TRANSFER PRICING AND ADVANCE PRICING AGREEMENTS

It can be particularly important where transfer pricing is difficult to benchmark because of lack of adequate market comparables, or in cases where tax authorities may have conflicting views over the same transaction. Aztec Software and Technology Service Ltd. vs. ACIT1, ITAT Bangalore bench has remanded the matter back to TPO to give Aztec another chance to prove that its transactions with group companies are at arm's length, leading to a multiplicity of proceedings result in redoing the entire transfer pricing assessments and stifling the appellate proceedings.. However, with the advent of APA, would bolster one of the canons of taxation - certainty.

APA in foreign Jurisdictions:

Portugal: put in place detailed rules on advance pricing agreements or APAs (decree number 620-A/2008, of July 16). The introduction of this procedural option for resolving future transfer pricing disputes between tax authorities and taxpayers was foreseen years ago in the preamble of the Portuguese transfer pricing regulations. These rules have been in force since January 1 2002 (article 58 of the corporate income tax code and decree number 1446- C/2001, of December 21). The Portuguese APA program is based on the best practices set forth by the EU Joint Transfer Pricing Forum and on the OECD guidelines for conducting advance pricing agreements under the mutual agreement procedure (MAP APAs).

Overview of the Portuguese APA program The new Portuguese APA rules specifically foresee the follows: *In what situations an APA can be requested.2 An APA can include all or a subset of intra group transactions. The selection of the transactions will depend primarily on the requests put forward by the taxpayers. * Three types of APAs can be requested.
1 2

[2007]107ITD141(Bang) Eduardo Goldszal and Catarina Breia - New regulations on APAs in Portugal

19 Int'l Tax Rev. 21

2007-2009

The legislation foresees the possibility of unilateral, bilateral and multilateral APAs. For bilateral and multilateral APAs the existence of a tax treaty between Portugal and the country where the related party is located is necessary. Duration of an APA: The terms of the APA may be no longer than three years; although renewals are possible if requested in the last six months of the agreement. APA accessory obligations: The taxpayer needs to prepare an annual transfer pricing report by the fifth month after the end of the fiscal year. Portugals Differences: On average, most APA programs may last longer than three years (limit in Portugal). However, since renewals of APAs are possible in Portugal, this difference may be muted; * APAs in Portugal can not be applied retroactively, only prospectively. That is, there is no roll back for open tax years; In some countries, APA programs do not require filing fees or fees are immaterial. In Portugal, pre-filing is free of charge. Then, in case the APA proposal is accepted, there is a filing fee that varies according to the taxpayer's level of sales. The renewal of the agreement implies a payment of approximately 50% of the initial filling fee. The new Portuguese APA program can be a valuable strategy in mitigating transfer pricing uncertainty and the risks of double taxation.

APA guidelines for European Union:

The EU Joint Transfer Pricing Forum issued Guidelines for Advance Pricing Agreements within the EU on February 26, 2007, SEC (2007) 246. As a general matter, the Guidelines for Advance Pricing Agreements within the EU are distinctly similar to the U.S. APA procedure. Despite this overall similarity, the Guidelines for Advance Pricing Agreements within the EU distinctly prefer bilateral APAs and multilateral APAs in contrast to unilateral APAs, a preference not shared with the U.S. APA procedure.

The APA Guidelines explain how member states should conduct the APA process, providing guidance to taxpayers in this regard. 3 Taxpayers and Member States that follow the Guidelines
3

Guidelines for Advance Pricing Agreements with the EU, section 6.

are expected to achieve a quick and efficient resolution of the APA process, which, in turn, is designed to encourage taxpayers to use APAs in the EU. These APAs should lead to more dispute avoidance and less double taxation. 4

The Guidelines envisage a four-stage process and describe what should happen at each stage of the process5: 1. A pre-filing or informal application stage6 2. A formal application stage'7 3. The evaluation and negotiation of the APA8 4. The formal agreement process9

The initial legal framework for the Guidelines for Advance Pricing Agreements within the EU is Article 25(3) of the OECD Model Convention, which permits countries to enter into APAs.

