Safe Harbour Rules In India

Presenter: Amit Maheshwari

October 10, 2013

2013 Transfer Pricing Associates Holding B.V.

AGENDA

Safe Harbour - Introduction

Indian History
Key Features of Indian Safe Harbour
Procedure
Threshold limits
Definitions modified in Final Rules
Drawbacks
What to watch out for
Conclusion

SAFE HARBOUR- INTRODUCTION

A provision that applies to a defined category of taxpayers or transactions that relieves

eligible taxpayers from certain obligations otherwise imposed by a countrys general TP
rules. Commonly followed in developed nations like USA and Australia.

Safe Harbour is a premium over the arms length price for providing certainty to the tax
payers. Has apparent benefits both for taxpayers and revenue authorities.

Observations shows that Safe Harbors are introduced with the prime objective to address
specific needs of a particular country.

Australia, New Zealand and Singapore introduced them to reduce administrative rigors
relating to relatively low value transactions. Mexico introduced them for contract
manufacturing (Maquiladoras) operations. In USA, these rules were promulgated mainly to
ensure that the US headquartered companies were charging out all the relevant costs that
were incurred centrally for groups benefit.

WHY SAFE HARBOUR?

Simplifying compliance.
Providing certainty , reducing disputes.
Relieving tax administration from audit of taxpayers, enabling better utilization of its
resources.

CRITICISM TO SAFE HARBOUR

Difficult to establish satisfactory criteria

Extensive research necessary
Unfair distribution of tax between tax jurisdictions
Double Taxation
Shift in Administrative burden
Tax planning opportunities having better than average profitability
Raises equity and uniformity issues

INDIAN HISTORY

Finance Act, 2009 Amends Income-tax Act, 1961 (the Act) that empowers the Central Board of
Direct Taxes (CBDT), the apex Indian tax administration authority, to issue transfer pricing safe
harbour rules.
92CB. (1) The determination of arm's length price under section 92C or section 92CA shall be subject
to safe harbour rules.
(2) The Board may, for the purposes of sub-section (1), make rules for safe harbour.
Explanation.For the purposes of this section, "safe harbour" means circumstances in which the
income-tax authorities shall accept the transfer price declared by the assessee.
Below is the extract of the budget speech of the Finance Minister
In order to further improve the investment climate in the country, we need to facilitate the
resolution of tax disputes faced by foreign companies within a reasonable time frame. This is
particularly relevant for such companies in the Information Technology (IT) sector. I, therefore,
propose to create an alternative dispute resolution mechanism within the Income Tax Department
for the resolution of transfer pricing disputes. To reduce the impact of judgmental errors in
determining transfer price in international transactions, it is proposed to empower the Central Board
of Direct Taxes (CBDT) to formulate Safe Harbour rules.

INDIAN HISTORY

14th August 2013 - CBDT releases draft Safe Harbour Rules for public comments.

18th September 20013 - CBDT issues final Safe Harbour Rules to be applicable for 5
Assessment Years starting from A/Y 2013-14.

Significant in the highly litigative transfer pricing scenario . Adjustments > USD 11bn in last
audit cycle.

KEY FEATURES OF INDIAN SAFE HARBOUR

Transfer Price to be accepted if within Safe Harbour limit.

No relief from rigorous documentation. It has to be maintained.

When option of Safe Harbour exercised, MAP route is closed leading to double taxation.

Shall not apply where associated enterprise is located in a no tax or low tax country or
territory. No tax or low tax country or territory means a country or territory in which the
maximum rate of income tax is less than 15%.

The taxpayer e can opt out of Safe Harbour Rules.

PROCEDURE

For exercising this option, assessee shall furnish form 3CEFA to the AO before the due date of filing the
return of income for:
o The relevant AY, where the safe harbour option is exercised only for that AY; or
o The first of the AYs where safe harbour option is exercised for more than one AY.

As part of the application in Form 3CEFA, the following details are to be provided:
o Details of the taxpayer;
o Details for the relevant AY or first of the relevant AYs for which the safe harbour option is exercised;
o Particulars of each eligible international transaction along with transfer price declared.

Form 3CEFA should be signed by the person authorized to sign the return of income of the taxpayer under
the Act.

Mere filing of the Form 3CEFA would not entitle the taxpayer to avail of the safe harbour option. The
same is to be processed by the AO within two months from the end of the month of receipt / filing of the
Form 3CEFA. If Form 3CEFA is not processed / an order not passed within the prescribed timeline (refer
following discussion), the taxpayer would be authorized to avail of the safe harbour option.

Option for Safe Harbour validly exercised shall continue to remain in force for the period specified in form
3CEFA or a period of five years whichever is less.

THRESHOLD LIMITS

Provision of Software development services & Information technology enabled services:

Operating Profit margin

Aggregate value of transactions

Not less than 20%

Does not exceed 500 crore rupees

Not less than 22%

Exceeds 500 crore rupees

Provision of Knowledge process outsourcing services:

Operating profit margin in relation to operating expense should not be less than 25%.

Eligible taxpayer: Contract service providers in IT / ITES who bear insignificant risk such that the foreign principal: (a)
performs most of the economically significant functions involved in the product cycle or R&D cycle; (b) provides capital and
other economically significant assets including the intangibles to the taxpayer; (c) controls and supervises the taxpayer; (d)
assumes economically significant realized risks; and (e) legally and economically owns any intangible or outcomes generated.

THRESHOLD LIMITS

Provision of Contract Research and development services wholly or partly related to

Software development:

Operating profit margin in relation to operating expenses incurred should not be less than 30%.

