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Safe harbour rules applicable for 'international transactions'

India
With the objective of reducing extensive transfer pricing litigation and to provide certainty to taxpayers, the Indian Government has introduced safe harbour provisions in the Indian Income-tax Act, 1961 in 2009. The provisions empower the Central Board of Direct Taxes (‘CBDT’) to specify safe harbours under which the transfer price, as declared by the taxpayer, would be accepted by the Indian Revenue Authorities (’IRA’). The Indian Government constituted a special committee in July 2012 that was entrusted with the task of engaging in sector wise consultations with stakeholders and finalising sector wise safe harbours. Pursuant to the committee’s recommendations, on 14 August 2013, the CBDT released draft safe harbour rules inviting comments from stakeholders. On 18 September 2013, the CBDT released the final safe harbour rules (‘the Rules’) which consider and incorporate comments received from stakeholders.

Taxand India discusses these new rules and their potential impact for businesses with operations in India, in particular the IT/information technology enabled services (ITes) sectors.

The final safe harbor rules are applicable for ‘international transactions’, ie cross-border transactions with related parties and are applicable starting from financial year (‘FY’) 2012-13 and 4 years thereafter. A taxpayer must elect to be sheltered under the safe harbour provisions by filing the appropriate forms. Comparability adjustments, the benefit of the tolerance band and the option of invoking the Mutual Agreement Procedure (‘MAP’) under the applicable tax treaty are not available for taxpayers who would opt to be sheltered under the safe harbour rules. The Rules specifically exclude ‘international transactions’ with no tax or low tax (less than 15 percent) jurisdictions.

The Rules prescribe the following sector wise safe harbours:

  1. For the provision of software development services other than contract research and development (‘R&D’),
    • Not exceeding INR 5,000 mn (approx USD 83.33 mn) – the taxpayer must earn 20 percent or more on operating expense; and
    • Exceeding INR 5,000 mn (approx USD 83.33 mn) – the taxpayer must earn 22 percent or more on operating expense.
  2. ​​For the provision of ITeS other than contract R&D:​
    • Not exceeding INR 5,000 mn (approx USD 83.33 mn) – the taxpayer must earn 20 percent or more on operating expense; and
    • Exceeding INR 5,000 mn (approx USD 83.33 mn) – the taxpayer must earn 22 percent or more on operating expense.
  3. For the provision of ITeS being knowledge processes outsourcing (‘KPO’) services other than contract R&D, the taxpayer must earn 25 percent or more on operating expense.
  4. Intra-group loans to a wholly owned subsidiary (‘WOS’),
    • Not exceeding INR 500 mn (approx USD 8.33 mn) – are required to carry a minimum interest rate of the base rate of State Bank of India (‘SBI’) (an Indian Public Sector Bank) as on 30 June of the relevant previous year, plus 150 basis points; and
    • Exceeding INR 500 mn (approx USD 8.33 mn) – are required to carry a minimum interest rate of the base rate of SBI as on 30 June of the relevant previous year plus 300 basis points.
  5. Explicit corporate guarantee to WOS,
    • For amounts less than INR 1,000 mn (approx USD 16.67 mn) – the Indian guarantor should earn 2 percent or more per annum on the amount guaranteed; and
    • For amounts exceeding  INR 1,000 mn (approx USD 16.67 mn), where the credit rating of the AE conducted by an agency registered with the Securities and Exchange Board of India is adequate to the highest safety – the Indian guarantor should earn 1.75 percent or more per annum on the amount guaranteed.
  6. For the provision of specified contract R&D services wholly or partly relating to software development, the taxpayer must earn 30 percent or more on operating expense.
  7. For the provision of contract R&D services relating to generic pharmaceutical drugs, the taxpayer must earn 29 percent or more on operating expense.
  8. In the context of manufacture and export of core auto components, the tax payer must earn 12 percent or more on operating expense.
  9. In the context of manufacture and export of non-core auto components, the taxpayer must earn 8.5 percent or more on operating expense.

Your Taxand contacts for further queries are:
Mukesh Butani
T. +91 124 339 5010
E. mukesh.butani@bmradvisors.com

Amod Khare
T: +912230217150
E: amod.khare@bmradvisors.com

Taxand's Take

In order to be sheltered under the safe harbour provisions, a taxpayer must furnish its application in the form prescribed by the IRA. The IRA will then verify the applicability of the safe harbour rules to the taxpayer in question and verify that the transfer price as declared by the taxpayer is in accordance with the safe harbour rules. However, even if the taxpayer is eligible and has complied with the safe harbour rules, it is still a mandatory requirement to conduct a yearly economic analysis and maintain transfer pricing documentation.

While the Rules do not reduce the extensive compliance burden on the taxpayer, it could reduce litigation around transfer pricing. However, the high margins proposed by the Rules coupled with the inability of the taxpayer to invoke MAP could lead to double taxation of income. For many taxpayers the cost of this double taxation may be much more than the need to buy peace on their Indian tax litigation. However, considering the potentially high cost of tax litigation, MNCs with small captive units in India may actually consider being sheltered under the safe harbour provisions given that many of these units operate at a cost plus 15 to 18 percent level.

Taxand's Take Author

Mukesh Butani
Taxand Board member
India

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