Budget 2025 Expectations: Transfer Pricing

Tarun Arora, Partner, Deloitte India

Current environment

The Transfer Pricing (TP) legislation was introduced in India over two decades ago and has undergone several changes to align with the evolving global and economic landscape. Despite these changes, TP law remains one of the most complex areas of the Direct Tax statute, as highlighted in a recent survey conducted by Deloitte. This is largely due to year-on-year litigation with huge demands emanating from divergent views of the taxpayer and tax administration on the interpretation of TP laws and a lack of guidance on a few complex TP issues. To address this, the Government of India introduced dispute prevention mechanisms such as Advance Pricing Agreements (APAs) and Safe Harbour Rules (SHRs). However, the SHRs could not achieve their intended objective due to limited coverage and high rates. This has increased the burden on APA inventory. APA conclusions are getting delayed due to the higher rate of APA applications every year compared with the conclusions with a limited number of officers. Additionally, some of the legal provisions in the TP regulations and compliance need simplification and alignment with global standards.

These challenges require the government's attention and necessary action to enhance tax certainty and promote ease of doing business for global multinationals operating in India.

Expectations

Top three asks:

Ask #1: Reduction in litigation

• Streamlining SHRs: Existing SHRs have been restricted to small companies, making them inaccessible to medium and large enterprises. Safe harbour rates are higher than the comparable benchmark, making them commercially unviable for taxpayers to adopt. Therefore, taxpayers will continue to face the risk of litigation or apply for APA to attain tax certainty. This increases the APA inventory. The APA programme should primarily involve cases with complex transactions and business models that require in-depth business and economic analysis to set transfer prices. The government may re-evaluate the safe harbour provisions on the following three aspects:
   reduce the class of transactions from the safe harbour and restrict them only to IT, ITeS and business support;
   provide the safe harbour rates closer to comparable benchmarks with a little premium for certainty; and
   increase the threshold to cover almost 75 percent of the companies operating in this relevant industry. This can serve the dual purpose of providing tax certainty to taxpayers and easing the APA burden.

• Streamlining APA scheme to expedite resolutions and remove certain anomalies in law

- Speedy unilateral APA conclusion: The government can consider introducing an objective/quantitative approach, such as indicative financial yardsticks for resolving routine cases, rather than a subjective approach and detailed case-based analysis. This may help in quicker decision-making and faster resolutions. This can be coupled with standard questionnaires for specific industries.

- Impetus on high-value APAs: The government may also consider segregating the APA cases into high-value and low-value cases based on the quantum of international transactions and allocating the high-value APA cases to a larger team of officers comprising senior tax officers. The low-value APA cases can be considered for negotiation and disposal under the matrix system to ease the inventory of pending APA cases.

- Increase the frequency of competent authority meetings with treaty partners: The limited number of competent authority meetings with treaty partners also affects the progress of the APAs. Regular and frequent competent authority meetings can augment the speedy conclusion of bilateral APAs.

- Mechanism for corresponding tax adjustment and withholding tax refund for AE on conclusion of APA: The APA scheme does not provide for corresponding tax adjustment in the hands of the associated enterprise based on the agreed Arm’s Length Price (ALP), resulting in excess withholding tax in India.

- Removal of restrictions under section 92(3) for unilateral APAs: Section 92(3) of the Act is a restrictive tax provision. Under this provision, the taxpayer’s taxable income already reported in the tax return cannot be reduced or losses cannot be increased due to TP adjustment. This provision was primarily introduced for TP audits. APA is a dispute prevention mechanism. Restrictions under section 92(3) should not apply to APA resolutions.

- Introduction of APAs for Specified Domestic Transactions (SDT): APAs can only be applied to determine the ALP of international transactions between Associated Enterprises (AEs) and the SDTs (i.e., transactions between domestic AEs) are outside the purview of APA. SDTs have been scrutinised by the tax officers, and it is likely that the litigation will increase in the future, with SDTs being applicable to transactions of entities covered by Section 115BAB. The introduction of APA for SDTs will provide taxpayers with an option to avoid disputes and reduce the inventory of TP litigation pending before various forums.

- Allowance of treaty benefits to US single-member Limited Liability Company (LLC): Due to the differences in treaty interpretation, Indian Competent Authority does not consider a US single-member LLC to be a “person” and a “resident” under Articles 3 and 4 respectively of the India-US tax treaty. Due to this, a single-member LLC, which is a common corporate structure in the US, is not allowed to claim the benefits of the India-US tax treaty in India. As a result, a US single-member LLC is not allowed to apply for a Bilateral APA or MAP in India. This results in hardship and double taxation for US MNEs with such corporate structures. The government may allow such single-member LLCs to apply for a MAP and/or bilateral APA to alleviate this hardship.

- Advertisement, Marketing and Promotion expenses (AMP): The dispute over whether AMP constitutes an international transaction has been ongoing in India since 2013 and is now before the Hon’ble Supreme Court. only provides an ALP for AMP expenses if the taxpayer accepts it as an international transaction. Since APA authorities have a detailed and holistic understanding of the business and functions of the taxpayer, APA may be allowed to provide a resolution for AMP issue without requiring the taxpayer to accept it as an international transaction, which may not be the correct position in the facts and circumstances of the case.

