Safe Harbour provisions in India since its introduction in 2013
had hardly received any positive response for over last three years
as compared to the phenomenal success of Advance Pricing Agreement
(APA). The reasons were very obvious – the safe harbour
margins were very high and not necessarily reflecting the arm's
length scenario and the APA's for similar transactions were
being inked at lower percentages.
Taking a cue from the above, the Central Board of Direct Taxes
(CBDT) vide notification dated 7 June 2017 has revised the Safe
Harbour Rules by relaxing the rates and making few other prominent
changes, which would make it an attractive option, especially for
SMEs.
Generally, safe harbour means circumstances in which Income Tax
Authorities shall accept the transfer price declared by the
taxpayer. The revised safe harbour provisions are applicable from 1
April 2017, i.e. (Financial Year) FY 2016-17 and shall continue to
remain in force for three years (instead of five years in the old
safe harbour regime). For example, if the eligible assessee
exercises the option to opt for safe harbour provisions in FY
2016-17, the provisions shall apply for FY 2016-17 and two
subsequent financial years i.e. up to FY 2018-19. Where the
taxpayer is eligible under the old safe harbour regime (notified in
2013) up to FY 2016-17, he shall have the right to choose the safe
harbour option (either old or revised) one whichever is most
beneficial to them.
Changes in circumstances under which transactions can
qualify for safe harbour provisions
The following table provides a synopsis of the revised safe harbour
provisions along with the changes compared to the provisions
released in 2013:
Eligible transaction | Revised Safe Harbour rates pursuant to the notification issued on 7 June 2017 | Comments | ||||||||||||||||||
Provision of software development services or Information Technology (IT) enabled services. |
17% operating margins if the annual transaction
value does not exceed INR 1 billion (approximately USD 15
million). 18% operating margins if the transaction value is between INR 1 to INR 2 billion (approximately USD 15 million to USD 30 million) |
The revised rules have reduced the safe harbour margin (from 20% or 22%) but have introduced a cap on the value of international transaction that would qualify for safe harbour provisions. Earlier regulations did not have any cap on the value of transactions. | ||||||||||||||||||
Provision of Knowledge Process Outsourcing (KPO) services. |
For annual transaction value that does not exceed INR 2
billion (approximately USD 30 million) operating margins
of:
|
The revised rules have reduced the safe harbour margins (from 25%) but have introduced a cap on the value of the international transaction that would qualify for safe harbour provisions. Along with that, now the operating margin is variable and dependent on the employee cost as a percentage of operating expense as compared to a blanket 25% earlier. | ||||||||||||||||||
Providing corporate guarantee | Irrespective of the guaranteed amount, the safe harbour rate has been reduced to 1% per annum of the amount guaranteed. | The revised rules have reduced the safe harbour guarantee fees (from 1.75% or 2%) to 1% and made its application more simplified irrespective of the guaranteed amount and credit rating of the Associate Enterprise (AE). | ||||||||||||||||||
Provision of contract Research and Development (R&D) services (relating to software development or generic pharmaceutical drugs). | 24% operating margin if the annual transaction value does not exceed INR 2 billion (approximately USD 30 million). | The revised rules have reduced the safe harbour margins (from 30% or 29%) but have introduced a cap on the value of the international transaction. | ||||||||||||||||||
Manufacture and export of auto components |
For core auto components - 12% operating
margin; For non-core auto components - 8.5% operating margin |
There is no change in the safe harbour rates. | ||||||||||||||||||
Advancing of intra-group loans (for loans denominated in INR and foreign currency) |
|
Safe harbour interest rates are now based on currency in which loan is denominated and also CRISIL credit rating. The revised safe harbour provisions acknowledge the difference in the currency has an impact on the base rate on which spread is added and have accepted the concept of interest rates linked to LIBOR which was till now heavily litigated by the Tax Authorities. | ||||||||||||||||||
Receipt of low value adding intra-group services |
The value of the transaction, including a markup not
exceeding 5%, does not exceed a sum of INR 100
million. Furthermore, there is a requirement that the method of cost pooling, the exclusion of shareholder costs and duplicate costs from the cost pool and the reasonableness of the allocation keys used for allocation of costs to the taxpayer by the overseas AE should be certified by an accountant. Low value adding intra-group services have been defined to mean services performed by one or more MNE of the group on behalf of other members of the same MNE group and which:
|
This is a completely new addition to the rules which is aligned to BEPS Action Plan 8-10. |
All conditions to qualify to become an eligible taxpayer remains unchanged under the revised safe harbour regime except for the addition of receipt of low value adding intra-group services.
The revised Rules have also broadened the definition of operating expenses on which safe harbour margins are applied, so as to include:
- Costs relating to employee stock option plan or similar stock-based compensation provided for by the AE of the taxpayer to the employees of the taxpayer;
- Reimbursement to AE of expenses incurred by the AE on behalf of the taxpayer;
- Amounts recovered from AE on account of expenses incurred by the taxpayer on behalf of those AEs and which relate to normal operations of the taxpayer.
The reimbursement and the recovery of expenses included in the
operating expenses should be at cost.
The definition of operating revenue has also been revised so as to
include costs relating to employee stock option plan or similar
stock-based compensation provided for by the AE of the taxpayer to
the employees of the taxpayer.
There are no changes in the procedural aspects under the revised
safe harbour regime which means that the taxpayer has to lodge its
option of availing safe harbour in Form 3CEFA by the due date of
filing return of income (for FY 2016-17 it is 30 November
2017).
SKP's comments
The recent measures taken by the Indian government in the transfer pricing arena by aligning Indian transfer pricing regulations with global best practices and introducing steps to reduce the transfer pricing litigation are commendable. Rationalising the safe harbour margins would now bring the government closer to achieving its earlier objective of reducing the transfer pricing disputes, providing administrative simplicity and certainty to the taxpayers and at the same time offer an alternative to APAs.
The cap on the value of international transactions would imply that it would largely benefit the SMEs. The lower safe harbour rates coupled with the reduction in the tax rate for SMEs announced in the budget earlier this year would imply a significant reduction in the tax outflow for SMEs. By aligning the revised safe harbour margins with the margins that are generally agreed to under the APA signed recently, the government perhaps has signalled its willingness to reduce the APA margins further in such cases. With the revised safe harbour margins one can definitely expect some withdrawals of APA's that are filed and lower number of APA's now, it also provides a great opportunity for MNC's to pursue APA's and negotiate a further lower markup thereby reducing their overall tax costs in India.
Similarly, revision of the safe harbour for outbound financial transactions – loans and guarantees are a welcome move. For loan transactions, while the interest rates and segregation of loans into foreign currency and INR denominated loans are fair, the obligation of credit rating being required of the overseas AE by CRISIL might be a burdensome and costly affair for the taxpayers opting for safe harbour provisions. However, the tax payer's position of adopting LIBOR-based rates for foreign currency denominated loan stands vindicated with the safe harbour provisions and we can now hope that revenue authorities can put to rest the existing litigation in this area.
Safe harbour on low value added intra-group services is a big, bold and positive move and just shows the intent of the Indian government to walk the talk on BEPS Action Plans. There is a huge amount of litigation on management cross charges and the safe harbour now introduced in this area will give a big boost to certainty and investors confidence.
Companies are advised to relook at their existing transfer pricing policies and re-evaluate them in light of revised safe harbour rules. Adopting to the safe harbour or APA is definitely recommended to keep the litigation at bay.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.