Income tax department to issue directive on safe harbour rules

The income tax department will issue a directive to its officers on the implementation of safe harbour rules in a move that is aimed at allaying fears of companies regarding various aspects of these and which should make transactions between multinationals and their Indian subsidiaries easier and, possibly, litigation-free.

The circular is expected to state that the relatively higher profit margins under safe harbour rules cannot be taken as a benchmark by the transfer pricing officer (TPO) and will not be counted against the company in subsequent evaluations.

In September, India’s finance ministry issued safe harbour rules to reduce transfer pricing litigations after taking into account feedback from all stakeholders on the draft provisions. Safe harbour rules are circumstances under which the tax department will accept the transfer price given by the assessee. Information technology (IT) and Information technology enabled service (ITeS) companies, contract research and development (R&D) centres in IT and pharma sectors, and auto component manufacturers are expected to benefit from these provisions.

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. It has been an area that the income tax department has been aggressively pursuing to garner revenues but has also led to large scale disputes between companies and the tax department.

Companies have to declare a higher operating profit margin—much above what will be considered an arm’s length price—to avail the safe harbour provisions but there was a fear that the transfer pricing officer may quote this margin in all future transactions.

“Apprehensions have been raised by the industry after we notified the safe harbour rules. We will issue written directives to the officers on how to handle these cases. In the event a company does not qualify for safe harbour, the TPO cannot take that price as the benchmark. The TPO will have to do his own analysis and decide on the right price,” said a finance ministry official who did not want to be identified. “A few other concerns have also been raised which will be addressed through the directive,” the official said.

Another finance ministry official said that the concerns of the industry will be addressed. “Reducing disputes related to transfer pricing was one of the main reasons for the introduction of safe harbour norms. So if industry has concerns, they will be addressed by CBDT (Central Board of Direct Taxes),” the official said.

Safe harbour rules were part of the Finance Act of 2009 but due to the lack of consensus, the rules were not notified. The need for safe harbour rules gained momentum after Prime Minister Manmohan Singh set up a committee under N. Rangachary, former chairman of CBDT and Insurance Regulatory and Development Authority (Irda), to address the concerns of the industry around transfer pricing and recommend safe harbour rules.

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

Samir Gandhi, a partner at Deloitte Haskins and Sells, said the safe harbour regime will take at least a year to settle down and for the issues to be addressed.

“The government is trying to ensure smooth implementation of safe harbour and the promised directive to the cadre is one such step. Safe harbour markups should not be considered or deemed arm’s length pricing,” he said. “However, there will be issues as it will not be easy for the TPO to determine whether a company is providing software service or acts as a contract R&D centre for software services.”

It is important that the government ensures that this does not become a detailed and long exercise, he added.