Safe harbour rules, one of the dispute prevention measures for transfer pricing cases which otherwise had suffered considerable litigation, were introduced in 2013 providing for certain profit margins and circumstances for different businesses which, if adopted by the tax payers, would allow the arm’s length prices declared by tax payers to be automatically accepted, and the tax payers would not suffer any transfer pricing adjustments. The option to avail the safe harbour was valid for a maximum of five years commencing from the financial year 2012-13.
But these safe harbour rules fell below the tax payers’ expectations and so were not able to generate significant interest - very few tax payers opted for the safe harbour. Low response was attributed largely to higher margins and no relief at all from compliance burden. Deficiency of high margin was thought to be corrected in the upcoming changes which are likely to be announced soon. But that would not bring any relief from documentation requirement.
If safe harbour is compared to other tax dispute prevention mechanism – Advance Pricing Agreement (APAs), brought in almost at the same time, it seems that the government seems to have paid more attention to that, and it is for these reasons APA programme has almost enjoyed euphoric success. It is perceived by tax payers as pragmatic and accommodating and it is for these reasons has witnessed large filing of APA applications till date; more than 700 APA applications are reported to have been filed, and so far 108 APAs (104 unilateral and 4 bilateral) have been concluded.
Just to put the high profit margin comparison between APA and safe harbours in context, let us take a look at the key export sector of IT and ITeS in the table below:
The comparison shows clearly that there is considerable gap between the arm’s length margin that is considered acceptable under a negotiated APA contract and the safe harbour margin. In this respect, one may be willing to concede the point that safe harbour margins are generally higher than arm’s length margins, the difference can be attributed to the “price or premium” for less administrative rigors and tax certainty. But this factum of premium cannot be stretched too far as they make the safe harbour rates unviable and unattractive.
The issue of reduced documentation requirement for the tax payers opting for safe harbour needs even more attention. The Rangachary committee set up to examine and suggest rules for safe harbour had recommended that documentation burden for tax payers opting for the safe harbour route should be less stringent than other tax payers not following this option. No relaxation in documentation presents a major disadvantage for tax payers who may be willing to pay a premium for availing the benefit of the safe harbour in exchange for the twin benefits of certainty on transfer prices and relief from compliance burden.
Advanced tax administrations having safe harbour rules do adopt a simplified approach. These simplification measures are mainly directed towards low risk tax payers such as small and medium enterprises, or small transactions with a de-minimis threshold. Even the OECD in its guidelines on the subject advises so.
The government, in the coming budget, should consider aligning the safe harbour provisions with other global best practices. In this respect, it may also be worthwhile to revisit some of the recommendations made by the Rangachary committee on the subject. Such changes will go a long way in limiting the protracted litigation on transfer pricing, and also help in establishing a truly effective and practical Safe Harbour regime in the country, ushering thereby a true ease of doing business initiative.
(Sanjay Kumar is Senior Director with Deloitte Haskins & Sells LLP)
Updated Date: Jan 18, 2017 11:29 AM