The EU APA Guidelines address unilateral APAs almost as an afterthought and a derogation of bilateral and unilateral APAs. The U.S. APA practice concerning unilateral APAs is contrary, as the United States places more value to unilateral APA than does the EU. Thus, the EU APA Guidelines acknowledge that there may be circumstances where a taxpayer has good reasons to believe that a unilateral APA is more appropriate than a bilateral APA.10 Nevertheless, the EU APA Guidelines clearly state that "bilateral APAs are preferred over unilateral APAs." The EU goes on to state that in cases where a unilateral APA may reduce the risk of double taxation to some degree, care must be taken that the unilateral APA is consistent with the arm's-length principle in the same way as bilateral or multilateral APAs.

4
5

Guidelines for Advance Pricing Agreements with the EU, section 6.

Guidelines for Advance Pricing Agreements with the EU, section 18; Annex, Guidelines for Advance Pricing Agreements with the E.U, section 20. 6 Guidelines for Advance Pricing Agreements with the EU, section 19. 7 Guidelines for Advance Pricing Agreements with the EU, section 20. 8 Guidelines for Advance Pricing Agreements with the EU, section 20. 9 Guidelines for Advance Pricing Agreements with the EU, section 21. 10 Annex, Guidelines for Advance Pricing Agreements with the EU, section 63.

The rights of other administrations and taxpayers should not be affected by the existence of a unilateral APA.11 Asian APAs:

While most tax authorities state that their rules follow the Organization for Economic Cooperation and Development (OECD) Transfer Pricing Guidelines, few countries in Asia are OECD Members.12 While Advance Pricing Agreements (APA), and Mutual Agreement Procedure (MAP)13 or competent authority (CA)14 process as it is commonly referred, are generally available to mitigate this risk; there are practical issues related to each as an option in an Asia context.15

Transfer pricing in Asia will continue to evolve, with the development of transfer pricing in each country in Asia unlikely to be uniform or follow a pattern; in part due to the different levels of economic development and political drivers and therefore tax policy approach. 16 Transfer pricing by its very nature crosses local boundaries and the need for a consistent application of policy calls for a coordinated approach. The challenge is not seeking out information on transfer pricing developments in Asia. Rather, the challenge is distilling that information, developing a narrative and prompting thought as to what it means and whether for instance, and if so how, business in Asia can respond on an "overall" basis; as opposed to reacting on a jurisdiction specific basis.

Guidance on seeking an APA is available (e.g., Australia, China, Japan, Malaysia and Singapore). Resort is being had to the APA process (e.g., Singapore, Japan and South Korea)

11

Annex, Guidelines for Advance Pricing Agreements with the EU, section 67.
Australia, Japan, New Zealand and South Korea are OECD member countries. India, China and Indonesia are OECD observers.

12 13

The MAP article in tax conventions allows designated representatives (the "competent authorities") from the governments of the contracting states to interact with the intent to resolve international tax disputes. These disputes involve cases of double taxation (juridical and economic) as well as inconsistencies in the interpretation and application of a convention.
14 15
16

The CA process is generally unable to mitigate interest or penalties. For example, in the case of the CA process due to the absence of a tax treaty. The CA process can take two or more years.

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although that is less evident in jurisdictions with "younger" transfer pricing regimes (e.g., China). However, APA guidance is still pending in some jurisdictions (e.g., Vietnam).

The transfer pricing regimes will continue to evolve, albeit at a rate and in a manner that reflects the broader nature of that tax system and issues will be clarified by means employed in that tax system; at one end of the spectrum, we can expect to see continued tax litigation and court rulings, at the other the informal views of tax authorities.

APAs in China:

China began using APAs on a trial basis in the late 1990s. In 1998, an APA was included as one of other reasonable methods of transfer pricing adjustments in Article 28 of The Regulation on the Taxation of Transactions between Related Parties (Trial)17 In 1998, the first unilateral APA was reached between a tax authority and an enterprise. In 2002, the APA program was formally introduced in Article 53 of The Implementation Rules of the Tax Collection and Administration Law of the Peoples Republic of China18 In order to standardize and ensure consistency of Chinas APA administration across the country, the SAT has implemented rules for APA monitoring and administration since 2005 requiring the local tax authorities to submit the draft unilateral agreement to the SAT for review and approval before its conclusion. In April 2005, Japan and China concluded the first bilateral APA in Chinas history. Subsequently, China reached bilateral APAs with the United States, the Republic of Korea, and other countries. At the beginning of 2009, Guo Shui Fa 2009 No. 2 Implementation Measures of Special Tax Adjustments (Trial Version) (the Measures) was
17

