Objective of safe harbour provisions
Safe harbour rules were introduced in the Indian transfer pricing regulations in September 2013 close on the heels of the Advance Pricing Agreement (APA) scheme that was introduced in 2012. The sector-by-sector safe harbours rules available from the financial year 2012-13 onwards were aimed at reducing protracted and highly intensive transfer pricing (TP) litigation which had catapulted India to being the third most litigious country in the world in a relatively short time!
Safe harbours are circumstances in which the tax authorities will accept the transfer prices declared by the multinational enterprises (MNE) – such as prescribed profit margin thresholds for specified services. The rules work on a self-declaration basis and there is no filing fees.
There has been talk of refreshing the Safe harbour rules to make them more attractive and in this context we analyse what led to the lacklustre safe harbour climate and what one can look forward to in the new Safe harbour rules.
Safe harbours – largely lacklustre
While the APA scheme has been largely successful gauging from the number of applications filed (approximately 700) and APAs concluded (120 including bilateral), the safe harbours has had very few takers pan India, leading to a near failure of the Safe harbour rules.
One of the primary factors that took away the sheen from the Safe harbour rules in comparison to the APA are the thresholds fixed for the Safe harbour rules are pitched high. At 20 percent operating margin for software & ITES services (22 percent if the value exceeds 500 crores), 30 percent for software R&D services, 29 percent for contract R&D relating to generic pharma drugs, 25 percent for KPO services etc. MNEs do not perceive the trade-off between certainty and additional high tax cost upfront as meaningful.
Also, the Safe harbour rules do not alleviate the need for MNEs to prepare the annual transfer pricing documentation justifying the transfer pricing and getting them certified. Having opted for a higher threshold there is hardly a need for MNEs to justify the pricing on an annual basis. The APA in contrast stipulates specific documentation where required but completely does away with a laundry list of documentation under the TP regulations.
Another spanner in the works is the classification of software services, ITES, contract software R&D and KPO – the definitions are not comprehensive and with the result a number of routine software development or ITES services could get classified as ‘R&D’ or KPO entailing a much higher safe harbour operating profit of 30 percent or 25% respectively.
Finally, the adversarial stance of TPOs was a spoilsport in the few cases that did opt for safe harbours where it was an encore of the TP audit experience. The safe harbour declaration of the applicant was seen with doubt and at times with a view to necessarily rule out R&D or KPO activities that command a higher safe harbour percentage.
Invigorate safe harbours
Clearly, removing the bottlenecks discussed and including specified domestic transactions would provide an additional fillip to the scheme. Instead of specific safe harbours, ranges can be prescribed to help businesses avoid year-end adjustments so long as the transfer pricing falls within the prescribed safe harbour range.
Significant experience is available with the revenue department in terms of the broad range of operating margin percentage agreed for broad buckets of transactions which are quite lower than the safe harbours. The safe harbour thresholds can be straightaway lowered basis this experience and these
Making safe harbours and the APA scheme mutually exclusive would help decongest the APA team’s workload while providing the same benefits to applicants under the safe harbours. The APA team’s time can as a result, be reserved for non-routine, more complex international transactions such as intangibles / cost contribution arrangements etc.
With the landmark adoption of BEPS action plan reports by all G20 and OECD countries in October 2015, the world is clearly moving in tandem to address international tax issues that led to double / non taxation. MNEs accounted for 80 percent of the global trade and about 42 percent of this is intra-group transactions (OECD studies) and will therefore continue to be a significant focus of tax administrations. With nationalistic calls from heads of states, a balancing act is clearly the need of the hour to ensure MNEs do not face trade barriers where no one wins if businesses lose. The Multilateral Instrument is soon going to be reality and one can expect India to move towards bilateral / multilateral safe harbour arrangements being agreed which would be a boon for MNEs operating captives bearing insignificant risks in India. Clearly, high pitched Safe harbour rules in India need to make way for simplified ones underscoring the ‘ease of doing business in India’.
(The writers are Partner, and Manager - Grant Thornton India LLP)
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Updated Date: Jan 30, 2017 17:25 PM