IN the year 2013, the CBDT had introduced the Safe Harbour Rules ('SHR'), optional for a taxpayer, with the conditions and circumstances under which norms / operating margins would be accepted for certain categories of international transactions by the tax authorities. The safe harbour margins are akin to an arm's length price which help taxpayers in avoiding disputes and protracted litigations.
With both APA and SHR in place, large taxpayers have opted for APA programme for certainty over SHR primarily because of the proposed high margins and limited coverage of inter-company transactions in the pre amended SHR.
The only thing which is not constant is "change". So, with the success of APA programme in India, the Indian government has taken one more positive step to reduce the burden of tax litigation, and foster ease and transparency for doing business in India, by amending the existing SHR 1.
The amended SHR has been extended to include additional category of international transactions. The rules have also revised the applicable price/margins that would be accepted as being at arm's length. The amended SHR has been extended up to FY 2018-19 with certain modifications in thresholds for the eligible international transactions .
Highlights of the amended SHR :
Some of the key highlights of the amended SHR are provided below:
- The amended SHR are applicable for the period of 3 years unlike the pre amended SHR which was valid for the period of 5 years ( from AY 2013-14 to AY 2017-18);
- The taxpayers have the option to choose the amended SHR or pre amended SHR for AY 2017-18, whichever is more beneficial to the taxpayer;
- The definition of 'contract research & development services' in the context of software development has been amended to exclude routine functions like debugging of software carried out by taxpayer, and where the source code has been made available to carry out such routine functions;
- The amended SHR has given more emphasis on the employee cost which is a key driver for a Knowledge Process Outsourcing ('KPO') and accordingly, different operating profit ('OP') margins have been determined depending on the percentage of employee cost i.e. higher OP margin with higher employee cost;
- The amended SHR has reduced the net OP margins for small and medium software development ('IT'), information technology enabled service ('ITeS') and contract research and development ('R&D') service providers for software and generic pharmaceutical drugs;
- The amended SHR for IT/ ITeS/ Contract R&D/ KPO services is restricted to the value of international transactions not exceeding INR 200 crores;
- The amended SHR has segregated the safe harbour interest rates for inter-company loans denominated in foreign as well as domestic currencies;
- For corporate guarantee, the amended SHR has introduced a single reduced rate at 1 percent to be considered for calculation of the commission;
- New category of international transaction relating to 'receipt of low value adding intra-group services' from the foreign associated enterprise ('AE') has been included within the purview of the amended SHR. This is a welcome move in line with the global practices and BEPS Action Plan 10;
- The definition of the operating cost has been amended to include costs relating to Employee Stock Option Plan ('ESOP') or similar stock based compensation by the AE to the employees of the taxpayer, reimbursement of expenses by the taxpayer to its AE and recovery of expenses by the taxpayer from its AE relating to the normal operations of the taxpayer;
- The definition of the operating revenue has been amended to include costs relating to ESOP or similar stock based compensation by the AE to the employees of the taxpayer;
- There is no change in the safe harbour margins for manufacture of auto and non-core auto components; and
- There is no change in the timelines / procedure within which the tax authorities need to take action on the safe harbour option exercised by the taxpayer.
Comparison of pre and post amendment Safe harbour margins :
The comparative analysis of pre and post amendment safe harbour margins are as under:
| # |
Eligible International Transactions |
Pre amendment SHR 2
(upto FY 16-17)
|
Post amendment SHR
(FY 16-17 to FY 18-19)
|
| Value of International Transactions |
Safe harbour margin |
Value of International Transactions |
Safe harbour margin |
| 1 |
Provision of IT and ITeS services |
<INR 500 crores |
20% |
<INR 100 crores |
17% |
| >INR 500 crores |
22% |
>INR 100 crores but <INR 200 crores |
18% |
| 2 |
Provision of KPO services |
No Threshold |
25%
|
<INR 200 crores |
24% (employee cost is at least 60% of operating expenses) |
| 21% (employee cost is 40% or more but less than 60% of operating expenses) |
| 18% (employee cost not more than 40% of operating expenses) |
| 3 |
Provision of contract research and development services with respect to software development |
No Threshold |
30% |
<INR 200 crores |
24% |
| 4 |
Provision of contract research and development services with respect to generic pharmaceutical drugs |
No Threshold |
29% |
<INR 200 crores |
24% |
| 5 |
Providing corporate guarantee |
Up to INR 100 crores |
1.75% |
Up to INR 100 crores |
1% |
| Above INR 100 crores, provided the wholly owned subsidiary has been rated to be of adequate to highest safety by a rating agency registered with SEBI |
2% |
Above INR 100 crores, provided the wholly owned subsidiary has been rated to be of adequate to highest safety by a rating agency registered with SEBI |
| 6 |
Advancing of intra-group loans denominated in INR |
- Up to INR 50 crores
- Above Rs 50 crore
|
- Base rate plus 150 basis points
- Base rate plus 300 150 basis points
|
No threshold value prescribed except where credit rating of AE is not available |
One year marginal cost of fund lending rate plus
- 175 basis point, for AAA to A or its equivalent rating;
- 325 basis point, for BBB-, BBB or BBB+ or its equivalent credit rating;
- 475 basis point, for BB to B or its equivalent credit rating;
- 625 basis point, for C to D or its equivalent credit rating; or
- 425 basis point, for credit rating of the AE is not available and the amount of loan advanced to the AE including loan to all the AEs in INR does not exceed INR 100 crores.
