The transfer pricing landscape in India
Almost two decades after the introduction of transfer pricing regulations in 2001, the Indian TP space has evolved and matured immensely, write Manoj Pardasani, Hasnain Shroff and Hardev Singh of BSR & Co. Today, India’s TP regulations are in line with international TP principles and the Indian government is continuing to align the TP regulations with global best practices.
In 2016, India adopted the three-tier transfer pricing (TP) documentation structure as prescribed by the OECD under BEPS Action 13. Further, provisions relating to secondary adjustments and thin capitalisation were also introduced into Indian regulations in 2017.
Over the past few years, the government has made several efforts to strengthen the dispute resolution mechanisms available in India, like the introduction of the advance pricing agreement (APA) programme in India in 2012 which has so far been hugely popular with the taxpayers. India also introduced safe harbour provisions in 2013, which were then revised in 2017, wherein most of the safe harbour rates were rationalised and safe harbour provisions for the receipt of low value adding intra-group services were introduced.
Where, as a result of primary adjustment to the transfer price, there is an increase in the total income or reduction in the loss for the taxpayer, the excess money which is available with its associated enterprise (AE), if not repatriated to India within the time as prescribed, will be deemed to be an advance made by the taxpayer to such AE and the interest on that advance will be computed as the income of the taxpayer, in the manner prescribed.
'Secondary adjustment' has been explained as an adjustment in the books of accounts of the taxpayer and its AE to reflect that the actual allocation of profits between the taxpayer and its AE are consistent with the transfer price determined as a result of primary adjustment, i.e. based on the arm's-length price as may be determined.
A taxpayer is required to make a secondary adjustment, where the primary adjustment (with effect from financial year [FY] 2016 to 2017) to transfer price has been made in the following situations:
Suo motu by the taxpayer in the return of income;
By the assessing officer (AO) during assessment proceedings, and has been accepted by the taxpayer;
An adjustment determined by an APA entered into by the taxpayer;
An adjustment made as per the safe harbour rules (SHR); or
An adjustment arising as a result of the resolution of an assessment by way of mutual agreement procedure (MAP).
A secondary adjustment would not be applicable, if the amount of a primary adjustment made did not exceed INR10 million ($150,000).
While the secondary adjustment provisions are aimed at preventing the erosion of the asset base from India, there are certain aspects that cause hardship for taxpayers and their AEs. Associated enterprises situated in jurisdictions outside India are required to make cash remittances to taxpayers in India, which would obviously require the AE to (i) make accounting entries consistent with Indian requirements, and (ii) seek tax deductibility in the other jurisdiction. Further, the tax administration of the other jurisdiction would need to review the arm's-length nature of the secondary adjustment (made from India) and allow a similar adjustment in its country.
This requirement in Indian tax law is extremely onerous for the AE and tax administration of the other jurisdiction. If the cash remittance against the secondary adjustment is not brought into India, an imputed interest would be added to the taxable income of the taxpayer in India in perpetuity, which is most undesirable for any multinational enterprise (MNE).
The situation described above gets even more intricate when the Indian taxpayer has multiple transactions with different AEs which are all aggregated for a combined arm's-length review (say, in a transactional net margin method, resale price method, or cost plus method). The resultant primary adjustment is easy to determine and directly impacts the determination of taxable income. However, to implement the corresponding secondary adjustment, i.e. to receive a cash remittance, one needs to attribute the same to one or more of the multiple AEs, which would give rise to further issues.
In line with the recommendations contained in the BEPS Action Plan 4 issued by the OECD, amendments relating to thin capitalisation were introduced into the Indian regulations in 2017.
Where an Indian company, or a permanent establishment (PE) of a foreign company in India, being the borrower, pays interest exceeding INR10 million in respect of any debt issued/guaranteed (implicitly or explicitly) by a non-resident AE, then such excess interest will not be deductible in computing income chargeable tax.
Excess interest shall mean the total interest paid/payable by the taxpayer in excess of 30% of cash profits or earnings before interest, taxes, depreciation and amortisation, or the interest paid or payable to the AEs for that previous year, whichever is the lower. Although there is a restriction on the deductibility of the interest in the hands of the taxpayer in a particular financial year to the extent it is excess, the same will be allowed to be carried forward for a period of eight years and will be allowed as a deduction in subsequent years. These provisions will be applicable for FY 2017 to 2018 and subsequent years.
Country-by-country reporting, master files and local files
The three-tier documentation structure as per the recommendations of the OECD under Action 13 of the BEPS project were introduced in India with effect from the Indian financial year April 1 2016 to March 31 2017. The country-by-country reporting (CbCR) and master file (MF) requirements were introduced in addition to the already existing local documentation requirements. The detailed rules with respect to CbCR and MF filing obligations were released on October 31 2017.
The parent entity of an MNE group or an alternate reporting entity (ARE), resident in India, will be subject to CbCR in India from FY 2016 to 2017 onwards, if the total consolidated group revenue of the international group exceeds INR55 billion. The CbC report will be filed with the Indian tax authorities within a period of 12 months from the end of the reporting accounting year.
A constituent entity (CE), of an international group resident in India, will be required to file a CbC report in India, if:
The parent entity is not obligated to file the CbC report in its country; or
If there is no agreement for the exchange of CbC reports between India and the country of the parent entity; or
There has been a systemic failure by that country.
In the above 3 cases, the due date for furnishing the CbC report is yet to be prescribed by the Indian tax authorities.
