21st century's competitive marketplace lives in the shadow of a hyper-competitive spirit, which creates a combined effect of growth and malaise for new, up-and-coming ventures. With multiple companies in the same domain targeting the same consumer base for marketing their products, companies seek to widen their reach and diversify territorially, if not product-based. Like buds from the mother plant of bloom, individual entities break out and germinate overseas with a certain degree of autonomy gifted to them, to target multiple demographics simultaneously. When transactions take place between these individual entities which are a part of a multi-entity venture, either for trading supplies or even labour costs, the price at which these entities transact with each other is called 'transfer pricing'. One can see it as a conduit of conversation between the diffused fragmentation of a company in monetary lingo. Since these conversations are internal and free of scrutiny unlike the case with transactions with third-parties, these problems came to the surface post-1991, with the opening up of the economy's silver gates for India to let in foreign services. Outsourced units by multinational companies were at a significant edge from Indian companies when it came to advantageously adjusting your transfer pricing margins to absorb the costs of globalization and multi-jurisdictional outreach. With an unprecedented spark in the number of disputes relating to inconsistencies in transfer pricing burdens, it clearly reflected a need for regulation to make sure these internal exchanges are clearly recorded on audit sheets and cannot be used to artificially disguise profits and losses of the company. One such set of rules are 'safe harbour' rules (SHR).

Safe Harbour Rules: How Do They Work?

Safe harbour rules assume the herculean task of making sense of chaos by neutralizing it with certainty in terms of some rules of conduct. It incentivizes transparent and safe conduct with benefits for the taxpaying companies, which encourages them to plan their internal transactions with the compliance of these regulations as a priority. Rather than depend upon the Income Tax Authority's case-by-case rationale, safe harbour rules list out the circumstances under which the authorities unquestioningly accept the declared transfer pricing, lending the process a predictable trajectory for the assessee. Transfer pricing covered by the prescribed range also has the added benefit under these rules to be protected from litigation, aiding and expediting dispute resolution in certain sectors. In India, the concept of safe harbour rules was introduced through the Finance Act 2009 as a welcome, much-awaited reform. The Central Board for Direct Taxes (CBDT) is the apex body for all policies related to direct taxes that makes and notifies the changes in safe harbour rules for the country. After 2009, the first couple of provisions were introduced by the government in 2013 for five years. The rules were revised in 2017 again, which was applicable till FY 2019-20. The CBDT on 20th May made changes to the SHR to extend their applicability to FY 2019-20, without any subsequent modifications. The taxpayers who opt for the SHR for FY 2019-20 need to file the return of income for the year on or before the date of furnishing the prescribed Form 3CEFA. 30 November 2020 is the due date for this election.

CBDT's 2020 Extension: Much Needed Relief

The current fiscal year has been fraught with challenges for the Indian economy on account of the pandemic and the disproportionate pressure this puts on businesses. Hence, when the income tax department made a decision for AY 2020-21 with respect to safe harbour rules, it was a sign of relief for struggling industries with associated enterprises (AE) overseas. A notification of the continuation of this relaxation period for taxpayers serves as a backbone of steel in precipitous times. This is especially true in the case of small to medium-sized companies, who had no other option but to safeguard themselves from unfair pricing through Advance Payment Agreements (APA), laying down the terms of their monetary exchange. This is a much more time-intensive and costly affair for such industries. It further provides guidance for labour in terms of a graded structure for Knowledge Process Outsourcing (KPOs) that assign a monetary exchange value on skill level. Such provisions are even markers for large-scale companies, who have to keep up with the changing regulations and standards and ensure compliance to avoid litigious proceedings. This equalizes bargaining power at a time fatal to business efforts. The extensions are also notably phased- instead of the usual three-year stretch, a one-year duration will allow the government to adapt and modify the rules with the changing dynamism of the crisis, helping it bide its time and cautiously proceed with implementation of relief measures.

However, looking beyond the welcome extension of these rules, one must examine the reformative efficacy of the rules in the economic slump brought about by the COVID era. Some welcome improvements would deal with a more objective criteria to evaluate fair arms' length pricing, especially in a distorted, crisis-struck economy. The accommodation of a broader range of comparables, which is in line with international best practices, as well as interquartile percentile measures, will help further the goal of global collaboration. Clarified definitions for the calculation of metrics as well as doing away with redundant processes are also some of the ideas discussed further as a taxpayer's potential narrative on the negotiation table.

