Advance Pricing Agreements and Double Taxation Avoidance

Advance Pricing Agreements (APAs) and Double Taxation Avoidance Agreements (DTAAs) are pivotal mechanisms in international taxation aimed at fostering certainty, transparency, and fairness in cross-border transactions. APAs enable multinational enterprises and tax authorities to pre-determine transfer pricing methodologies, providing clarity on how transactions between related entities will be taxed. On the other hand, DTAAs are bilateral or multilateral agreements between countries designed to alleviate the burden of double taxation on individuals and entities operating across borders. Both APAs and DTAAs play critical roles in promoting international trade and investment by mitigating tax uncertainties and preventing fiscal burdens that may arise from conflicting tax jurisdictions. This essay delves into the intricacies of APAs and DTAAs, exploring their significance, implementation processes, and impact on global taxation frameworks.

Tags: GS – 2, Government Policies & Interventions, GS – 3, Growth & DevelopmentIndia and its Neighbourhood- Bilateral Groupings & Agreements- Inclusive Growth

For Prelims: Central Board of Direct Taxes, Advance Pricing Agreements, Double Taxation Avoidance Agreement, Tax evasion

For Mains: Significance of APAs in ensuring tax certainty, Double Taxation Avoidance Agreements and their significance, Ease of Doing Business

Table of Contents

Context:

The Central Board of Direct Taxes (CBDT) has reached a significant milestone by finalising 125 Advance Pricing Agreements (APAs) during the fiscal year 2023-24.
This notable increase in APA signings highlights the increasing significance of transfer pricing regulations and the endeavours to offer assurance to taxpayers.
In a complementary development, India and Mauritius have revised their Double Taxation Avoidance Agreement (DTAA) to combat tax evasion and promote equitable taxation practices.

What is an Advance Pricing Agreement?

About:

An APA is a formal agreement between a taxpayer and a tax authority regarding transfer prices.
APAs enable businesses to mitigate the risk of their transaction prices being contested by tax authorities.
The APA program has significantly advanced India’s goal of fostering ease of doing business, particularly for Multinational Enterprises (MNEs) with numerous cross-border transactions among their group entities.

Types of APAs:

Unilateral APAs: Mitigate risks for transactions between domestic entities but do not guarantee avoidance of double taxation for transactions with foreign entities. Proceedings are relatively shorter compared to other types of APAs.
Bilateral APAs: Mitigate risks for transactions between a domestic entity and a foreign entity, ensuring the elimination of double taxation. Proceedings are longer as two states must reach an agreement.
Multilateral arrangements: Mitigate risks for transactions among related entities in three or more states, serving as a protective measure for complex transactions and ensuring security for both parties, albeit with lengthier proceedings.

Key Features of APAs:

The APA process is voluntary and complements appeal and other mechanisms under Double Taxation Avoidance Agreements (DTAA) for resolving transfer pricing disputes.
The term of an APA can be a maximum of nine years (including five years prospectively and four years retrospectively if the taxpayer has opted for the roll-back mechanism).
The procedure ensures the safeguarding of sensitive data provided by businesses.
Statistical data and summary information are published, without disclosing the names of entities with concluded arrangements or applicants.

Importance of APAs for Businesses:

Provides tax certainty in determining the arm’s length price of international transactions.
Reduces the risk of potential double taxation through bilateral or multilateral APAs.
Decreases compliance costs by eliminating transfer pricing audit risk and resolving disputes.
Eases the burden of record-keeping by providing advance knowledge of required documentation.
APAs enable businesses to mitigate the risk of their transaction prices being inaccurately set or contested by tax authorities.
APAs can be an effective tool for businesses to manage their tax risks and planning.

Central Board of Direct Taxes (CBDT):

Established under the Central Board of Revenue Act, 1963, the CBDT is a statutory body functioning within the Department of Revenue under the Ministry of Finance.
It plays a crucial role in providing inputs for policy formulation and strategic planning concerning direct taxes in India. Additionally, it oversees the administration of direct tax laws through the Income Tax Department.

Double Taxation Avoidance Agreement (DTAA):

A DTAA is a tax treaty signed between two or more countries with the primary aim of preventing taxpayers from being taxed twice on the same income.
These agreements are applicable when a taxpayer resides in one country but earns income in another.
DTAAs can be comprehensive, covering all income sources, or limited to specific areas like income from shipping, air transport, or inheritance.
In 1983, India and Mauritius entered into a DTAA to address double taxation concerns, applying to residents of both nations.