The master file consists of part A and part B. Part A is required to be filed by every CE of an international group, whether or not it satisfies the dual thresholds specified below; and part B is required to be filed only by those CEs which satisfy both of the thresholds mentioned in Table 1.
The master file must be filed with the Indian tax authorities on or before the due date of filing of the return of income.
1. Consolidated group revenue of the international group for the accounting year exceeds
INR 5 billion
2. The aggregate value of an international transaction:
• During the accounting year, as per the books of accounts, exceeds
• In respect of a purchase, sale, transfer, lease or use of intangible property during the accounting year, as per the books of accounts, exceeds
INR 500 million
INR 100 million
While the master file requirements as per the Indian regulations are similar to the OECD's recommendations in Action 13, under Indian regulations affected companies must also provide:
A description of the functional, asset and risk (FAR) analysis of all the CEs that contribute at least 10% of the revenues or assets or profits of the group;
A detailed description of the financial arrangement of the group, including the names and addresses of the top 10 unrelated lenders; and
A list of all the entities of the international group engaged in the development and management of intangible property, along with their addresses.
Stringent penalty provisions have also been introduced into the Indian TP regulations for failure to comply with the master file and CbCR documentation requirements.
Local file-related regulations that already exist in the Indian TP regulations will continue, and no separate rules in this regard have been announced.
Advance pricing agreements
India's APA programme was introduced in 2013 and received a very positive response from taxpayers. An APA is effective for a period of up to five consecutive years. Further, the rollback of APAs enables taxpayers to apply the transfer prices agreed upon in an APA to be rolled back for a period not exceeding four previous years, subject to conditions. Therefore, an APA in India can now provide certainty for up to a period of nine years.
In the five years since the inception of APAs in India, over 900 APA applications and over 200 APAs have already been concluded. This signifies both the popularity of the APA programme among taxpayers, and the commitment of the government to the programme.
Concluded APAs to date have included resolutions on a gamut of international transactions, like import and export of goods, technical services, marketing support services, software development, engineering design services, administrative/business support services, contract research and development, sales and marketing services, HR consultancy services, clinical research services, receipt of licence fees, and so on.
Transfer pricing issues relating to management charges and brand royalty were also agreed upon in bilateral APAs with the UK in 2016. (See the Central Board of Direct Taxes (CBDT) press release on APAs dated February 1 2016.) Further, in 2018, unilateral APAs on the vexed issue of advertising, marketing and promotion (AMP) expenses were also concluded. Another landmark achievement in 2018 was that the APA authorities accepted the price determined by the customs authorities as the arm's-length price (ALP) for certain imports.
On the bilateral APA front, several bilateral APAs have been signed to date with countries including Japan, the UK, the US and the Netherlands.
Mutual agreement procedures
The mutual agreement procedure (MAP) mechanism in India has been gaining a lot of attention over recent years, with the government making a conscious effort to promote MAP as an effective dispute resolution mechanism.
Until recently, India had a policy of no bilateral APA and MAP applications being accepted in the absence of Article 9(2) in tax treaties. Recently, it has been decided that TP MAP and bilateral APA applications will be accepted, regardless of the presence or otherwise of Article 9(2) (or its relevant equivalent article) in double taxation avoidance agreements (DTAs). This may provide further impetus to the APA and MAP programme in India.
The existing safe harbour provisions under the TP regulations have been revised and extended for a further period. The revised provisions will now be applicable from assessment year (AY) 2017 to 2018 to AY 2019 to 2020. Most of the safe harbour rates have been rationalised in the revised rules on safe harbours, and provisions for the receipt of low value adding intra-group services have also been introduced. The safe harbour provisions have been extended to receipt of such services by Indian entities under the revised SHRs.
Advertising, marketing and promotion expenses/marketing intangibles
In the past few years, the issue of marketing intangibles has become very prominent in India wherein Indian subsidiaries of global MNEs incurring AMP expenses have been challenged by the Revenue. The Indian Revenue alleges that the AMP-related activities add value to the trade mark/ brand (owned by the foreign parent entity) by way of brand building, and the local subsidiary must be compensated by the brand owner (foreign parent) either in the form of a service fee, or reduced/nil royalty payments. Since Indian TP regulations do not provide any specific guidelines on intangibles, other than defining them as part of an 'international transaction', the issue has become a much litigated bone of contention among the taxpayers and the Revenue.
Over the past few years there have been several High Court and tribunal rulings on the AMP issue, in favour of both taxpayers and the tax authorities. However, despite several judicial rulings, the AMP issue is far from being resolved and has now reached the doorstep of the Supreme Court of India. Even though the Supreme Court is expected to deliver a verdict that might put this controversy to rest, it is more likely that the Supreme Court may not rule on the AMP issue in an all-encompassing manner and may only lay out certain parameters, which might provide a broad framework on how to proceed in cases of marketing intangibles. There are various categories of taxpayers seeking a resolution – traders, manufacturers, a mix of trading and manufacturing, service providers, marketing entities, and so on, with each such taxpayer having its own set of peculiar facts. Thus, the broad framework will then need to be applied to the unique facts and circumstances of each case. The critical factor here is the implementation of guidelines expected to be laid down by the Supreme Court.
With BEPS-related regulations being implemented in India and worldwide, and with more information at their disposal, tax authorities are expected to be extensively scrutinising MNE businesses. Taxpayers will likely need to have robust underlying documentation and ensure that their global TP policies are aligned to local TP policies in various jurisdictions. In an uncertain post-BEPS world situation, taxpayers may have to proactively identify alternate dispute resolution options like APAs or MAPs to manage their TP issues and achieve certainty.