How Budget 2025 can address litigation bottlenecks to improve ease of doing business

Over the past decade, India's remarkable ascent into the World Bank’s Ease of Doing Business index, from a 142nd place in 2014 to 63rd since 2020, has attracted much global attention. Initiatives such as Make in India and the reforms to boost foreign direct investment have played key roles in this progress. Yet, behind the glowing headlines, there still lies the fundamental challenge of reducing the bottlenecks faced by businesses on account of protracted tax litigation. This is evident from the whopping 5,80,188 appeals pending before the Commissioner of Income Tax (Appeals) [“CIT(A)”] as on 26 September 2024. Further, about 64,311 appeals are awaiting resolution before the Income-tax Appellate Tribunal, High Courts and the Supreme Court as on 31 March 2024, involving over Rupees 14 Lakh Crore of amounts disputed.

Among these disputes, transfer pricing (“TP”) litigation emanating from cross border related party transactions, emerges as a thorny issue. The following are a few areas that may be considered to reduce this bottleneck and provide the required tax certainty.

Revamping Safe Harbour Rules

Safe harbour rules ease the burden of managing TP by providing fixed rates or margins which can be followed by businesses, and accepted by the tax department without lengthy audits and consequent legal battles. However, the prescribed rates are higher than industry norms and benchmarking analyses conducted from public domain data, making them less appealing for most businesses. Further, high unilateral margins could come with an inherent threat of the audits getting triggered in foreign jurisdictions.

In the Union Budget of July 2024, the Hon’ble Finance Minister announced plans to revamp these rules by expanding their scope and making them more attractive. While businesses eagerly await the updated regulations, aligning these rates with industry benchmarks including acceptable bilateral ranges and broadening their scope, could be a game-changer.

Fast-Tracking Advance Pricing Agreements (“APA”)
APA is one of the most successful programs of the Indian Government providing an investor conducive environment. Introduced in 2012, it provides companies with certainty in relation to TP by entering into a definitive agreement with the taxpayer. However, the average duration for concluding an APA, ranges from 45.97 months to 63.11 months, leaving businesses waiting in long queues, particularly in cases involving complex transactions. The numbers tell the story. As of 31 March 2024, a staggering 858 APA applications out of a total of 1847 applications filed, remain in inventory5. The following measures can help in reducing the turnaround time for entering into an APA:

• Increasing the officer strength handling the APA cases at all levels;
  
• Posting of officers in the APA team over longer periods prior to their transfers to ensure continuity on the case from filing to resolution;
  
• Fastrack resolution of renewal cases and cases involving routine transactions under a standard framework.
  

Modernizing Profit Attribution Rules
In the buzzing world of e-commerce, foreign multinationals operating in India face a recurring puzzle - how much of their profits can be linked to their Indian operations on account of permanent establishments constituted in India.

Currently, the tax department follows formulary apportionment which uses broad financial metrics like turnover and assets to apportion global profits to Indian operations. This stands in stark contrast to the globally accepted functionally separate entity approach, which evaluates profits based on functions, assets, and risks undertaken in the jurisdiction. The lack of clear domestic guidelines often leads to conflicting interpretations, dragging cases all the way to the Supreme Court.

The solution lies in revamping the rules to incorporate precise and modern attribution guidelines aligning with international practices.

Rationalising the Dispute Resolution Panel (“DRP”)
The DRP was created in 2009 as an alternative to filing appeals before the CIT(A), specifically to avoid protracted disputes, since disposition of appeals by CIT(A) is time consuming. DRP is required to issue directions to AO within nine months.

Ironically, as DRP directions are not appealable by tax department, the DRP has been generally conservative in deciding in the taxpayer’s favour. This leads to higher appeals at Tribunal level, thereby completely defeating the purpose for which DRP was formed. As of today DRP is merely a quicker route to reach the Tribunal. Therefore, scrapping the DRP as a body and further empowering the CIT(A) by introducing a definitive timeline for passing orders can streamline the litigation process. Alternatively, a DRP should not continue as extension of the assessments but rather can be converted or replaced with a mediation mechanism.

Charting a Forward Path
India's impressive climb in the ease of doing business rankings is a testament to its potential. At the same time, without doubt, cross border transactions have been on the rise. Therefore, to truly unlock the potential of further FDI, tackling the challenges in TP dispute resolution and mitigation measures would play pivotal roles. Addressing these hurdles will not only speed up dispute resolution but also create a more predictable and welcoming environment for businesses.

The author is Partner, Deloitte India