Provision of Contract Research and development services wholly or partly relating to

Generic Pharmaceutical drugs:

Operating profit margin in relation to operating expenses incurred should not be less than 29%.

Eligible taxpayer: Contract service providers in Software and pharma R&D who bear insignificant risk such that the foreign
principal: (a) performs most of the economically significant functions involved in the product cycle or R&D cycle; (b) provides
capital and other economically significant assets including the intangibles to the taxpayer; (c) controls and supervises the
taxpayer; (d) assumes economically significant realized risks; and (e) legally and economically owns any intangible or
outcomes generated.

THRESHOLD LIMITS

Advancing of Intra-group loans:

Operating Profit margin

Aggregate value of transactions

Base rate of SBI as on 30th June of relevant PY plus 150 basis points

Does not exceed 50 Cr. rupees

Base rate of SBI as on 30th June of relevant PY plus 300 basis points

Exceeds 50 Cr. rupees

Provision of Corporate guarantee :

Commission/ Fees

Amount guaranteed

2% per annum

Does not exceed 100 Cr. rupees

1.75% per annum

Exceeds 100 Cr. Rupees

Eligible taxpayer: Intra-group financing transactions by Indian companies having overseas investments

THRESHOLD LIMITS

Manufacture and export of Core auto components:

Operating profit margin in relation to operating expenses incurred should not be less than 12%.

Manufacture and export of Non-core auto components:

Operating profit margin in relation to operating expenses incurred should not be less than 8.5%.

Eligible taxpayer: Auto component manufacturers

DEFINITIONS MODIFIED

KPO definition rationalized, specifically includes services requiring application of knowledge

and advanced analytical and technical skills

Income tax expense excluded from the definition of Operating expenses

Clarification that explicit corporate guarantee does not include letter of comfort, implicit
corporate guarantee, performance guarantee

Definition of generic pharmaceutical drug introduced. It means a drug that is comparable

to a drug already approved by the regulatory authority in performance characteristics

Definition of ITeS, KPO, and Software development services excludes R&D and contract R&D
both

Corporate guarantees exceeding Rs. 100 Cr are also under safe harbour provided the credit
rating is of the highest safety

DRAWBACKS

Tax payers choosing to opt Safe Harbour shall not be allowed the adjustment and allowance under the
second proviso to section 92C(2), which says if the variation between the decided ALP and price at which
the transaction has actually been undertaken does not exceed 3% of the latter, the actual price shall be
deemed to be ALP.

Safe Harbour doesnt give relief from burdensome documentation that has to be maintained under
normal provisions of transfer pricing and also the report required to be furnished u/s 92E shall has to be
submitted by the assessee choosing Safe Harbour.

Would result in Double taxation since the rules in India are unilateral & not bilateral. Bilateral APA more
suitable for large taxpayers

Such players would have to pursue normal TP documentation & audits, with the chances of facing
protracted litigation.

No clarification that it the Safe Harbour Rules will not be treated as rebuttable assumption

Margins still high especially in this economic downturn

DRAWBACKS

Determination of what is insignificant risk could turn out to be an exhaustive and time consuming
exercise.

Safe Harbour on Guarantee Commission could have been based on slab.

WHAT TO WATCH OUT FOR?

Taxpayer remains an entity bearing insignificant risk in respect of IT / ITES / KPO / software R&D / pharma
R&D.

Assesses should interpret the eligibility definition quite carefully to avoid any future disputes regarding
his eligibility by AO/TPO.

The facts and circumstances on the basis of which the safe harbour option was exercised remain
unchanged which does not give the AO a reason to doubt the eligibility for a subsequent AY.
Examples of facts and circumstances
o
o
o
o

Functional or risk profile of the taxpayer in respect of the transaction

Contractual conditions in respect of the transaction
Conduct of the taxpayer in respect of the transaction
Substantive nature of the transaction.

CONCLUSION

The final rules are a welcome improvement over the draft rules in terms of target profit
margins , coverage and rationalization of definitions

It would have been better if the rules allowed dispensation from maintenance of
documentation which was also widely expected by Industry stakeholders.

Though the rules are a step in the right direction and a very welcome step, it is hoped that
the Revenue authorities dont use them a rebuttable assumption in the field or during the
course of APA/MAP negotiations.

Overall the final rules are a welcome move and reflect the fact that the Indian Government
has its ears to the ground and is keen to attract FDI and intends to avoid disputes.

THANK YOU

Transfer Pricing Associates

Transfer Pricing Associates is an independent professional service and solution provider of expert transfer pricing, valuation and customs services. With
our vast global network covering over 50 countries and a highly diverse staff with profound knowledge, extensive professional and industry
experiences, we deliver premium quality services and solutions customized to your global business.
+31 20 462 3530 | www.tpa-global.com | info@tpa-global.com

Ashok Maheshwary & Associates

Ashok Maheshwary & Associates is a global consulting and advisory firm with headquarters in India and specialized in a selective range of professional
areas within the fields of International Tax, Transfer Pricing, Valuations, Transactions Advisory and Foreign Exchange Regulations.
+91 124 4148033 | www.akmglobal.com | amit@akmglobal.com

The views expressed and the information provided in this material are of general nature and is not intended to address the circumstances of any particular individual or entity. The above
content should neither be regarded as comprehensive nor sufficient for making decisions. No one should act on the information or views provided in this publication without appropriate
professional advise. It should be noted that no assurance is given for any loss arising from any actions taken or to be taken or not taken by anyone based on this publication.
2013 Transfer Pricing Associates Holding B.V.
All Rights Reserved.