By E. Miller Williams, Jr., Counsel, Alston & Bird, Atlanta, and Richard L. Slowinski, Partner, Alston & Bird, Washington, DC
Although the negotiation process has slowed due the Covid-19 pandemic, demand for bilateral advance pricing agreements (APAs) between India and the US continues to grow due to the high potential for adjustments and the risk of double taxation. US multinationals with a significant presence in India should carefully consider the benefits of obtaining a bilateral APA.
The US and India business relationship has developed over the past 30 years with the investment by US multinationals into India significantly growing too. During the period April 1, 2019, to March 31, 2020, it was estimated by the Indian government that the US direct investment was approximately USD 43 billion, which was around 8% of total foreign direct investment.
As the number of US multinationals doing business in India and their direct investment have grown, so have the amount and complexity of tax disputes for these companies, primarily in the area of transfer pricing. This has led many US multinationals to seek a bilateral ruling from both governments on their intercompany pricing through a bilateral APA.
An APA is an agreement with a tax authority that determines the intercompany pricing based on a formal process of providing information and analysis to reach an agreement on the pricing. The tax authorities agree to perform only high-level annual reviews that the pricing was in line with the APA as opposed to a full transfer pricing audit. A unilateral APA is an agreement with only one tax authority in the transaction, whereas a bilateral APA binds both tax authorities. A bilateral APA is negotiated based on the mutual agreement provisions of the bilateral income tax treaty between the two countries.
This article provides background of the bilateral APAs between the US and India and an update on the current status of the negotiations. Also, it sets forth several items US multinationals should consider when thinking about filing a request for a Bilateral APA.
Background
The US Internal Revenue Service (IRS) developed the US APA program in the early 1990s and has grown it into the current Advance Pricing and Mutual Agreement (APMA) program that is involved annually with working on over 500 APA cases and resolving 100 to 150 APAs. India initiated its APA program in 2012, and it quickly developed, with over 600 applications in the first several years.
However, during this period, the IRS advised India that, due to positions taken in various transfer pricing cases, the IRS would not work with India to resolve double tax cases under the US-India income tax treaty. In line with this decision, the IRS also stated it would not accept and negotiate bilateral APA cases with India. However, by 2015, the two governments came together in two meetings that year to begin resolving double tax cases through the mutual agreement process.
On September 25, 2015, Douglas O’Donnell, Commissioner of the IRS Large Business and International (LB&I) Division at the time, along with Akhilesh Ranjan, representing competent authority for India, announced that the IRS APMA Program would begin developing bilateral APAs with India. Later, John Hughes, Senior Tax Adviser (transfer pricing), LB&I, and now the APMA Director, said that the agency would begin accepting bilateral APAs by March 31, 2016 (the filing date of APA requests in India). He further clarified that all such bilateral APA submissions would need to be prepared in accordance with Revenue Procedure 2015-41, 2015-35 IRB 263 (new APA procedures issued in August 2015).
The IRS APMA Program began accepting formal applications for bilateral APAs between the US and India in February 2016. This process allowed US multinational companies with operations in India (and Indian multinational companies with operations in the US) to seek certainty on their transfer pricing from a bilateral perspective. Also, companies with pending unilateral APA requests in India were permitted to convert that request to a bilateral APA.
Prior to this time, the only option for an APA was a unilateral APA negotiated and issued by the Indian tax authority. While it provided certainty, the result tended to be very favorable to India and did not allow for corresponding adjustments under the mutual agreement procedures of the US-India income tax treaty for adjustments upward to back years or arising from IRS challenges. Accordingly, a bilateral APA with India and the US is considered the better approach.
Achieving certainty
In late 2016, the IRS and Indian tax authority reached a verbal agreement on the first bilateral APA and finalized it in 2017. By 2017, several other bilateral APAs had been agreed and then eventually signed by the two governments.
This led to many companies having an interest in the bilateral APA program to the extent that, by the end of 2020, over 100 US–India APAs had been filed, with approximately 20 being resolved. India has grown to be the country with the second highest number of APAs, just behind Japan.
