For years, the corporate tax functions of U.S.-based multinationals operating in India have faced a difficult choice: whether to comply with the U.S. or with Indian transfer pricing regulations. While the rules in both jurisdictions appear quite similar on paper, in practice the application of those rules by their respective tax authorities have been substantially different. For example, where the Internal Revenue Service (“IRS”) might assert that the arm’s-length pricing for a service rendered in India is cost plus 10%, India’s Income Tax Department (“IT Department”) might assert cost plus 25% to 30%. Most U.S. taxpayers choose to comply with the IRS’ view and fight the transfer pricing in India, leading to a painful, uncertain, and never-ending process.
Each fiscal year, a taxpayer can expect to be audited by the IT Department and have an adjustment issued in the field for additional tax due. To resolve such a dispute, some combination of tax court and Competent Authority is pursued. While the courts in India in recent years have been more accommodating in resolving such matters, there is still usually a gap left between the end result on the Indian side and what is accepted by the IRS in the U.S. Absent any Competent Authority relief, that gap results in double taxation.
While this has been the norm for years, developments in the last month signal an opportunity for U.S. taxpayers to resolve outstanding historical disputes and potentially eliminate uncertainty on a going forward basis.
Competent Authority Stalemate
Over the last several years, the U.S. and Indian Competent Authorities have simply not seen eye to eye. In fact, the two sides have had trouble even holding meetings. Pursuant to the Mutual Agreement Procedures (“MAP”) between the U.S. and India, to stave off payment of additional tax due via Competent Authority relief, a taxpayer must secure a line of credit in India. While taxpayers have been waiting for the two governments to agree on the proper taxation of cross-border payments, interest on these payments is accruing, and the cost of resolution continues to increase. Currently there are approximately 250 MAP cases pending and awaiting resolution, with many remaining open for several years.
In January 2015, Douglas O’Donnell, LB&I’s Deputy Commissioner (International), for U.S. Competent Authority, and Akhilesh Ranjan, for India’s Competent Authority, met in Delhi on the eve of President Barack Obama’s visit to India. At that meeting, the two sides agreed to a framework for resolving 60 cases involving disputes in the software development and information technology enabled services (“ITeS”) domains.
The expectation is that these cases will be resolved completely in March 2015.
Advance Pricing Agreements
In 2013, India began offering unilateral Advance Pricing Agreements (“APAs”) to taxpayers wishing to secure certainty with respect to transfer pricing. While any completed APA would result in a binding agreement with the IT Department, the IRS would be under no obligation to accept the transfer pricing resulting from the negotiations. Despite this, the IT Department has signaled publicly that under a unilateral APA it will seek markups closer to the 17% range than the 30% range previously sought in the field. This has been enticing to many taxpayers, leading to 146 total applications filed in the first year of introduction of the program, followed by 232 in the subsequent year.
With the agreement between Competent Authorities creating the potential to significantly reduce the MAP backlog, and an apparent meeting of the minds on common methodologies and terms for establishing arm’s-length transfer pricing, both the U.S. and India have signaled an interest in pursuing bilateral APAs. A bilateral APA is the only possibility for achieving certainty with respect to transfer pricing. Such certainty would be a far cry from the uncertain tax positions U.S. multinationals have faced for years in India, and could lead to a potentially significant reduction in reserves on the balance sheets and uncertain tax positions on U.S. companies’ tax returns.
What it all Means
Only time will tell if, in fact, the two Competent Authorities have reached a framework for resolving outstanding historical disputes and reaching successful bilateral APAs. On the Indian side, however, there are real signs that the federal government recognizes the damage caused by heavy handed revenue generating tactics, and is prepared to usher in a more business friendly environment.
On the heels of a significant loss by the IT Department in the Bombay High Court with respect to a dispute with Vodafone, the Ministry of Finance declared it will not appeal the decision, and issued a directive to the IT Department to reverse course pursuing adjustments in the field. Telecommunications Minister Ravi Shankar Prasad declared at a recent press conference that “investors' confidence has been shaken in the past because of the very fluctuating tax policy.” He went on to state that he “wants to convey a clear message to investors the world over that this is a government where the decisions will be fair, transparent and within the four corners of the law.” India’s newly elected Prime Minister, Narendra Modi, clearly understands the implications of recent government policy and stated during President Barack Obama's recent visit to India that the government will offer tax certainty. He clarified that multinationals operating in India “will find a tax regime that is predictable and competitive... have removed some of the excesses of the past...and will now soon address the remaining uncertainties.” In fact, the first budget of the new Government rationalized the new transfer pricing provisions and introduced the possibility of using a range concept and multiple year data, aligning it with developed economies and the OECD. The Finance Minister also gave a boost to the APA program by allowing for roll-backs for up to four years for an agreed APA.
Regardless of whether there is a long-term platform for agreement in place, there clearly seems to be an opportunity today for resolving uncertain positions between the U.S. and India. Between Competent Authority, an Indian unilateral APA, and the potential for a bilateral APA, there are suddenly options available for U.S. taxpayers that simply did not exist before. Additionally, a significant number of unilateral applications filed in India by U.S. companies during the past two years that have yet to be formalized, these companies may opt for conversion to bilateral APAs.
Anyone looking to get clarity and resolve disputes should strike while the iron is hot.
Sudit K. Parekh’s transfer pricing practice has over two decades of experience in international taxation and transfer pricing and has been rated amongst the leading tax and transfer pricing firms in India for the last six years by the International Tax Review. With a dedicated transfer pricing team of 35 professionals, including Chartered Accountants, MBAs, and Economists,
Sudit K. Parekh & Co. is well known for delivering customized, practical, and defendable transfer pricing solutions for multinational companies.
We encourage you to contact a member of your engagement team or one of the professionals listed in this publication to discuss any questions or concerns that you may have regarding what True Partners Consulting and Sudit K. Parekh & Co. can do for your business.
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