Advance Pricing Agreement

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Relevance: GS-III: Effects of liberalization on the economy, changes in industrial policy, and their effects on industrial growth.

Advance Pricing Agreement (APA)

Evolution of advance pricing agreement concept in India

  • The transfer pricing framework in India has been introduced through the Finance Act, 2001 which requires determination of Arm Length Price (ALP) for all the international transaction between associated enterprises.
  • Since then, the ALP determination has been a matter of long-aged and numerous disputes between the department of revenue and the taxpayer.
  • To minimise these disputes, the concept of advance pricing agreement has been introduced in India by the Finance Act, 2012 through the insertion of section 92CC and 92CD in the Income-tax Act, 1961.
  • An APA is an agreement between a taxpayer and the tax authority determining the Transfer Pricing methodology for pricing the taxpayer’s international transactions for future years.
  • An APA provides certainty with respect to the tax outcome of the taxpayer’s international transactions.
  • The idea behind signing an APA is to bring in more transparency and clarity for a taxpayer in terms of tax risks and possible exposure to such risks. 

Transfer Pricing: 

  • It is the rates/prices that are used when selling goods or services between company divisions and departments, or between a parent company and a subsidiary.
  • In principle, a transfer price should match either what the seller would charge an independent, arm's length customer, or what the buyer would pay an independent, arm's length supplier. However, they have become a major tool for tax avoidance.

Difference between Tax avoidance and tax evasion 

  • Tax avoidance refers to an attempt to reduce the tax liability using legal means and regulating the business in such a way as to reduce the tax imposed by the act to the minimum. Tax avoidance uses legal means to avoid the payment of taxes.
  • Whereas tax evasion uses illegal means through falsification of account books, overstatement of deductions, understatement of income to evade the payment of taxes.
  • Most of the corporate companies use tax planning to reduce the payment of taxes. It is a legal practice in which the taxpayers use the loopholes of the tax laws to reduce their tax liability.

Why we need APA?

The primary goal of such programs is to provide certainty to taxpayers in respect of the transfer price of the cross-border transactions undertaken by such taxpayers with their group entities. Rapid growth in international trade through an increasing number of Multi-National Enterprises (MNEs) has given rise to numerous tax disputes on the issue of transfer pricing.

Types of APAs:

  • Unilateral APA: An APA that involves only the taxpayer and the tax authority of the country where the taxpayer is located.
  • Bilateral APA: An APA that involves the taxpayer, associated enterprise (AE) of the taxpayer in the foreign country, tax authority of the country where the taxpayer is located, and the foreign tax authority.
  • Multilateral APA: An APA that involves the taxpayer, two or more AEs of the tax payer in different foreign countries, the tax authority of the country where the taxpayer is located, and the tax authorities of AEs.

Benefits of APA

  • The very first benefit of APA is the purpose for which it was rolled out, that is, to check evasion of taxes.
  • APAs offer certainty in terms of the tax liability of taxpayer’s foreign transactions by the application of Arm’s Length Pricing technique to decide upon the prices of international transactions.
  • Following the APA guidelines minimizes the time and effort that goes into audit tasks. This removes the threat of audit for an enterprise taxpayer who has business across several countries.
  • As for tax authorities in various countries, the formulation and application of APAs remove extra pressure on their resources and reduces the cost of administration as well.
  • For taxpayers, APAs are even more relevant in these times because business-driven restructurings and changing transfer pricing policies can be compelling reasons to pursue APAs. 
  • APAs boost a country’s attractiveness to investors by providing a definite and predictable policy regime.
  • With limited resources, companies can choose to invest in getting certainty through APAs as a cost-effective alternative to uncertain and long-drawn litigation.

Conclusion

The progress of the APA scheme strengthens the Government’s resolve of fostering a non-adversarial tax regime. The Indian APA program has been appreciated nationally and internationally for being able to address complex transfer pricing issues in a fair and transparent manner.



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