|
| 7 |
Advancing of intra-group loans denominated in foreign currency |
No separate safe harbour specified for foreign currency denominated loans |
No threshold value prescribed except where credit rating of AE is not available |
Interest rate not less than 6 months LIBOR plus
- 150 basis point, for AAA to A or its equivalent rating;
- 300 basis point, for BBB-, BBB or BBB+ or its equivalent credit rating;
- 450 basis point, for BB to B or its equivalent credit rating;
- 600 basis point, for C to D or its equivalent credit rating; or
- 400 basis point, for credit rating of the AE is not available and the amount of loan advanced to the AE including loan to all the AEs in INR does not exceed INR 100 crores.
|
| 8 |
Manufacture and export of core auto and non-core auto components |
No threshold |
12% - core
8.5% - non-core
|
No threshold |
12% - core
8.5% - non-core
|
| 9 |
Receipt of lowvalue-adding intra-group services |
Not applicable |
Not Applicable |
<INR 10 crores
(Value including cost plus 5%) |
- Mark-up on cost of 5%; and
- Reasonableness of allocation keys used for allocation of costs to the Assessee by AEs, cost pool etc., have to be certified by an accountant
|
Key positives:
- Revision of Net operating margin for IT / ITeS /KPO/Contract R&D service providers
The significant change in the amended SHR is the reduction of the net operating margins for IT / ITeS /Contract R&D services providers for software development and generic pharmaceutical drugs.
Given the significant involvement of the skilled resources in KPO industry, the CBDT has wisely tied up the safe harbour margins to the level of employee costs in relation to the operating expenses of the routine service providers. This means that higher the ratio of employee cost to operating expenses, higher the safe harbour margins. This varied level of margins provides an opportunity to the taxpayer to opt for the most appropriate safe harbour margins based on its employee cost ratio.
The CBDT's decision to lower the safe harbour margins / reduction in the aggregate value of international transaction to INR 200 crores for the applicability of the safe harbour provisions is expected to be widely accepted by small and medium enterprises, which will be broadly in line with the present government's vision to improve the prevailing tax environment within the country.
With the revised margins, it is expected to produce a positive impact as the small to medium size corporates are expected to derive the maximum benefit out of this amended rules and given this limitation on threshold for applicability under amended SHR, APA remains the only viable option for foreign multinationals having high value international transactions to achieve certainty in their inter-company dealings.
- Segregation of safe harbour interest rates for inter company loans
The amended SHR has gone a step ahead by providing separate safe harbour interest rates for intercompany loans denominated in foreign currencies in addition to domestic currencies. This is a significant modification, as there were no interest rates available for foreign currency loans in the pre amended SHR. The tax authorities audited numerous foreign currency denominated loans transactions and proposed adjustments in line with INR loan rates. Although the appellate bodies had directed to evaluate the interest rates for foreign currency denominated loans using foreign rates, the field officers have shown a reluctance to consider such directions as a part of their audit process. With the amended safe harbour provisions coming out with distinctive rates for foreign currency denominated and domestic currency denominated loans separately, the CBDT has made its stand clear for determination of the arm's length interest rate treatment of such loans. It is expected that many companies, having significant intercompany loan transactions, would resort to the amended SHR for getting certainty on their intercompany dealings.
- Low Value-added Intra-group Services
Another key element in the amended SHR is the introduction of the low value-added intra-group services. In general, the amended rules seek to make SHR more attractive for eligible taxpayers of this services with the objective of reducing transfer pricing litigation provided that the method of cost pool along with allocation keys used for such services is certificated by an accountant . The definition of low value-added intra-group services is same in SHR and BEPS Action Plan 10 except herein, it also includes services for which there are no reliable external comparable services to determine the arm's length price excluding few specified services.
