Govt notifies safe harbour rules to reduce transfer pricing disputes

Mint

In a move to reduce transfer pricing disputes, the government notified safe harbour regulations that were considerably more accommodating than those put out in the draft version.

Safe harbour rules, or the circumstances under which the tax department will accept the transfer price provided by the assessee, will now be applicable for five assessment years rather than two years as proposed in the draft rules to provide more certainty to companies, revenue secretary Sumit Bose told reporters on Wednesday.

Transfer pricing refers to the practice of arm’s length pricing for transactions between group companies based in different countries to ensure that a fair price—one that would have been charged to an unrelated party—is levied.

The tax department has been aggressively scrutinizing cases related to transfer pricing, leading to an increase of Rs.60,000 crore in claims.

The government has also relaxed the transaction limit for availing safe harbour regulations in sectors such as information technology (IT) services and IT-enabled services (ITeS), which will help large companies benefit from these rules.

In the draft regulations, only transactions below Rs.100 crore were eligible for getting the safe harbour benefits. The final rules have relaxed this and now transactions up to Rs.500 crore will be eligible for safe harbour, provided the operating profit margin that is declared in relation to operating expense is 20%. For transactions above Rs.500 crore, this margin should be 22%.

“These are much more palatable regulations and large IT services, KPO (knowledge process outsourcing) and BPO (business process outsourcing) firms will benefit from this relaxation,” said Vijay Iyer, a partner and national leader (transfer pricing) at EY. “Though the margin is a few notches above arm’s length, it is a premium that companies may be willing to pay for reducing uncertainty around their tax liability.”

In a press statement, Nasscom, the lobby group of technology and back-office services companies, welcomed the rules and said they would “help reduce litigation, offer certainty and would help attract new investment as well as expansion of existing centres”.

The government has also removed the ceiling of Rs.100 crore for transactions such as corporate guarantees between group companies. Transactions of this nature above Rs.100 crore will escape the tax department’s scrutiny if the wholly-owned subsidiary is given the highest rating by a rating company.

There are also some relaxations for KPOs. The operating margin requirement has been reduced to 25% from 30%. The transaction limit ceiling has also been done away with. Distinctions will also be made between KPO and BPO units.

Safe harbour rules were part of the Finance Act of 2009, but the rules were never notified. The issue again came to the forefront after Prime Minister Manmohan Singh set up a committee under N. Rangachary, former chairman of the Central Board of Direct Taxes and Insurance Regulatory and Development Authority, to address the concerns of the industry around transfer pricing and recommend safe harbour rules. The income-tax (I-T) department released draft safe harbour rules last month based on this committee’s recommendations.

With the notification of safe harbour rules, besides IT and ITeS companies, contract research and development (R&D) centres in IT and pharma sectors, and auto component manufacturers will also be able to avail of this provision.

Revenue secretary Bose also said that the I-T department has set clear timelines in which the eligibility of the assessee will be determined to avail the benefits under these regulations.

Also, the safe harbour opted by an assessee could be invalid in an assessment year only if there is a change in the facts and circumstances relating to the eligibility of the assessee or of the international transaction.

Mukesh Butani, chairman of BMR Advisors, said the safe harbour provisions have now emerged as a credible alternative to advance pricing agreements (APAs) for companies that are looking to avoid transfer pricing disputes with the I-T department.

“The regulations will benefit multinational companies, but there is a trade-off. The operating profit margin limits are still high and the companies will have to pay a price to buy peace with the department,” he said. “Also, there is no relaxation in transaction or operating profit margin limits for auto component manufacturers and contract R&D centres.”

APA is an agreement between a taxpayer and the tax department on a transfer pricing procedure for a particular set of transactions.

Sanjay Tolia, partner for transfer pricing at Price Waterhouse and Co. in India, said higher markups for higher turnovers do not make any sense.

“This goes beyond the arm’s length principle. In the current times when the rupee is under tremendous pressure, these rules could have been used for garnering more forex for the country rather keep them away,” he said.