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Advance Pricing Agreement

Advanced pricing agreement is an agreement between one or more tax authorities and one or more taxpayers specifying transfer pricing methodology for pricing the tapers transaction in the future years. An advance pricing agreement aims to avoid the disputes by determining an advance set of criteria to apply which are related to transfer pricing disputes within a specified time for specific cross border controlled transactions.

An advance pricing agreement also ensures compliance with the arm length principle. The main objective of the Advance Pricing Agreement is to provide tax certainty to the intragroup transactions and the process of multinational enterprises operating in India, enhance the tax revenue, and reduce disputes.

There are no monetary limits or other prescribed criteria for a taxpayer to be eligible for applying for an Advance Pricing Agreement but only those persons can be eligible for an Advance Pricing Agreement who has entered into international transactions and who has proposed to undertake intentional transactions. The advance pricing agreement is valid not exceeding 5 consecutive financial years. And it can be extended or renewed for a further period of up to 5 years.

The board may enter into an Advance Pricing Agreement with any person to determine the Arms's Length Principle or the manner of determining ALP in connection to foreign transactions under Section 92CC of the Income Tax Act of 1961.

Advantages of Advance Pricing Agreement

  1. Elimination of potential transfer pricing adjustments and avoiding the tax audit for the transaction covered by the advance pricing agreement (reduction of related costs and efforts
  2. The advance Pricing Agreement avoids double taxation.
  3. Elimination of penalties for the potential transfer pricing agreement and the interest of late payment.
  4. The cost incurred with the preparation of the transfer pricing file for the transaction which is covered by the Advance Pricing Agreement also eliminated.
  5. An advance pricing agreement makes the country an attractive destination for foreign investments. 
  6. The advance Pricing Agreement programme also strengthens the government's resolve to foster a non-adversarial tax regime.
  7. For tax authorities, an Advance Pricing Agreement reduces the cost of administration and also frees scarce resources.
  8. Consequently, Advance Pricing Agreement provides a win-win situation for all the stakeholders involved

Purpose of Advance Pricing Agreement.

The Advance Pricing Agreement process is legally binding on both the parties for a period of five consecutive years or less as agreed between the taxpayer and the Central Board of Direct Tax. The regular transfer pricing audit is carried out on a year on year basis. Advance Pricing Agreement provides certainty and reduces litigation. Transparency and an open-minded approach during negotiation, both by tax authorities and taxpayer is the key to a successful Advance Pricing Agreement. No negotiation process is involved in the regular transfer pricing assessment.

APA provide tax certainty to the investors (foreign) and reduces tax litigation by a large amount.
It also provides the certainty of approach to determine the Arm's Length Price( ALP) of the international transactions. Arm's Length Price means a price which is applied in a transaction between persons other than associated enterprises in uncontrolled conditions. 

Terms of  Advance Pricing Agreement.

These are the things which are included in the Advance Pricing Agreement.
  • International transactions are covered by APA.
  • Agreed transfer pricing methodology.
  • Determination of the Arms' length price.
  • Critical assumption.

Types of Advance Pricing Agreement:

  • Unilateral Advance Pricing Agreement
  • Bilateral Advance Pricing Agreement.
  • Multilateral Advance Pricing Agreement.
In a unilateral advance pricing agreement only the tax authority ( CBDT) of the country where the taxpayer is located and the taxpayer is involved. 

In Bilateral Advance Pricing Agreement involves the taxpayer, associated enterprise i.e. AE of the taxpayer in the foreign countries where the taxpayer is located and foreign tax authorities. 

In Multilateral Advance Pricing Agreement involves the taxpayers, and two or more associated enterprises of the taxpayer in different foreign countries, the tax authorities of the country where the taxpayer is located and the tax authority of the associated enterprise. 

There is no time limit specified in the rules for the conclusion and negotiation of the advance pricing agreement. But the tax authorities indicate that they will endeavour to enter into unilateral advance pricing agreements within one year and bilateral advance pricing agreements / multilateral advance pricing agreements within two to three years.