The India and Mauritius DTAA Amendment Entail?

Principal Purpose Test (PPT): The India-Mauritius Double Taxation Avoidance Agreement (DTAA) now incorporates the Principal Purpose Test (PPT) through an amended protocol. Under the PPT, treaty benefits will be denied if it is determined that the primary purpose of any transaction or arrangement was to obtain those benefits.
Article 27B: A new article, Article 27B, has been added to the treaty to define the ‘entitlement to benefits.’ This article outlines the conditions under which treaty benefits, such as reduced withholding tax on interest, royalties, and dividends, will be denied.
Focus on Preventing Treaty Abuse: The amendment to the DTAA aims to tackle concerns related to tax evasion and avoidance resulting from the misuse of treaty provisions. With the inclusion of the PPT, the revised treaty seeks to ensure that tax benefits are not exploited for improper purposes.
Uncertainty Regarding Past Investments: Despite the amendment, there is uncertainty surrounding the treatment of investments made under the previous provisions of the DTAA. Clarity is awaited from the Ministry of Finance regarding the applicability of the new provisions to existing investments

India and Mauritius have established robust commercial relations over the years:

Since 2005, India has stood as one of Mauritius’ prominent trading partners.
For the fiscal year 2022-2023, Indian exports to Mauritius amounted to USD 462.69 million, while Mauritian exports to India totaled USD 91.50 million, resulting in a total trade volume of USD 554.19 million.
Over the past 17 years, trade between the two countries has witnessed a significant surge, growing by 132%.
Initially, petroleum products constituted the primary export item from India to Mauritius, shifting later to include pharmaceuticals, cereals, cotton, seafood, and bovine meat.
Conversely, Mauritian exports to India encompass commodities such as vanilla, medical devices, aluminium alloys, scrap paper, refined copper, and men’s cotton shirts.
Between 2000 and 2022, Mauritius has been a significant source of Foreign Direct Investment (FDI) for India, contributing a cumulative worth of USD 161 billion, largely attributed to the Double Taxation Avoidance Agreement (DTAA).
In 2021, Mauritius and India inked the Comprehensive Economic Cooperation and Partnership Agreement (CECPA), marking India’s inaugural trade pact with an African nation.
Further enhancing economic ties, the Unified Payment Interface (UPI) and RuPay card services were introduced in Mauritius in 2024, aimed at facilitating seamless domestic and international transactions for users in both countries.

UPSC Civil Services Examination, Previous Year Questions (PYQs)

Prelims

Q:1 With reference to India’s decision to levy an equalisation tax of 6% on online advertisement services offered by non-resident entities, which of the following statements is/are correct? (2018)

It is introduced as a part of the Income Tax Act.
Non-resident entities that offer advertisement services in India can claim a tax credit in their home country under the “Double Taxation Avoidance Agreements”.

Select the correct answer using the code given below:

(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Ans: (d)

Source: (PIB)

FAQs

Q: What is an Advance Pricing Agreement (APA)?

An APA is a mutual agreement between a taxpayer and tax authorities regarding the transfer pricing method to be applied to transactions between related entities. It aims to prevent transfer pricing disputes by establishing clear guidelines upfront.

Q: How does an APA benefit taxpayers?

APAs provide certainty and predictability in tax planning by reducing the risk of transfer pricing adjustments and associated penalties. They also save time and resources by resolving potential disputes before they arise.

Q: What is a Double Taxation Avoidance Agreement (DTAA)?

A DTAA is a treaty between two countries to prevent taxpayers from being taxed twice on the same income. It allocates taxing rights between the two countries and provides mechanisms for resolving conflicts arising from overlapping tax jurisdictions.

Q: How does a DTAA facilitate international trade and investment?

DTAA promotes cross-border trade and investment by eliminating or reducing double taxation, thereby enhancing the attractiveness of foreign investment and fostering economic cooperation between treaty countries.

Q: What are the key differences between APA and DTAA?

APAs focus on transfer pricing issues between related entities within a single jurisdiction, aiming to provide certainty and prevent disputes. DTAA, on the other hand, addresses the issue of double taxation between two or more countries, promoting international trade and investment through tax treaties.

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Advance Pricing Agreements and Double Taxation Avoidance Agreement – UPSC