Transfer pricing (TP) litigation and uncertainty are at a high in India, given the depth and breadth of adjustments carried out over the past several years of TP audits. In this backdrop, the Government had promised a set of safe harbour rules, which would enable TP authorities to accept the transfer pricing declared by the taxpayer without litigation. A committee headed by former Tax Board Chairman N. Rangachary was set up to suggest a framework for safe harbour rules in five sectors, including information technology and IT-enabled services, contract R&D in IT and pharma, financial transactions related to outbound loans and corporate guarantees, and the OEM (original equipment manufacture) business for auto parts.

Following deliberations by the committee and a long wait, the draft transfer pricing Safe Harbour Rules were released by the Central Board of Direct Taxes on August 14. These are applicable for assessment years 2013-14 and 2014-15 (see table) .

Whether the safe harbour percentages meet industry expectation cannot be said conclusively. Safe harbours, in general, are not arm’s length and are essentially a premium that the taxpayer may opt to agree on to avoid compliance and litigation burden. In light of this, while some profit margins prescribed in the range of 20 per cent and the corporate guarantee rate of 2 per cent seem moderate and may find takers, the mark-ups for others such as 29-30 per cent interest rates linked to the base rate do need some re-consideration.

The board has also not done away with transfer pricing documentation for safe harbour applicants, which was widely expected and recommended in the committee report. Further, the threshold of transactions for IT, ITES and KPO (knowledge process outsourcing) at Rs 100 crore would leave many taxpayers currently facing litigation outside the rules. So, while the compliance burden remains, the audit certainty for small taxpayers seems to be the sole purpose of the safe harbours.

Taxpayers are free to charge lower mark-ups, subject to normal transfer pricing scrutiny. The draft safe harbour rules clearly state that where a taxpayer does not opt for the safe harbour, the tax officer should determine the arm’s length mark-up using the TP methods prescribed, with no regard to the safe harbour price or margin. The major apprehension is that TP authorities might determine the margins approximating the safe harbours even if a taxpayer has not opted for them. More importantly, the rules provide for the definition of various categories of eligible services, such as what constitutes software development, ITES, KPO, contract R&D. These definitions may require some deliberation and fine-tuning in the final rules, to avert ambiguity and application by TP authorities even where the taxpayer may not opt for the safe harbour. It is also interesting to note that the Rangachary committee has nowhere distinguished a KPO from normal ITES.

The rules also provide that taxpayers having transactions with no- or low-tax countries cannot opt for safe harbour rules. This seems to overlap with the current mood of Base Erosion and Profit Shifting (BEPS), where a consensus action by tax authorities across countries is planned to discourage unilateral positions or safe harbours that provide tax arbitrage opportunities.

Another crucial aspect the taxpayer should evaluate before opting for safe harbour is the acceptability of the Indian safe harbours in the associated enterprise (AE) country. If the acceptability is uncertain, the taxpayer cannot access the double tax treaty concluded with India, as this is specifically excluded for the safe harbour.

Overall, the draft rules in the current form may not serve the primary purpose of reducing the anticipated level of compliance and litigation. There may not be many takers for the safe harbours and, on the contrary, it may complicate the open litigation positions by creating and defining what would constitute a KPO or contract R&D merely on the premise of nature of activity. The safe harbour rules are in the draft stage and the board is expected to factor in most of the public comments/ representations to allay concerns before issuing the final safe harbours shortly after August 26.

Supratik Mukherjee, Manager, Transfer Pricing Services contributed to the article.

The author is Partner and Practice leader, Transfer Pricing Services, Grant Thornton India LLP

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