Consultation for Advance Pricing Agreement

The person who proposed to enter into an advance pricing agreement has to make an application in writing to the Director-General of Income Tax.

When the request is received then on the receipt of the request pre-filing consultation will hold by the team. In pre-filling consultations involving bilateral or multilateral agreements, the component authority in India or its representative will be involved.

However pre-filing consultation would not bind the CBDT or the taxpayers to initiate the APA process or to enter into the APA process. However, it may be possible that in pre-filing meetings the authorities may indicate their reluctance to accept the proposed methodology which could influence the negotiation process. It is expected that the understanding reached at this stage will be communicated in writing. 

Advance Pricing Agreement Application Procedure

Taxpayers who want to enter into an advance pricing agreement then he has to furnish an application in the prescribed format with the required fee. 
In the unilateral agreement, the application for the advance pricing agreement has to be filed before the Director-General of Income-tax (International Taxation).
In the case of multilateral and bilateral agreements, the application has to be filed to the competent authority in India. 

In the advance pricing agreement, the taxpayers have to furnish the following details:
  • International transaction details
  • Type of Advance Pricing Agreement applied.
  • Proposing transfer pricing methodology.
  • Why not opt for a bilateral or multilateral Advance Pricing Agreement.
  • Detailed functional analysis.
  • Five years consolidated financial statement. 

However, Taxpayers can enter into the pre-filing consultation process on a no-name basis. However, considering the extent of detailed information to be furnished, one needs to evaluate whether and to what extent anonymity can be maintained.

Regarding transactions which are of continuing nature already happening dealings, the application has to be filed before the first day of the previous year relevant to the first assessment year for which the Advance Pricing Agreement application is made. In the case of the remaining transactions, the application has to be filed before proceeding with the international transaction. Advance Pricing Agreement authorities can get the additional documents or additional information from the taxpayers after the verification of the application and the authorities can visit the business premises of the applicant also.

The team of Advance Pricing Agreement prepare the draft and carry the enquiry. 

Advance Pricing Agreement applications prescribed fees

An Advance Pricing Agreement application is required to be accompanied by the filing fees as below:
  • If the Amount is not exceeding Rs. 100 Crores then the fee for filing advance pricing agreement is 10 lakhs
  • If the Amount is not exceeding Rs. 200 Crores then the fee for filing an advance pricing agreement is 15 lakhs.
  • If the Amount is exceeding Rs. 200 Crores then the fee for filing an advance pricing agreement is 20 lakhs.

Advance Pricing Agreement: cancellation

If any defect is noticed in the application filed by the applicant following a successful pre-filing consultation and if the application is withdrawn at this stage, then the fee paid by the applicant shall be refunded.

Advance Pricing Agreement can be cancelled on the following grounds:
  • If the person fails to comply with the terms and conditions of the Advance Pricing Agreement and fails to file an annual compliance report.
  • If there are any errors in an annual compliance report.
  • If there is no consensus on the terms of the revised Advance Pricing Agreement.
  • The effects can not be given to the provision of an Advance Pricing Agreement due to failure on part of the applicant.
  • If an agreement is cancelled based on the discovery of fraud or misrepresentation of facts on the part of the applicant the same shall be deemed cancelled ab-initio and an audit will take place accordingly.

Renewal of Advance Pricing Agreement

The Advance Pricing Agreement can be renewed by the taxpayers by making an application. Taxpayers have to follow the same procedure to renew the Advance Pricing Agreement as we discussed above except for pre-filing consultation. 

Decision Matrix for Advance Pricing Agreement
The following key points should be considered by a taxpayer while deciding whether to go or not to go for the advance pricing agreement process:
  • ongoing and expensive audit history
  • nature of transactions being complex;
  • facts are expected to remain stable over a period of the next few years;
  • New transactions, proposed to be entered, which may give rise to litigation; and
  • Transactions entailing business restructuring, intangibles, financial transactions etc.
In the aforementioned cases, APA may be preferred to achieve certainty in the pricing of transactions.

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