Re-Examining 'Arms' Length' Pricing in Indian Tax Law

The idea behind transfer pricing regulation is to neutralize the 'relationship' advantage- the parent company leverages its power to adjust profit-loss margins and cut deals which are exploitative of tax laws through internal process manipulation. To do that, it adopts the 'arm's length' principle of computation to ensure a neutral, impartial figure between subsidiaries and the parent company as if it were a transaction with a third party. Arm's length pricing is a foundational basis for the SHR to exist, and that has proven to be a burdensome and controversial method of computation. Since the idea is to prove that there is no influence of the relationship of the two parties on the price, this standard can only guarantee distorted efficacy in complex transactions. In cases of commodity sales, one can simply cross-check with comparative market prices, but in more intricate deals that involve trademarked items, one has to resort to relative standards. Even good faith efforts to make sure the transactions are compliant fail, since the authorities can just analyse and judge the figure differently. The current rules also display a marked non-conformism with globally accepted norms and concepts in terms of computation. It uses single year data and a 3% variation to arrive at a figure, when globally, countries use multiple year data and a 'range concept'. This is seen as an international best practice that delivers better results.

However, this does not solve the problem of hard-pressed industries like the IT industry, which has been reeling from the COVID-19 hit. The SHR came to relieve their situation by allowing them to provide services to their overseas units at a lower profit margin, making them breathe easier. However, the current threshold of 17% is low and drives the IT sector down due to its rigid requirement and zero flexibility. The percentile range for these companies is very low, with only companies in the 35th - 65th percentile range qualifying as comparables. Even significant reforms in computation does not solve this problem. Countries all over the world use an interquartile range of 25th - 75th percentile for a broader comparable range to test arms' length transactions. Since two such metrics show a deviation from international best practices, significant difficulties were expected to arise when a bilateral Advanced Pricing Agreement was being considered cross-jurisdictionally, since such metrics may be met with refusal. The new notification does not address these concerns, as promptly brought up by NASSCOM's pre-budget recommendation report.

Infusing Dynamism in Our Indicators: Surviving COVID-19

It has been common criticism that the current rules do not take into account the changes in the global business scenario every subsequent year. It needs dynamic benchmarks that factor in fluctuations, both negative and positive, especially when ratios and ranges are being computed. This will help the current rules tackle the global industry standards by reflecting the present changes in real time. With all countries making rapid changes to accommodate the economic earthquake brought about by the pandemic, no such provision has been considered or factored in by the CBDT, leaving taxpayers at the mercy of outdated, unrevised dates. Such interventions are considered in 'conditions of the market' and may be evaluated by policy makers. Some definitions, especially those concerning various international transactions permitted under safe harbour rules also need clarifications.

One of the widely considered concerns is the mandate of Section 92CE, which deals with secondary adjustments and repatriation of the money to India, with respect to bilateral APAs and MAPs. There are two competent authorities of two different countries involved in making a contract in this case. Since the agreement made will have already considered the terms of bringing the money into the home country, in this case, India, such an agreement should be excluded from Section 92CE since its international character would prevail over domestic laws, making it redundant legally and administratively. There is the added ambiguity for unilateral APAs which reached their conclusion before Section 92CE was inserted. This section needs a lot of specificity to avoid hardship for the taxpayers. One of the most pressing objections is the possibility of double taxation. Lack of specificity in rules that deal with associated enterprises abroad may result in them paying taxes in their home country and repeating the payment in the country of their parent company.

Bringing Back Lost Stakeholders

The new SHR threshold of Rs. 200 crores for international transactions from an earlier threshold of Rs. 500 crores has also restricted the domain to exclude many eligible assessees. In India's rapidly developing economy, the services sector comprises more than 50% of the GDP. The reduction leads to their exclusion, which might create a more litigious backdrop to dispute resolution for this bracket. A lot of the metrics mentioned in the rules place their reliance on CRISIL ratings. Internationally, there are credit rating agencies with a far more reliable standing, which are trusted abroad and which would lend a much-needed uniformity in interpretations of the metrics when it comes to international operations. Hence, adopting them would be a better change than just using CRISIL for persuasive value. This move further accommodates much needed international flavour. Taxpayers who opt for the rules for FY 2019-20 have to file their return of income for the year in Form 3CEFA. However, no clarifications have been issued regarding the definition of operating and non-operating income and expenses, crucial for this process.

Conclusion

The rules leave a lot of questions unanswered, but these questions arose from the working of these rules from 2017 till present day. The notification to extend these rules is a wise decision since it is anticipated that reforms, especially tax relaxations and lowering of rates are soon to follow to provide much-needed relief to businesses heavily impacted by the pandemic. The notification signifies the belief of the government to take these rules forward in post-COVID reconstruction efforts. Since all of these efforts will have to be attuned with global economic reconstruction, it is imperative that rules on such an integral aspect of international taxation and business reflect a global colour, keeping their concepts in line with internationally accepted standards and using trusted, well-endorsed ideas. With pleas for tax relaxations already piling up in huge numbers, these reforms are quick to follow with adequate lobbying for lesser unnecessary compliance and more specific regulation. The issuance of the circular opens the floor for negotiation. It is through collaboration with all government agencies and information repositories that an otherwise templatized version of safe harbour rules can be turned into a bold, daring reform that rejuvenates businesses with supportive regulation and desired fiscal stimulation.

(The Author specialises in providing corporate consultancy in transfer pricing and inbound & outbound investments)