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Dawn of a new era of transparency and trust

By Rahul Mitra of KPMG in India.

Ever since transfer pricing (TP) was introduced in India in 2001, it has become the single largest source of tax disputes and litigation for MNCs operating in India, thus positioning the Indian Revenue Service as one of the toughest revenue administrators in the world. However, the scenario has undergone a sea change over the last three years, particularly post the advent of the current government, where the Indian Revenue Service has been striving to tone down the rigours of TP audits; and also settle disputes through the machineries of advance pricing agreement (APA) and mutual agreement procedure (MAP).

Recent legislative amendments

The Indian government has introduced three major legislative amendments to the TP regulations over the past year, namely:

1) Master file and country-by-country (CbC) reporting

In line with OECD/ G-20 BEPS Action plan 13, the Indian government has introduced the concepts of master file and CbC reporting with effect from fiscal year beginning on April 1, 2016, vide the union budget 2016-17. The requirement of preparing local documentation files has been in vogue in India since 2002. Though the detailed guidelines around master file and CbC reporting are yet to be released by the government, they are expected to be in line with BEPS Action plan 13, as above. The government has also made it clear that the monetary threshold for CbC reporting would be retained at that prescribed level under BEPS guidelines, namely the Indian Rupee equivalent of €750 million ($836 million). The first compliance for master file and CbC reporting is due on November 30 2017.

2) Secondary TP Adjustment

The Indian government has introduced the concept of secondary TP adjustment, vide the union budget, 2017-18, to be applied to primary TP adjustments made in the hands of taxpayers for fiscal years beginning on or after April 1 2016. Under the scheme of secondary TP adjustment, the primary TP adjustment would be deemed to be an advance given by the Indian taxpayer to its foreign associated enterprise (AE); and if the same is not repatriated to India within a prescribed timeline, an amount of interest income would be imputed in the hands of the Indian taxpayer in the form of a secondary TP adjustment. The scope for secondary adjustment has been extended to resolutions under APAs and MAPs, safe harbours, apart from determinations under TP audits; and also suo moto offerings by taxpayers in tax returns. The detailed guidelines around secondary TP adjustments, namely the time frame for repatriating the money represented by the primary TP adjustment, manner of calculating the interest income, including rate of interest to be applied, etc., are expected to be released by the government shortly.

3) Limitation of interest deductions

In line with BEPS Action plan 4, the Indian government has introduced, vide union budget, 2017-18, a provision for limitation of interest deductions in the hands of Indian taxpayers or permanent establishments of foreign companies, with respect to interests paid on loans taken from overseas AEs; or on loans taken even from third party lenders, which are either guaranteed (explicit or implicit guarantee) or backed by advanced placed, by overseas AEs, up to 30% of earnings before interest, depreciation, tax and amortisations (EBIDTA). While the disallowance of interest would be made only with respect to loans taken either from or involving overseas AEs, as above, for the purposes of computing the overall limit of 30% of EBIDTA, even interests paid on rank third party loans, namely without involvement of any overseas AE whatsoever, would be taken into account. The amount of interest so disallowed in any fiscal year, may be carried forward for a maximum period of eight years, for being allowed as deduction in subsequent fiscal years, subject to satisfying the overall criterion of 30% of EBIDTA in such subsequent fiscal year. The provisions for limiting deduction for interests apply on and from fiscal year beginning April 1 2017. Banks and insurance companies have been kept outside the ambit of such provisions.

Revised/updated country chapter for United Nations (UN) TP manual

The Indian Revenue has recently updated its country chapter, for being appended with the revised UN TP manual. As such, the Indian Revenue has not released any official circulars or guidelines on TP to this date, except for the one on contract research and development (R&D) services, which was issued in March 2013. Thus the country chapter appended with the revised UN TP manual, at least provides some insights on the mindset of the Indian Revenue in dealing with some of the complex issues relating to TP. The revised or updated country chapter has certainly demonstrated positive and progressive thinking on the part of the Indian Revenue on critical areas, e.g. marketing intangibles, location savings, etc., while on some of the other matters, there is scope for further rationalisation. The views of the Indian Revenue on some of the issues are discussed below:

1) Overall acceptance of recommendations of OECD/G-20 BEPS Action plans 8 to 10

The Indian Revenue has stated that it overall endorses the recommendations of BEPS Action plans 8 to 10, dealing with TP, except for the ones with respect to low value-adding intra-group services (IGS), as the Indian Revenue considers IGS to be a serious issue of possible base erosion.

2) Marketing intangibles

a) It appears that for the first time, the Indian Revenue is keen to address the issue on marketing intangibles under the economic fundamentals of TP, by moving away from the arbitrary manner of inflicting routine adjustments, which has been the norm in the last six or seven rounds of TP assessments.

b) The Indian Revenue states that compensation for advertisement, marketing and sales promotion (AMP) functions need not be separate; and can be part of the price of another transaction. Further, where the licensee of the brand performs AMP functions with the intention to exploit the results itself, obviously in the capacity of the economic owner of the marketing intangibles, then no separate compensation is required to be paid in favour of the licensee taxpayer, as understandably, the licensee taxpayer would have enjoyed; or be enjoying, the fruits from the market itself.

c) Thus, the Indian Revenue appears to have finally accepted and acknowledged the concept of economic ownership of marketing intangibles, by the licensee of trademark, something, which it had been refraining from doing for the past several years. Incidentally, this had been the fulcrum of most of the disputes on the relevant issue, particularly for entrepreneurial licensed manufacturers and buy-sell companies, and also for normal risk-taking marketing distributors. Such acknowledgement on the part of the Indian Revenue, even though quite late in the day, but thankfully not late enough to make the scenario irretrievable, is indeed laudable.

d) In case the Indian Revenue sticks to such a correct fundamental approach towards TP, then the entire litigation around the issue of marketing intangibles, which is currently pending before the Supreme Court, more on legal grounds, namely the presence of international transaction or otherwise, with respect to AMP expenditure incurred by licensees of brands, under the fact pattern of TP adjustments made to this date, would actually be put at rest on positive terms.