Article 28 on the Taxation of Transactions between Related Parties (Trial): Transfer Pricing Adjustment Methods for Purchases and Sales of Tangible Assets: ... (IV) Other appropriate methods: If none of the first three methods are applicable, the tax authorities can choose other reasonable methods, such as profit -comparison method, profit-split method, and net profit method, among others. The enterprise can also adopt an advance pricing arrangement after applying for and obtaining approval from the tax bureau in charge. 18 Article 5 of the Implementation Regulations of the Administration of Tax Collection and Administration Law of the Peoples Republic of China: The taxpayer may propose a pricing principle an d calculation method to the in-charge tax authority concerning the transactions between them and associated enterprises. The in-charge tax authority shall examine, verify and decide whether to approve the proposal. If approval is given, an advance agreement shall be reached with the taxpayer concerning pricing related matters and the tax authority shall supervise the implementation.

promulgated to facilitate the implementation of the Corporate Income Tax Law of the Peoples Republic of China and its Implementation Regulations. Chapter Six of the Measures provides more detailed rules and implementation guidance on Chinas APA program.

DTC, 2010 Perspective: The transfer pricing provisions contained in DTC 201019 are broadly similar to those contained in the IT Act. The definition of "Associated Enterprises" has been expanded to include two more criteria, namely (i) the provision of services by one enterprise to another, either directly or indirectly, and the conditions are influenced by such other enterprise, and (ii) "any specific or distinct location of either of the enterprises as may be prescribed."20 DTC 2010 also introduces advance pricing agreements ("APA"s).21

An APA is an arrangement that determines, in advance of controlled transactions, an appropriate set of criteria (for example, method, comparables and appropriate adjustments thereto, and critical assumptions as to future events) for the determination of the transfer price for those transactions over a fixed period. It empowers the Central Board of Direct Taxes to determine the Arm's Length Price ("ALP")22 in relation to such international transactions.

The ALP is subject to safe harbor rules, which is defined to mean circumstances in which the tax authorities should accept the transfer price as declared by the taxpayer. Interest, dividends (other than dividends on which dividend distribution tax is paid), royalties, or fees for technical services would be subjected to a twenty percent withholding tax. This is, however, subject to relief available under the respective DTAAs.

19 20 21 22

117. 291.
at twentieth sched.

123.

One of the ways that will facilitate certainty in tax liability is through advance pricing agreements. APA is an agreement between taxpayer and the tax administration for a specified number of years mentioning the criteria for determining transfer prices for future transactions between related enterprises. While concluding an APA, comparability with open-market conditions and assumptions vis--vis future events may play a role. APA finds a place in the transfer pricing provisions of the American and British tax laws. The APA may be retroactively revoked in fraud or malfeasance, cancelled in the event of misrepresentation, mistake/omission of fact or lack of good faith compliance and revised if the critical assumptions change. It is not clear why our regulations are silent on APA.

APAs may be bilateral, unilateral or even multilateral. Bilateral or multilateral APAs may cover conditions in more than one country and thus might confer greater credibility and universality of application. One must, however, guard against over allocating profits to any one country where the APA has been arrived at depending on the tax shelter or relief.

In Germany, unilateral APAs of foreign tax authorities are not accepted by the German revenue department without an audit in accordance with German tax standards. The intention is apparently to ensure that such imbalances do not occur. The principles of interpretation are applied to ascertain the intention of the Legislature and though they are considered to be good servants, they are bad masters. Intention of the Legislature is best understood from the language used, which is the .Golden rule of interpretation. Only when there is ambiguity or absurdity, external aids may be pressed into service. Statement of objects and reasons or the speech of the Finance Minister may be referred to, to ascertain the history and object, but they cannot control meaning of a provision when language is clear and free from ambiguity. . Further, in the light of catena of decisions dealing with the issue of interpretation of the statute and the power of the Legislature, it is well-settled principle that primary rule of construction is the language used and in case of ambiguity or absurdity, meaning consistent with object and purpose of a statute has to be assigned without

doing violence to the statute. Statement of objects can be referred to find out the history and object of the statute but it does not control the interpretation when language is clear.23

23

Coca Cola India Inc. v Assistant Commissioner of Inome-tax (CWP No. 16681 of 2005, decided on 17 December 2008 by Adarsh Kumar Goel and L.N. Mittal, JJ, since reported as (2009) 1 Comp LJ 460 (P&H).