The IRS’s announcement and report concerning APAs, dated March 23, 2021, shows two charts indicating that over 20% of the pending 400+ APAs relate to India and over half of the pending cases relate to India, Japan and Canada. To date, the arm’s length returns required in the bilateral APAs have been much more reasonable than the returns proposed in the India transfer pricing audits, and mark-up on total cost ranges have been lower than those found in the India unilateral APAs.
In terms of case processing, the IRS and Indian tax authority continue to work APA cases despite Covid-19 challenges. In October and December 2020, the IRS and Indian tax authority held formal meetings by conference call. However, the severity of Covid-19 in India has caused a slowdown in processing in 2021, limited site visits by the Indian tax authority, and prevented the Indian tax authority from meeting with IRS APMA.
From the IRS APMA program perspective, the IRS was able to add additional personnel in 2020 and 2021, increasing the number of team leaders, economists and managers by 30%. This allowed the IRS APMA team to put additional resources on the Indian (and other) cases and move them forward. The IRS has been able to complete a number of position papers and send those for consideration by the Indian tax authority.
Also, the two governments have still been able to hold administrative case discussions in 2021 and even resolved one bilateral APA case with some unique circumstances. The IRS is attempting to work with India to resolve cases in conference calls or by email. However, the Indian tax authority seems to be interested in having more formal APA meetings to discuss the APAs. The two governments hope to meet this fall to continue to negotiate and settle APA and MAP cases.
Based on the authors’ experience, India and US competent authorities were meeting on a regular basis to discuss and resolve cases prior to Covid. In addition, the two governments had joint site visits primarily in India along with a few in the US. In 2020, despite Covid, the IRS and India were able to meet and discuss cases by conference call on a number of occasions, however, not joint site visits. In 2021, due to the Covid situation in India the progress has slowed, however, the IRS and India continue to work on the APAs and hopefully will meet later this year.
Continued need for US–India bilateral APAs
Without an APA (unilateral or bilateral), an Indian subsidiary faces annual transfer pricing documentation requirements, detailed audits and most likely some adjustments, leading to additional tax on income already taxed in the US. Prior to the APA program being developed in India, the tax authority conducted numerous transfer pricing audits and, in most cases, proposed significant income allocations. US multinationals filed numerous court cases to dispute such proposed allocations.
In India, the appeals process and litigation can take over 10 years to reach resolution. Accordingly, US multinationals should obtain a bilateral APA with India, assuming they have significant presence and related party transactions with their affiliated companies in India. The reality is that obtaining the bilateral APA is just part of the cost of doing business in India.
An additional reason to pursue a bilateral APA with India is the level of expected activity likely stemming from the OECD’s base erosion and profit shifting (BEPS) initiatives. BEPS initiatives may allow for countries to become more aggressive in their transfer pricing claims for higher profits due to the activities in their local countries. More US multinationals will likely pursue bilateral APAs to enlist the IRS in their negotiations with the tax authorities in India and other countries to mitigate risks associated with costly future audits.
In addition, the IRS is taking note of the returns earned by subsidiaries in India and other countries and initiated the captive services provider campaign to analyze such arrangements. The following is a description of the campaign from the IRS website:
The section 482 regulations and the OECD Transfer Pricing Guidelines provide rules for determining arm’s length pricing for transactions between controlled entities, including transactions in which a foreign captive subsidiary performs services exclusively for the parent or other members of the multinational group. The arm’s length price is determined by taking into consideration data available on companies performing functions, employing assets, and assuming risks that are comparable to those of the captive subsidiary.
Excessive pricing for these services would inappropriately shift taxable income to these foreign entities and erode the U.S. tax base. The goal of this campaign is to ensure that U.S. multinational companies are paying their captive service providers no more than arm’s length prices. The treatment streams for this campaign are issue-based examinations and soft letters.
With increased audit pressure from tax authorities in both India and the US, companies doing business in India should evaluate the benefits of obtaining bilateral APAs.
Conclusion
Although the bilateral APA process can be lengthy and complex, the fact that over 20 bilateral APAs have been agreed by the US and India is good news for US multinationals hoping to achieve a higher degree of financial and operational certainty for their pricing between India and the US. US multinational companies with significant operations in India that have intercompany transactions with the US should carefully evaluate the benefits they can derive from obtaining bilateral APAs with the US and India.
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