit results in findings of failure to comply with the terms of the agreement
- enterprise fails to file the annual compliance report in time
- annual compliance report contains material errors
- enterprise does not agree with any revisions in agreement. (Rule 10R)
For renewal of an Advance Pricing Agreement, the procedure for pre-filing consultation has to be followed. (Rule 10S)
Rollback of an Advance Pricing Agreement
After the recent amendments, Advance Pricing Agreements can be rolled back retrospectively to similar transactions in the past years as well. This period is limited to the past four years. To avail rollback of an advanced pricing agreement, an application has to be made in Form 3CEDA. However, firstly the following conditions for rollback have to be satisfied:
- the international transaction must be in all respects
- return of income for the rollback period has been filed
- chartered accountant’s report for the rollback period has been filed
- the rollback is requested for all periods in which such transactions have occurred (and not selectively)
- the transaction must not have been appealed before an appellate tribunal
- rollback must not result in reducing the total income as declared in the return for the rollback period
The fees applicable for rollback is INR 0.5 million to be paid along with the application. (Rule 10MA)
The applicant has to file a modified return of income in respect of the rollback period for which the agreement has been applied for, along with payment of additional taxes arising out of the same. (Rule 10RA)
Points to consider before applying for Advance Pricing Agreement
While Advance Pricing Agreements are highly beneficial to the taxpayers, they also involve hefty filing fees, consultation charges and also long negotiations. Therefore, an enterprise must consider entering into Advance Pricing Agreement and ensure certainty in transfer pricing of transactions when –
- it has an ongoing and expensive audit history
- the nature of international transactions of the enterprise is complex
- the facts are expected to remain stable over a period of next few years
- new transactions, proposed to be entered into, may give rise to litigations
- transactions involving business restructuring, intangibles, financial transactions, etc.