- Profit attribution to Permanent Establishments (PE) in APAs: Significant litigation exists regarding the existence of a PE and its profit attribution. The government may consider amending the APA provisions to allow arm’s length profit attribution under APA for potential PE cases that are facing litigation in India without having to accept the existence of PE in India. This is similar to the approach adopted in settling such disputes under the Mutual Agreement Procedure (MAP).

• Mandatory timelines for Commissioner of Income Tax (Appeals) (CIT(A)) to pass the order: The Income Tax Act does not provide any mandatory timeline for CIT(A) to pass the order. It is seen that many appeals are pending for 4 to 5 years before the CIT(A), thus delaying the litigation process and making the entire CIT(A) route ineffective. CIT(A) is an administrative appellate mechanism, and imposing a timeline for disposal at the CIT(A) level can bring certainty of delivery, being an important taxpayer service.

Ask #2: Relaxation in TP compliance and documentation for Non-resident taxpayers

• Exemption from filing form 3CEB: Section 115A of the Income Tax Act 1961 (I-T Act) exempts a non-resident from filing an Income tax return if it is assessable to tax in India for dividend, interest, royalty or fee for technical services and the taxes have been appropriately withheld from such taxable income. However, Section 92E has not been amended consequent to the above exemption under section 115A(5) of the Act. This leads to a situation where a non-resident does not need to file a tax return in India but still needs to file Form 3CEB to avoid penalties for not reporting an international transaction. Considering the above anomalous situation, it is recommended that section 92E be amended to provide an exemption to non-resident assessees from filing Form 3CEB, where they are exempted under section 115A(5) from filing tax returns in India.

• Dividend receipts not be classified as international transactions: After the abolition of dividend distribution tax, dividend income is taxable in the hands of shareholders. A non-resident shareholder receiving dividends may still be required to file Form 3CEB. However, dividend payment by a company is an appropriation of profits and arises out of corporate action. Hence, the ALP of dividends is not determinable or technically covered under TP. The law should specifically provide an exemption for transactions such as dividend and bonus shares, which are not covered under TP regulations. Therefore, TP reporting and compliance are not required for such transactions.

• Aligning Country-by-Country (CbC) threshold with OECD guidance: Section 286 of the I-T Act, read with rule 10DB(6) of the I-T Rules, provides for a threshold of INR6400 crore for an MNE group to be liable to file the CbC report. However, per the OECD, in BEPS Action 13, an MNE group is liable to file a CbC report if its aggregate consolidated revenue exceeds EUR750 million. As the Indian TP law prescribes the threshold in INR, Non-resident MNEs must do a currency conversion to evaluate the requirement to file a CbC per Indian law. Due to this conversion and constant currency fluctuations, some MNE groups breach the local threshold of INR6400 crore. In contrast, they remain under the global limit of EUR750 million, which creates an additional compliance burden in India.
  
  The government should amend the Rules to provide that if an MNE group does not breach the OECD threshold of EUR750 million, it should not be required to file a CbC report even if, due to currency fluctuations, it breaches the threshold of INR6400 crore per the Indian I-T Act.

Ask #3: Simplification of law

• Introduction of specific rules for Profit attribution for PEs: Indian tax law contains Rule 10 under the Income-tax Rules, 1962 (Rules) for the attribution of profits to PEs. Rule 10 requires profit attribution to PE as a reasonable share of global turnover or profits or any other basis as may be reasonable. This is an ad-hoc mechanism without any scientific basis. The government issued a consultation paper in 2019 to guide profit attribution. However, taxpayers made multiple representations of the approach provided therein. The profit attribution approach was not finalised and issued by the government. The government should provide guidelines for profit attribution to PEs in India and set out its approach for global profit allocations. TP analysis is a globally accepted method of profit attribution to PEs. Even the APA negotiations are being impacted due to the absence of clarity on India’s approach to PEs.

• Definition of associated enterprise to cover newer forms of entities such as business trusts and LLP- Section 92A: TP law was introduced more than two decades ago. The AE relationship is defined under section 92A, which provides the basic test for the AE relationship and covers direct or indirect participation in capital management and/or control. Section 92A(2) provides thirteen conditions in which two or more enterprises would be considered to be AEs. However, new corporate structures such as LLPs and business trusts have emerged over the years, which were not envisaged while drafting section 92A. The government may amend the provisions of section 92A to cover newly constituted forms of organisations such as REITs and LLPs.

• Clarity on the use of Fair Market Value (FMV) under Rule 11UA versus ALP: The current Income Tax rules provide the valuation approach under Rule 11UA for the valuation of assets. The taxpayer, at his option, may choose any of the methods as prescribed under Rule 11UA(2). Per Section 92 of the Income Tax Act, any cross-border transaction between two associated enterprises should be undertaken at Arm’s length. However, Chapter X of the Income Tax Act does not provide any valuation basis for computing the ALP.

In the absence of specific valuation rules under Chapter X, there is an ambiguity as to whether the valuation done per Rule 11UA can be challenged by the tax officer. The government may clarify the appropriate valuation method to be adopted by the taxpayers undertaking such cross-border transactions.