3) Location savings

a) It is heartening to note that the Indian Revenue has come out of its earlier stand, as reflected in the earlier version of the country chapter, to now acknowledge that location specific advantages (LSAs) and location savings, which the Indian economy might provide to overseas MNCs, who have set up businesses in India, would stand duly subsumed or factored in, the results of proper local comparables selected for determining the arm's-length price of transactions entered into by the Indian subsidiary companies with their overseas AEs, where typically the Indian subsidiary companies would be acting as service providers of their overseas related parties.

b) The Indian Revenue has clarified that if such proper local comparables can be identified, then no further upward adjustment on account of premium profits, if any, emanating out of LSA or location savings, being referred to as location rent in TP parlance, would need to be made to the results of the Indian taxpayers.

Developments around APAs

1) Post the introduction of the APA programme in 2012, the Indian Revenue has resolved more than 150 APAs until March 2017 in a most non-adversarial manner through congenial negotiations with taxpayers and revenue authorities of other countries.

2) Taxpayers have reposed significant confidence in the new image of the Indian Revenue, as manifested in the APA programme; and have filed more than 800 APA applications over the last five years.

3) The Indian Revenue has recently released a report on the progress of the APA programme until March 2017. KPMG in India had conducted a survey within the industrial community for gathering the views of the industry on the success of APA programme; and also suggestions for the improvement thereof. The results of the APA survey were relayed to the Indian Revenue, who listened to the feedback and suggestions with care and interest; and gave their comments as well. KPMG thereafter released the APA survey 2017, being one of the first of its kind in India, incorporating the views and suggestions of the industrial community; and also comments of the Indian Revenue.

4) Approximately 85% of the APA applications filed till date have been unilateral ones. The relative slow progress of the bilateral APA programme can be ascribed to the following reasons:

a) The largest trade partner for India, namely US, had initially distanced itself from accepting requests for bilateral APAs involving India, in view of the long pendency of bilateral MAP cases. However, pursuant to India proactively resolving more than 100 MAP cases with US during 2015, US finally agreed to accept applications for bilateral APAs from early 2016.

b) The Indian Revenue had taken a unique stand that absent the provisions of corresponding adjustment, being equivalent to the ones contained in Article 9(2) of the OECD Model Convention, in a tax treaty signed by India with any country, the Indian Revenue would not entertain bilateral APA or MAP involving such country. As a result of the said stand, several important countries, having significant trade with India, had been outside the ambit of the bilateral APA programme, as their tax treaties with India did not have such clause of corresponding adjustment in TP, namely Italy, Germany, France, Korea, Singapore, etc.

c) Incidentally, India has recently renegotiated its tax treaties with Singapore and Korea, as a result of which, the relevant clause around corresponding adjustment has been incorporated within such treaties effective April 1 2017. Thus, on and from such date, the corridor for bilateral APAs have opened up between India and the said countries.

d) Out of the approximately 150 APAs signed till March, 2017, 11 APAs were bilateral, involving UK and Japan. It is expected that the traction on bilateral APAs would increase manifolds in the days ahead.

The environment of TP in India is looking better than ever before. As would appear from the discussions above, the Indian Revenue has responded well to the faith and trust reposed by taxpayers on the tax administration, by streamlining policies, taking positive stands on critical issues in TP; and also resolving disputes in an upfront and non-adversarial manner. Thus, the entire environment around TP in India is transforming into one of mutual trust and confidence between taxpayers and the Indian Revenue.

Rahul Mitra



KPMG in India

Building 10, Tower B, 10th Floor

DLF Cyber City, Phase – II

Tel: +91 98300 55821

Rahul Mitra is a partner and the national head of the Global Transfer Pricing practice of KPMG in India. Rahul is a chartered accountant and honours graduate in Commerce.

Prior to joining KPMG in India, Rahul was the national leader of PwC India's transfer pricing practice between 2010 and 2014. Rahul was a partner in the tax practice of PwC India between 1999 and 2014.

Rahul has 25 years of experience in handling taxation and regulatory matters in India. He specialises in inbound and outbound planning assignments, value chain transformation or supply chain management projects, and profit attribution to permanent establishments.

Rahul independently handles litigation for top companies at the level of the Income Tax Tribunals. Some of the major wins of Rahul before the tax tribunals in transfer pricing matters have been setting precedents, both in India and globally, such as BMW India marketing intangibles in the case of distributors, and GAP India remuneration model for procurement services company, addressing issues of Berry Ratio & location savings.

In his personal capacity, Rahul has handled several APAs in India, involving clients from across industries; and also covering complex transactions, e.g. industrial franchise fees/variable royalties under non-integrated principal structures; contract R&D service provider model; distribution models, with related marketing intangible issues; and financial transactions.

Rahul has been a paper-writer and speaker in several tax conferences held in India and abroad. Rahul is a member of the global editorial board of the magazine Transfer Pricing Forum published by Bloomberg BNA. He has been a visiting faculty of the National Law School in the subject of transfer pricing and international tax treaties.

Rahul was the country reporter on the topic non discrimination in international tax matters, for the IFA Congress held in Brussels in 2008. Rahul was invited by the OECD to speak at the 2012 Paris roundtable conference on developing countries' perspectives on APAs.

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