Safe Harbour Rules Draft released for feedback and comments by stakeholders

DRAFT “SAFE HARBOUR RULES”

 

The Ministry of Finance, Government of India, has issued a Press Release on 14th August, 2013 inviting comments and suggestions on Safe Harbour Rules. The draft rules have been framed based on the recommendations of the Rangachary Committee.

 

WHAT IS SAFE HARBOUR?

With increase in business with foreign customers and vendors, many of whom are related parties for the Indian entity doing business with them, the provisions relating to Transfer Price (TP) and Arms Length Price (ALP) have become very critical. It is commonly known that there are many disputes between the Revenue Authorities and the taxpayer on the computation of TP/ALP. In India, the authorities have been very aggressive in arriving at estimates of TP/Alp and their estimate is, quite often, at variance with the TP/ALP declared by the taxpayer. Vide Finance (No. 2) Act, 2009, a new section, viz. 92CB, was inserted in the Income Tax Act, 1961 (Act) which says that the determination of ALP shall be subject to safe harbor rules. It defines “safe harbor” as circumstances in which the income-tax authorities shall accept the transfer price declared by the taxpayer.

 

TO WHOM WOULD THE SAFE HARBOUR RULES APPLY?

The draft Rules propose that safe harbor rules would apply to an “eligible assessee” who enters into an “eligible international transaction” in certain circumstances as specified.

 

WHO IS AN ELIGIBLE ASSESSEE?

An “eligible assessee” means a person who has exercised the option for application of safe harbor rules and who:

  1. Is engaged in providing software development services or ITES or KPO services, with insignificant risk, to a non-resident associated enterprise;
  2. Has made any intra-group loan;
  3. Has provided a corporate guarantee;
  4. Is engaged in providing contract R&D services wholly or partly relating to software development, with insignificant risk, to a non-resident associated enterprise;
  5. Is engaged in providing contract R&D services wholly or partly relating to generic pharmaceutical drugs, with insignificant risk, to a non-resident associated enterprise; or
  6. Is engaged in the manufacture and export of core and non-core auto components and where 90% or more of total turnover during the financial year are in the nature of OEM sales.

 

WHAT IS AN ELIGIBLE INTERNATIONAL TRANSACTION

This refers to an international transaction between the eligible assessee and its associated enterprise. Either or both should be non-resident. The transaction should undertaken by the eligible assessee and should comprise of:

  1. Software development services, ITES or KPO services, where the aggregate value of such transactions during the fiscal year does not exceed INR 100 crores for each of such services.
  2. Advance of intra-group loan, provision of corporate guarantee, contract R&D services wholly or partly relating to software development or generic pharmaceutical drugs and manufacture and export of core and/or non-core auto components.

 

WHAT IS INSIGNIFICANT RISK?

The draft rules propose that an eligible assessee with insignificant risk shall be identified having regard to the following factors:

  1. The non-resident associated enterprise (foreign principal) performs most of the economically significant functions involved in the work. These would include conceptualization and design of the product, providing strategic direction and framework, either through its own employees or through its other associated enterprises (which excludes the eligible assessee). The only role of the eligible assessee would be to carry out the work assigned by the foreign principal;
  2. The capital, funds and other economically significant assets (including intangibles required) are provided by the foreign principal or its other associated enterprises. The eligible assessee is only remunerated for the work carried out by it;
  3. The eligible assessee works under the direct supervision of the foreign principal. The foreign principal should not only have the capability to control or supervise by also actually controls or supervises the activities carried out;
  4. The eligible assessee does not assume or has no economically significant realized risks. This requirement is not a “paper requirement” but shall be judged from the actual conduct of the foreign principal;
  5. The eligible assessee has no ownership right (whether legal or economic) on any intangibles that are generated during the course of rendering of the services. This should vest in the foreign principal as evidenced both by the contract as well as from the conduct of the parties.

 

WHAT ARE THE CIRCUMSTANCES THAT ARE SPECIFIED

The circumstances specified are set out in the table below:

 

Eligible International Transaction Circumstances specified
Software development services Operating Profit Margin (OPM) is 20% or more on Operating Expenses (OE).
ITES OPM is 20% or more on OE.
KPO OPM is 30% or more on OE.
Intra-group loans where the amount of loan advanced does not exceed INR 50 crores. Interest rate should be at least base rate of SBI as at 30th June of the relevant fiscal year + 150 basis points.
Intra-group loans where the amount of loan advanced exceeds INR 50 crores. Interest rate should be at least base rate of SBI as at 30th June of the relevant fiscal year + 300 basis points.
Corporate guarantee not exceeding INR 100 crores Commission of 2% or more per annum on the guaranteed amount.
Contract R&D services relating to software development OPM is 30% or more of OE
Contract R&D services relating to pharmaceutical drugs OPM is 29% or more of OE
Manufacture and export of core auto components OPM is 12% or more on OE
Manufacture and export of non-core auto components OPM is 8.50% or more on OE

 

HOW ARE OPERATING EXPENSE (OE), OPERATING REVENUE (OR) AND OPERATING PROFIT MARGIN (OPM) DEFINED?

OE means the cost incurred during the course of its normal operations and in connection with eligible international transactions for the fiscal year. It includes depreciation and amortization expenses relating to the assets used by the taxpayer but excludes the following:

  1. Interest expense;
  2. Provision for unascertained liabilities;
  3. Pre-operating expenses;
  4. Loss arising out of translation of foreign currency items;
  5. Extra-ordinary items;
  6. Loss on sale of assets/investments of the taxpayer;
  7. Other items not relating to the operating activities of the taxpayer.

 

OR means the revenue of the taxpayer earned during the course of its normal operations and in connection with eligible international transactions for the fiscal year. It excludes the following:

  1. Interest income;
  2. Provision no longer required written back;
  3. Refunds relating to income-tax expense of taxpayer;
  4. Income arising out of translation of foreign currency items;
  5. Extra-ordinary items;
  6. Income on sale of assets/investments of the taxpayer;
  7. Other items not relating to the operating activities of the taxpayer.

 

OPM is defined as (OR-OE)/OE.

 

OTHER IMPORTANT POINTS IN THE DRAFT RULES

  1. Documentation requirements shall continue to apply;
  2. Eligible assessee may not invoke MAP for such transactions where the TP of the eligible assessee is accepted by the Revenue authorities;
  3. For exercising option of safe harbour, Form3CEG should be submitted to the Assessing Officer on or before the due date for filing annual return of income.
  4. Assessing Officer may conduct enquiry to ascertain whether the taxpayer is entitled to apply for safe harbour.
  5. Software development services, ITES, KPO etc have all been defined in the proposed rules and may be referred to.
  6. The rules shall be effective A.Y. 2013-14 and 2014-15.
  7. The rules shall not apply for international transactions entered into with an associated enterprise located in a “no tax” or “low tax” country as defined, or located in a territory specified in section 94A of the Act.

Links:

Draft Safe Harbour rules

Rangachary Commission Report Part 1

Rangachary Commission Report Part 2 to 6

 

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