Impact on APA mechanism due to lockdown.

Introduction

This ongoing pandemic disease, popularly known as Covid-19, needs no elaboration. The entire world has engulfed under its sweep. This is much more than what any of us have ever

witnessed in the past.

This certainly will have (though already started to have) a ripple effect on the global economy with a complete lockdown all over. The businesses are shut, be it manufacturing operations, aviation operations, hotel chains, restaurant, transportation facilities, etc., sparing no industry. To make the matters worse, it is still not known how much more damage will be caused by it before it eventually subsides – if, at all, it does.

With this brief background, we now proceed to discuss the potential impact of this ongoing pandemic  disease, on the Advanced Pricing Agreement (‘APA’) mechanism. APA is one of the tools opted for by the assessees, inter alia, to attain tax certainty and avoid litigation.

The potential impact could be on the (unilateral/bilateral) APAs already in force and the ones which were under final stages of negotiation.

Why renegotiation may be warranted?

With the impact which Covid-19 will have on the businesses (regardless of the industry in which the business operates), it may lead to drastic changes in the business dynamics viz. business models, supply chain  models, value chain models, etc.

Hence, the APA terms (critical assumptions, financial projections, etc.) on which the transactions were originally entered and agreed with the CBDT, may not remain the same.

All such changes may now make it unfeasible for an assessee to continue with the terms agreed in its APA. Provisions of APA under the Income-tax Act, 1961

In India, the provisions of APA are governed by section 92CC and section 92CD of the Income-tax Act, 1961 (‘the Act) read with Rule 10F to Rule 10T and Rule 44GA of Income-tax Rules, 1962 (‘the Rules’). Based on section 92CC, an APA can be entered for a total period of 9 years (including roll-back period of 4 years) at a stretch.

Sub-section (6) of section 92CC of the Act, reads as under:

(6) The agreement referred to in sub-section (1) shall not be binding if there is a change in law or facts having bearing on the agreement so entered.

[Emphasis supplied]

Assume that a Company, namely ABC Ltd., has entered into a Unilateral APA, with the Central Board of Direct Taxes (‘CBDT’) in March 2019, which covered financial year (‘FY’) 2017-18 to FY 2021-22 (assuming no roll back period has been opted for).

In our example, say ABC Ltd. agreed for a cost plus 20% mark-up for rendering certain services to its related entity abroad but, in the above backdrop, the related entity, while renegotiating, reduces the margin to 15%.

Based on the literal interpretation of sub-section (6) of section 92CC, can ABC Ltd. step back and say this  APA agreement is no longer binding on it? Can this forced renegotiation of contractual terms be called as change in facts having bearing on the APA? Potentially, yes.

Furthermore, is renegotiation of APA terms legally possible? Yes, Rule 10Q of the Rules  provides for an  option to CBDT to revise the terms of an APA, either suo-motu or on request from the assessee or competent authority in India or the Director General of Income-tax (International Taxation) or competent authority in the other country (in case of bilateral or multilateral APA). Even the executed APAs provide for the same.

Furthermore, the APAs which were almost in the final stages of negotiation may require all the parties (could

be more than two in case of bilateral) to get back to the drawing board and re-negotiate the terms. Conclusion

It will not be surprising to see taxpayers lining up before the CBDT for renegotiating the terms of the APA. Not sure if that has ever happened before.

Not to forget, with the large-scale impact this will potentially have on the businesses, even the revision of terms of APA would require detailed discussion within the organisations and would be a practical challenge. Projections which were made basis normal expected growth rate would drastically fall making it difficult for the taxpayers to justify their positions.

Only time will tell if CBDT, considering the gravity of the situation, will appreciate and agree to potential loss in the tax revenue or it will restrain relenting to the situation because even they will look to maximise their tax collections to reduce the major dent this disease is likely to have on the overall economy.

Points to ponder

Having discussed the above from the Indian context, this issue could be faced by all taxpayers across the world who have entered into the APAs which are still in force. Depending on the provisions of tax laws of the respective countries, taxpayers may act accordingly.

However, what if such tax laws do not specifically provide for any renegotiation? Can a taxpayer enforce ‘doctrine of force majeure’ even if there is no such clause in the APA?

Even if force majeure is not present, a taxpayer may invoke other similar legal doctrines, depending on the governing law of the contract in that particular country. These include frustration of purpose or commercial impracticability, and in civil law jurisdictions, doctrines like hardship and changed circumstances.

Time to explore all such possibilities?