Transfer Pricing – Alternative Dispute Resolution Mechanisms March 2012

1. Transfer Pricing – Alternative Dispute Resolution MechanismsMarch 2012

2. Contents Transfer Pricing - Background and recent trends Normal Dispute Resolution Mechanisms Alternate Dispute Resolution Mechanisms Dispute Resolution Panel Mutual Agreement Procedure Advance Pricing Agreement 1

3. Transfer Pricing - Background and Recent Trends

4. Transfer Pricing - A Global Overview • New and expanding transfer pricing legislation and rules are in vogue in many countries • Stepped up enforcement globally in the form of: • More auditors, better training • Increasingly sophisticated • Change in scrutiny mechanism • Complex issues and transactions are picked up for scrutiny and increasingly challenged • India, China, Australia, Korea and Japan have all recently seen an increase in number of cases picked up for scrutiny • Singapore and other tax authorities have signaled intent to step up Transfer Pricing (TP) compliance and field audit work.

5. Ten most aggressive tax authorities for Transfer Pricing Asian Countries aggressive tax authority poll - India ranks second following Japan and preceding China (source -TP Week)

6. Transfer Pricing - Scrutiny Trend • Since introduction of the Transfer Pricing regulations in India in 2001, the Directorate of Transfer Pricing has made adjustments of approximately INR 45,000 cr (approximately US $ 10,000 million) (source - Extract of Finance Minister’s speech made at a press conference on January 25, 2011 on prevention of money laundering) • Transfer Pricing additions touch INR 44,500 cr in the recently completed round of Transfer Pricing Audits ended 31 October 2011 (approximately US$ 9,271 million)(source - DNA Money newspaper publication, November 15, 2011) • On an average, Transfer Pricing adjustments are made on 54%* cases picked up for scrutiny • *Estimates based on various sources 5

7. Key Triggers and Contributors for Transfer Pricing Audits • Key Triggers for Aggressive Audits • Consistent losses / low margins of the taxpayer attributable to inter-company transactions • Significant changes in profitability of the taxpayer and its Associated Enterprises • High Royalty / Technical fee payouts, Cost recharges, Management Fees, Cost allocations • Net losses incurred by routine distributors • Low mark-ups for services • Significant Advertisement and marketing spends by manufacturing / distribution companies Contributors to Aggressive Audits: • Mounting fiscal demand on Government • Need to preserve tax base • Unprecedented sharing of information between revenue authorities Substantial increase in transfer pricing audits and disputes across the Globe , India is no exception…. 6

8. Normal Dispute Resolution Mechanism

9. Dispute Resolution Mechanism – Traditional Route • Most direct tax disputes are dealt under traditional dispute resolution avenues • Each level of hierarchy involves substantial period of time • At times, cases at lower levels are passed in favour of revenue Timelines to achieve any possible certainty in tax positions – Years !!!!

10. Dispute Resolution Mechanism - Issues • Tax uncertainty coupled with substantial period in litigation process • Huge number of pending cases before the various dispute resolution fora • Aggressive approach in tax collections and tedious tax refund process dents taxpayers confidence • Conflicting decisions at various levels of dispute resolution fora adds to the complexity of the Indian tax laws • Possibility of further litigation

11. Alternate Dispute Resolution Mechanism

12. Mechanisms to resolve Disputes - Practical Experiences • Dispute Resolution Panel (DRP) • Mutual Agreement Procedure (MAP) • Advance Pricing Agreements (APAs) 11

13. Dispute Resolution Panel (DRP)

14. DRP Process Draft Order by tax officer Receipt of draft order by taxpayer TP Order prejudicial to taxpayer Taxpayer files objections to variations to the DRP Taxpayer intimates to tax officer of acceptance of variation No action taken by taxpayer DRP to issue directions binding on the tax officer Tax officer to pass final order Tax officer to pass final order (Within 9 months from the end of the month in which draft order is issued) (Within one month from end of month in which period for filing objections with DRP expires) (Within one month from end of month in which acceptance received) Tax officer to pass final order Taxpayer to file appeal with CIT within 30 days of receipt of final order from AO (Within one month from end of month of receiving binding directions from DRP)

15. Dispute Resolution Mechanism Perceived Benefits • Specialist Panel - Three views instead of one • Speedy Resolution - Time bound • Direct Appeal to the ITAT by the taxpayer • Department cannot appeal against the DRP directions • No demand till AO issues final order based on DRP directions Experiences • Over 1,000 cases filed across 8 cities - strain on 9 month timeline • Frequent and numerous adjournments consequent to absence / transfer of panelists • Very short hearing notices and time limit set for hearing • Absence of independent institutionalized form of Dispute Resolution • Legal issues not dealt with by DRP On a writ petition filed by Vodafone, the Delhi HC held that DRP should pass a reasoned order

16. DRP vs. CIT(A) Depending upon the facts and circumstances of each case, the CIT(A) route may be preferred in cases where: • No compelling reasons for a fast track to ITAT hearing • Covered matter – ITAT / Higher authorities’ orders are in favor • Directions of DRP are non-speaking • If CIT(A) has ruled in favor of taxpayers on similar issues in preceding years • If no favorable order exists, possibility that the CIT(A) could exercise flexibility / independence in approach