It is however interesting to see that CBDT has taken a bold stand to include the most contentious transaction in the amended SHR. By doing this, the tax authorities are trying to build up a sense of secured business environment for the multinationals having their presence in the country and have low-value adding intra-group services. Historically, the tax authorities were very keen on auditing such intra-group services and would propose an adjustment determining the arm's length price to be NIL causing undue hardship to the taxpayer as well as their AEs. Further, no efforts were made to improve the situations as most of the Tribunal rulings would remand back the case to the lower tax officers for re-look of the documents resulting in protracted litigation.
Post this amendment, the taxpayer would still need to carefully examine their intra group payments as challenges would be there in the absence of any guidance as to how tax officer will examine the applicability of such transactions under the purview of SHR. Overall, this change is in the right direction that aims to improve the overall tax environment for the multinationals and benefit the taxpayers having such transactions as they would be covered from any unfavorable transfer pricing audit.
Challenges and Uncertainty:
While amended SHR is a welcome move and beneficial, their availability is not without concerns, some of which are:
- Risk of double taxation will still continue for taxpayer opting for safe harbour as reporting of higher margin in one jurisdiction (to comply with safe harbour levels) need not be necessarily accepted by the tax administration in the other jurisdiction;
- Taxpayer need to be aware of the secondary adjustment while opting for Safe harbour provisions
- Once safe harbour margin is accepted by tax authority, the taxpayer shall not be entitled to invoke the mutual agreement procedure ('MAP') under an applicable tax treaty;
- Requirement of maintaining requisite documents pertaining to international transactions has not been done away with for the taxpayers opting for safe harbour provisions;
- Excluding taxpayers transacting with low tax or no tax countries from the ambit of safe harbour rules creates a further exception;
- Identification of cost relating to ESOP provided by AE to employee of taxpayer and recovery of expenses relating to business operations of taxpayer for the purpose of calculation of mark-up requires a careful consideration;
- The existing definition of KPO services could have been further strengthened in order to bring more clarity in terms of type of transactions that may get covered in the amended SHR;
- The bifurcation of the taxpayer's activity into IT and Contract R&D remains complex and requires extensive technical analysis;
- The CBDT could have included the other leg of the 'low value-adding intra-group services' transaction in its amended SHR, especially when the Indian tax authorities are scrutinising the India-based multinationals for such charges;
- Although, the guarantee commission / interest rate has been brought down in the amended SHR, yet there is no change in the definition of guarantee / interest transaction and their coverage remains same as per pre amended SHR, wherein the following remains uncovered;
- Guarantee / intra group loans by taxpayer towholly owned subsidiary is only covered and not otherwise
- The definition of "intra group loans" is silent in respect of loan sourced in foreign currency
The amended SHR are also applicable only to few sets of intercompany transactions. The CBDT could have increased the coverage by extending the benefit to international transactions other than IT/ ITeS / KPO which are otherwise covered in APA 3.
Conclusion:
Transfer pricing is a key area of concern for most of the multinationals in India. In light of growing uncertainty, protracted litigation and progress of APA programme, the CBDT's step of amending the SHR is a welcome move and is likely to enhance the ease of doing business in India.
Safe harbour provisions may grant a greater sense of assurance to taxpayers in terms of acceptability of their transfer price by the tax authorities without onerous audits. This may lead to overall improvement in terms of saving administrative and monetary resources for both the taxpayer and the tax administration.
The advantage that SHR has over APAs is that they are less time-consuming, cost effective, and small and medium enterprise can adopt them for the limited category of transactions subject to fulfillment of certain conditions. On the other hand, large enterprises with complex business and high value chain involving intangibles and related royalty payments would find it more reasonable to go for an APA (than safe harbour) using a profit split or similar analysis under the pro BEPS period.
Given the fact that transfer pricing audits have significantly reduced from the last year due to the adoption of risk based assessment by the tax authorities in last audit cycle, it is to be seen how these amended safe harbour provisions are accepted and implemented by the taxpayers to achieve more certainty in their inter-company dealings.
However, doubts still remains on whether these amended SHR will entirely help in achieving the stated objectives of reduced transfer pricing disputes and usher in more certainty unless resolved appropriately. The overall success of these amended safe harbour provisions will depend on the effective implementation measures to be adopted by the Indian tax authorities.
(Vikas Gupta is a Chartered Accountant, TamojitLodh is an MBA from recognized university and Arvind Agarwal is a Chartered Accountant. All the views in the article are personal.)
1. vide notification 46/2017 dated 7 June 2017.
2. vide Notification No.73/2013 [F.No. 142/28/2013 - TPL].
3. Refer Annual report published by Indian Government on APA programme.
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