The Finance (No 2) Act (FA), 2009 introduced provisions in the Indian Income-tax Law (ITL) that empowered the Central Board of Direct Taxes (CBDT), the apex Indian Tax Administration, to issue transfer pricing “safe harbor” rules. A “safe harbor” is defined in the ITL as circumstances in which the Tax Authority shall accept the transfer price declared by the taxpayer. The CBDT on 14 August 2013 released draft safe harbor rules for public comments. After considering comments of various stake holders, on 18 September 2013, the CBDT issued the final safe harbor rules.
These rules provide minimum operating profit margins in relation to operating expenses a taxpayer is expected to earn for certain categories of international transactions, such as provision of software development services, information technology enabled services, (ITES), knowledge process outsourcing (KPO) services, contract research and development (R&D) services, manufacture and export of automotive components etc. that will be acceptable to the Tax Authority. The rules also provide acceptable norms for certain categories of financial transactions such as intra-group loans made or guarantees provided to nonresident affiliates of anIndian taxpayer.The CBDT, issued transfer pricing (TP) safe harbour rules on 18 September 2013, applicable for five years beginning from financial year (FY) 2012-13 to FY 2016-17. A “safe harbour” is defined in the Indian Income tax law (ITL) as circumstances in which the tax authority shall accept the transfer price declared by the taxpayer.
The CBDT, vide notification 46/2017 dated 7 June 2017, has now amended the safe harbour rules by extending the applicability to an additional category of international transaction as well revising the applicable price/margins that would be accepted as arm’s length. The safe harbour provisions are now extended up to FY 2018-19 with certain modifications in thresholds for the eligible international transactions. For FY 2016-17, the taxpayer has the option to opt for the safe harbours under the old rules or the amended rules, whichever is more beneficial. As per the amended rules, a new category of international transaction for receipt of low value-adding intra-group services has been added. In general, the amended rules seek to make the safe harbour rules more attractive for eligible taxpayers with the objective of reducing TP litigation.
International transactions and applicable safe harbour transfer price
The transfer price declared by an eligible taxpayer shall be accepted by the tax authorities for the below mentioned eligible international transactions subject to the ceilings/circumstances stated as under:
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Eligible international transaction |
Up to FY 2016-17 |
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From FY 2016-17 to 2018-19 |
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Threshold limit prescribed |
Safe harbour |
Threshold limit |
Safe harbour margin |
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margin |
prescribed |
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P r o v i s i o n |
o f s o f t w a r e Up to INR 5 |
20 % or more on Up to INR 1 |
17 % or more on |
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development services other than |
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total operating billion |
total operating |
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contract research & development |
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costs |
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costs |
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(R&D) services with insignificant |
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risks |
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Above INR 5 billion |
22 % or more on Above INR |
1 18 % or more on total operating |
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total operating billion but up to costs |
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costs |
INR 2 billion |
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Provision of information Up to INR 5 |
20 % or more on Up to INR 1 |
17 % or more on |
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technology |
enabled services billion |
total operating billion |
total operating |
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(ITES) with insignificant risks |
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costs |
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costs |
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Above INR 5 billion |
22 % or more on |
Above INR |
1 18 % or more on total operating |
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total operating |
billion up to INR costs |
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costs |
2 billion |
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Amendment Safe Harbor Rules |
Provision of knowledge process No Threshold outsourcing (KPO) services with insignificant risks
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25 % or more on Up to INR 2 |
I) 24 % or more on |
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total operating billion |
total |
operating |
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costs; |
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the |
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costs |
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employee cost in |
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relation |
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Operating cost is |
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at least |
60 %; |
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ii) 21 % or more |
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o n |
t o t a l |
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operating |
costs; |
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a n d |
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t h e |
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employee cost in |
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the |
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Operating cost is |
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40 % or more but |
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less than 60 %; or |
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iii) 18 % or more |
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o n |
t o t a l |
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operating |
costs; |
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a n d |
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t h e |
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employee cost in |
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relation |
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the |
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Operating |
cost |
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does not exceed |
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40% |
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Amendment |
Advancing of intra-group loan to Up to INR 500
- non-resident wholly owned million subsidiary (WOS)
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The Interest rate NA |
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d e c l a r e d |
i n |
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relation to |
the |
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international |
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transaction, |
is |
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e q u a l |
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greater than the |
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base |
rate |
of |
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State |
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India (SBI) as of |
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30 June of the |
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r e l e v a n t |
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previous |
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plus 150 |
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points. |
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Safe Harbor Rules |
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Above INR 500 million |
The Interest |
rate |
declared in NA |
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relation to |
the |
international |
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transaction is equal to or greater |
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than the base rate of SBI as of 30 |
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June of the |
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Implications:
- If safe harbour opted, taxpayer not entitled to make any comparability adjustments nor avail benefit of the prescribed variation.
- Taxpayer required to comply with TP documentation & Form 3CEB filing requirements even if they opt for the safe harbour rules.
- Form 3CEFA to be furnished for the initial year to exercise safe harbour option. Option exercised to remain in force for lesser of the period specified in Form 3CEFA
- Relatively simplified audit process prescribed for taxpayers opting for safe harbour in respect of eligible transactions
- Ineligible to invoke MAP if taxpayer’s safe harbour option is accepted
The other key aspects relating to the amended rules are as follows:
- A definition has been provided for low value adding services.
- To claim eligibility under the safe harbour rules for receipt of low value adding services, the allocation methodology needs to be certified by an Accountant as defined the rules.
- The definition of contract R&D services relating to software development has amended to exclude services which involve making available source code to carry out routine functions.
- Definition of employee costs has been provided.
- Definition of operating costs and operating income has been expanded to include costs relating to stock based compensation provided to employees and reimbursement of expenses.
- For the FY 2016-17, the taxpayer has the option to opt for the safe harbours under the old rules or the amended rules whichever is more beneficial.
Most of the other provisions, including those relating to maintenance of documentation and compliance procedures continue to apply under the amended rules.
