The agreement is expected to be signed when Obama meets Modi in Delhi starting January 25 (file photo: Reuters)
India has worked out a bilateral tax agreement with the United States, which could be signed during U.S. President Barack Obama’s visit, that would boost foreign investment and ease investors’ concerns raised by high profile cases against Vodafone and Shell.
The pact, which industry executives say would specifically target the contentious issue of transfer pricing, is part of the government's broader push for bilateral tax deals with top trading partners.
According to Reuters, transfer pricing, or the value at which multinational companies trade products or services between their units across borders, has been a contentious issue in India in recent years.
The Income Tax department has aggressively pursued billions of dollars of claims, alleging that foreign companies have underpriced goods or services provided by their Indian units, in order to pay less tax.
Several multinational companies, such as Vodafone Group Plc, Royal Dutch Shell Plc, IBM Corp, Microsoft Corp and Hewlett-Packard Co, have been targeted in the recent past. The tax department charged the firms with under-invoicing the value of products, services or shares offered to the parent companies and, therefore, lowering tax liabilities.
A few companies including Shell have won favourable rulings in the courts, but many other cases are still being litigated. According to tax lawyers the new agreements between India and other countries would not affect those cases.
A finance ministry source told Reuters there was already a broad agreement between the Indian and U.S. tax authorities. Tax officials and lawyers with direct knowledge of the matter said the aim of the pact was to make it easier to predict the fiscal impact of doing business in India.
Finance Minister Arun Jaitley has repeatedly asked tax officials to move towards a tax-friendly regime to erase the "bad name" that India has earned among foreign investors.
In his interim budget on taking office last year, Jaitely had announced new measures to reduce litigation on the transfer pricing issue.
India signed its first transfer pricing tax pact with Japan last month. The tax department is also reportedly in talks with the U.K. and a few other European nations, with agreements likely to be signed later this year.
"This is a very positive framework where the government is saying that we don't always have to go ahead and litigate in most of the transfer pricing cases," said Sanjiv Malhotra, a partner law firm BMR & Associates LLP’s direct tax practice.
Under the bilateral pacts, the government will enter into so-called advance pricing agreements (APAs), which set the tax liability of the transfer pricing value for the next five years, with other countries.
Talks between Delhi and Washington for an agreement first started in late 2013. The endorsement of India's APA programme by US tax authorities will reassure investors that their tax credits won't be challenged.
It will also send a strong signal to overseas investors that Prime Minister Narendra Modi’s government is committed to a non-adversarial tax regime.