The safe harbor regime which was initiated by the Central Board of Direct Taxes (“CBDT”) in the year 2013 has now taken another leap to the relief of the Indian taxpayers. On 7th June, the CBDT published a notification making significant changes to the safe harbor rules by amending the Income Tax Rules, 1962. These changes have simplified and enhanced the safe harbor regime in India and are being construed in a positive light by tax payers as of now. At this juncture, we bring to you a simplified note on the working of the safe harbor mechanism along with its related concepts.
To provide certainty to taxpayers, to align safe harbor margins with industry standards and to enlarge the scope of safe harbor transactions, the CBDT has notified a new safe harbor regime. Before proceeding with the salient features of this notification, we take a moment to explain in brief as to what constitutes the safe harbor regime.
“Transfer price is, thus, a price which represents the value of good; or services between independently operating units of an organisation. But, the expression "transfer pricing" generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises.”
Many multinational enterprises, having establishments in different countries, adopt different business methods to escape or evade taxes by selling their products/ services, at very low prices, to their entity in a foreign country, having lesser tax duties than the home countries where such products/ services are manufactured. These countries then sell these products/ services where lesser tax duties are applicable. This way the foreign entity makes a huge profit and the home country of the products shows a loss dominant balance sheet, thereby paying lesser and lesser taxes. This is the crux of transfer pricing.
The Income Tax authorities regulate transfer pricing setting a threshold limit below which the entity cannot sell its products/ services via intra group transactions.
Safe harbour is basically a method of regulating transfer pricing by setting up a minimum revenue/ margin which if satisfied by the eligible assesse, the Assessing Officer will accept whatever price is declared by the assesse for providing products/ services to his foreign counter part.
Safe harbour is a boon to these assesssees. By safe harbor, the authorities trust the assesse declared price and accept it. However, this trust is conditional. The assesse has to pass through three filtering stages to become eligible to the benefits of safe harbor.
Firstly, the assessee has to opt for this route. The provisions for application of safe harbor are optional. Secondly, only certain types of entities are eligible. These majorly include entities providing software development services, services related to IT, internet development, contract R & D related software development or general pharmaceutical development or intragroup loans or corporate guarantees etc. These are prescribed in detail in Rule 10TB. Lastly, the transactions should be those prescribed in Rule 10TC. Another important point for qualification is that minimum limit for safe harbor in case of various sectors has to be adhered to.
The new regime initiated by the recently released notifications, has many positive features. It is to be effective from 1st of April, 2017, i.e. A.Y. 2017-18 and shall continue to remain in force for two immediately succeeding years thereafter, i.e. up to A.Y. 2019-2020.
A new category of transactions being “Receipt of Low Value-Adding Intra-Group Services” has been introduced.
The CBDT has introduced a gradation in rates for knowledge process outsourcing services, a structure of 3 different rates of 24%, 21% and 18% has been provided, based on employee cost to operating cost ratio, replacing the single rate of 25% in the previous regime.
In respect of transactions involving provision of contract research and development services wholly or partly relating to software development and provision of contract research and development services wholly or partly relating to generic pharmaceutical drugs, safe harbour margins have been reduced to 24% from 30% and 29% respectively in the previous regime.
In case of risks in intra-group loans denominated in foreign currency, they will be benchmarked to the 6-month London Inter-Bank Offer Rate (LIBOR) as on 30th September of the relevant year and on loans denominated in Indian Rupees to the 1-year SBI MCLR as on 1st April of the relevant year.
We look forward to the positive effect of this new regime in the coming assessment years.