17. Mutual Agreement Procedure (MAP)

18. MAP Procedure Tax Dispute Taxpayer approach CA of the contracting state of his residence CA of home country rejects application CA of home country accepts application for MAP Dispute capable of Unilateral resolution Yes CA of home country unilaterally resolves No No Success No Agreement is reached Should be resolved by consultation Success Mutual agreement is reached

19. Confirmation of receipt of MAP application by other CA within 1 month Review of position paper and determination response on it within 6 months Approval of mutual agreement by the taxpayer within 1 month MAP application filed within 3 years of being aggrieved Mutual agreement between CAs and drafting of MoU within 6 months Confirmation of MAP application and advising to other CA within 1 month Exchange of closing letters within ASAP Negotiation between CAs within 6 months Implementation of mutual agreement within 3 months Analysis & Evaluation by the CA and issuance of position paper within 4 to 6 months Acceptance of MAP application and notification to taxpayer within 1 month How long is a MAP process

20. MAP vs. Indian Judiciary

21. MAP – Current Updates • Indo-US Competent Authorities recently arrived at a mutual agreement in respect of US captive providing software\ IT enabled services • Margin of 18 percent for fiscal year 2003-04 and 17.5 percent for fiscal year 2004-05 concluded as opposed to 24% to 26% proposed by Indian Revenue • This settlement results in a gross relief of approximately 9% and would also entail a correlative adjustment, and thereby eliminating double taxation • Based on the above conclusion the 5% relief, working capital / idle capacity adjustments would not be available. Would the 17.5% be a guiding factor while arriving at the mark-up for safe harbour???

22. Advance Pricing Agreements (APA)

23. APA – An Overview • The OECD transfer pricing guidelines Chapter IV, Section F define Advance Pricing Arrangement (‘APA’) as: • “An arrangement that determines, in advance (emphasis added) of controlled transactions, an appropriate set of criteria (e.g. method, comparables and appropriate adjustments thereto, critical assumptions as to future events, etc.) for the determination of the arm’s length price for those transactions over an agreed period of time.” • APA provides win-win situation for all the parties involved • APA’s are of 3 types: • Unilateral APA – APA between taxpayer and tax authority of domestic country • Bilateral APA – APA between taxpayer and two tax authorities • Multilateral APA – APA between taxpayer and multiple tax authorities Although simpler to implement than a bilateral/multilateral APA, unilateral APAs not recognized by the foreign tax authority……. 22

24. APA Process (1) Planning • APA Strategy • Fact gathering and analysis • Economic analysis • Finalise APA and sign agreements • Adjustments and APA annual reports (2) Pre-filing (5) Dispute Resolve APA Administration • Prepare pre-filing docs • Pre-filing meetings • US fee payment (3) APA Submission (4) Post Submission • Receive/ reply to tax authority questions • Meeting with the Authorities • Site visits • Recommended negotiating position • CA negotiation • Prepare and file APA request/submission • Acceptance Letter

25. Advance Pricing Arrangement – Indian Context • The Board may enter into an APA with a taxpayer for determination of the ALP in respect of an international transaction • Determination of ALP by any method including one of the prescribed methods • APA term would be limited to a maximum term of five consecutive financial years – No provision for roll back • The APA would be binding on the taxpayer and the Tax Authorities, and only in respect of the international transactions for which the agreement is sought • The DTC provisions appear to cover only Unilateral APAs • The Board to frame rules for APAs

26. APAs – Potential Benefits & Challenges in the Indian Context • Potential Benefits • Certainty on Tax Issues (Particularly in case of complex high risk transactions) • Avoidance of protracted litigation (time consuming and expensive) • Facilitates Transfer Pricing planning • Could provide opportunity to apply agreed methodology to resolve similar issues in open prior years • Challenges • Costs could be significant and could take multiple years to finalize • Creating knowledge/ research base, appropriate resources, databases and other infrastructure requirements • Extent of information required - exposes all aspects of the business due to voluntary nature of the process • Reliable prediction about the future outcomes would be difficult to make - assumptions initially made may not adequately reflect changing market conditions • Considering that the DTC proposes what appears to be a Unilateral APA - whether this will be able to resolve issues associated with double taxation

27. APAs in India – The Way Forward • Provision for Bilateral / Multilateral APA mechanisms • Clearly defined goals and responsibilities for the APA program, including strong legal framework incorporating APA mechanism into domestic tax law • Dedicated APA team, separate from Transfer Pricing Officers associated with the audit - to ensure consistency in interpretation of critical assumptions and enhance effectiveness • Availability of specialist resources with industry knowledge for the APA team along with requisite database • Formulate position on rollbacks - taxpayers must have assurance that past closed years will not be reopened for audit based on the transfer pricing agreed in the APA 26

28. Q & A Questions Kishore Nair Senior Manager, B S R & Co Email: kishorenair@kpmg.com & Answers ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials.