By Mayur B. Nayak
Tarunkumar G. Singhal
Anil D. Doshi
Chartered Accountants
“Safe Harbour Rules”
were notified by the CBDT in the year 20131, which were applicable
to certain select International Transactions, prominent among them were
transactions relating to software, KPO, R&D, manufacturing of auto
components and intra-group loans and guarantees. These Rules aimed at reducing
litigation in the arena of Transfer Pricing. However, these Rules failed to
attract taxpayers due to prescription of high thresholds. A Committee was set
up to look into various aspects of safe harbor regime and based on its report
new safe harbor rules are notified by the CBDT on 7th June 2017. This
article analyses various provisions, their impact and potential issues that may
arise there from.
1.0 Introduction
Safe Harbour Rules (SHR) were first introduced in India vide CBDT
Notification No. SO 2810 (E) dated 18th September 2013. These Rules were
applicable only to international transactions for the Assessment Year (AY)
2013-14 and four AYs immediately following that, i.e. for and up to AY 2017-18.
A new set of SHR have been introduced with effect from 1st April 2017 which
shall apply with effect from the AY 2017-18 and two AYs immediately thereafter
i.e. for and up to AY 2019-20. Thus, new SHR will be effective for three years
only as oppose to five years in case of erstwhile SHR. These Rules are
discussed in the subsequent paragraphs.
It is provided that where a tax
payer is eligible for both the Rules (i.e. Old and New) (the same is possible
for the AY 2017-18, being an overlapping year), then he has an option to choose
the one which is most beneficial to him.
Explanation to section 92CB
of the Income-tax Act, 1961 (the Act) defines safe harbour to mean
circumstances in which the Income-tax authorities shall accept the transfer
price declared by the assessee.
The United Nation’s Practical Manual on Transfer Pricing for Developing
Nations released in the year 2013 defines “Safe harbour rules as rules whereby
if a taxpayer’s reported profits are below a threshold amount, be it as a
percentage or in absolute terms, a simpler mechanism to establish tax
obligations can be relied upon by a taxpayer as an alternative to a more
complex and burdensome rule, such as applying the transfer pricing
methodologies”.
OECD Transfer Pricing Guidelines defines a safe harbour as “a provision
that applies to a defined category of the taxpayers or transactions and that
relieves eligible taxpayers from certain obligations otherwise imposed by a
country’s general transfer pricing rules.”
2.0 New SHR effective from 1st April 2017
A new category of
transactions being “Receipts of Low Value-Adding Intra-Group Services” has been
introduced. The peak rates of safe harbour margins have been reduced in many
categories. In respect of knowledge process outsourcing, (KPO) safe harbour margins
are slashed and divided in to three rates of 18%, 21% and 24% instead of single
rate of 25% in the earlier regime. Moreover, the new rates are linked to
employee cost to operating cost ratio. These and other changes are elaborated
in more detail in the table, which also carries comparison of the old and new provisions.
Comparative
Provisions of the Old and New SHR
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Comparative
Provisions of the Old and New SHR
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Sr. No
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Eligible
International Transactions
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Safe Harbour Margin –
New Provisions
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Safe Harbour Margin –
Old Provisions
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1
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Provision of Software Development Services
[Rule 10TA(m)] read with
[Rule 10TC(i)]
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Operating Profit Margin (OPM) in relation to Operating
Expenses (OE):
For Software Development Services
(i) 17% or more, where the value of international
transaction does not exceed Rs. 100 crore;
(ii) 18% or more, where the value of international
transaction exceed Rs. 100 crore but does not exceed Rs. 200 crore;
For ITES
(i) 17% or more where aggregate value of such
transactions during the previous year does not exceed Rs. 100
crore; or
(ii) 18% or more where aggregate
value of such transactions during the previous year exceeds Rs. 100 crore
but less than Rs. 200 crore.
[As the limit of Rs. 500 crore stands reduced, the
companies with high value transactions will have to per force opt for
unilateral or bilateral Advance Pricing Agreements (APAs) to have certainty
of arm’s length pricing]
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Operating Profit Margin (OPM) in relation to Operating
Expenses (OE):
(i) 20% or
more where total value of such transactions during the previous year does not
exceed Rs. 500 crore; or
(ii) 22% or
more where total value of such transactions during the previous year exceeds
Rs. 500 crore.
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Provision of Information Technology Enabled Services (ITES)
[Rule 10TA(e)]
read with
[Rule 10TC(ii)]
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Remarks:
(i) “OPM” in relation to “OE” means the ratio
of operating profit, being the operating revenue in excess of operating
expense, to the operating expense expressed in terms of percentage.
(ii) Rule 10TA defines “Software Development
Services” as well as ITES. In both cases it is clarified that any research
& development (R&D) services will not be included in the definition
whether or not such R&D services are in the nature of contract R&D
services.
(iii) It may be noted that for applying the
threshold of Rs. 100 crore or two crore, as the case may be, to the Software
Development Services, one need to consider the value of international
transaction (could be read as “single transaction”); whereas for ITES, one
need to consider the aggregate value of all transactions during the relevant
previous year. Earlier this distinction was not there and for both types of
services, the thresholds were computed by to the aggregate value of all
transactions during the previous year.
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2
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Provision of Knowledge Process Outsourcing Services (KPO)
[Rule 10TA(g)]
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Value of the International Transaction should not exceed
Rs. 200 crore and the OPM to OE shall be as follows:
(i) 24% or more if Employee Cost (EC) to Operating Expense
(OE) is at least 60%;
(ii) 21% or more if EC to OE is 40% or more but less than
60%;
(iii) 18% or more if EC to OE is less than 40%.
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OPM to OE shall be 25% or more.
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Remarks:
(i) Employee Cost (EC) has been defined in
Rule 10TA by insertion of clause (ca). OE has already been defined in clause
(j) of Rule 10TA.
(Refer paragraph 3.1 below for further
details)
(ii) Looking at the nature of highly skilled
employees in KPO industries, taxpayers are likely to fall in the higher
brackets of 21% or 24% as EC is higher for KPO services.
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3
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Provision of Contract R&D Services wholly or partly
relating to Software Development.
[Rule 10TA (aa)] read with
[Rule 10TC(vi)]
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Value of the International Transaction should not exceed
Rs. 200 crore and the OPM to OE shall be 24% or more
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OPM to OE shall be 30% or more.
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Remark:
Though there is a reduction in SHR margin, the
applicability is restricted to small transactions and therefore tax payers
with large amount of transaction will have to opt for APA.
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4
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Provision of Contract R&D Services wholly or partly
relating to Generic Pharmaceutical Drugs.
[Rule 10TA(d)] read with
[Rule 10TC(vii)]
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Value of the International Transaction should not exceed
Rs. 200 crore and the OPM to OE shall be 24% or more
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OPM to OE shall be 29% or more.
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Remarks:
(i) Contract R&D services in relation to
Generic Pharmaceutical Drugs (GPD) is not defined. However, GPD is defined to
mean a drug that is comparable to a drug already approved by the regulatory
authority in dosage form, strength, route of administration, quality and
performance characteristics and intended use.
(ii) Other comment relating to large
transactions as mentioned above at point no. 3 applies here also.
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5
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Manufacture and Export of Core Auto Components
[Rule 10TA(b)] read with
[Rule 10TC(viii)]
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No change.
OPM to OE shall be 12% or more.
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OPM to OE shall be 12% or more.
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Remark:
Core Auto Components are
defined in Clause (b) of Rule 10TA.
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6
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Manufacture and Export of Non- Core Auto Components
[Rule 10TA(h)] read with
[Rule 10TC(ix)]
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No change.
OPM to OE shall be 8.5% or more.
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OPM to OE shall be 8.5% or more.
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Remark:
Rule 10TA (h) defines non-core auto components as the ones
which are other than core auto components.
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7
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Advancing of intra-group loans in Indian Rupees
[Rule 10TA(f)] read with
[Rule 10TC (iv)]
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Interest rate should not be less than the one-year marginal
cost of funds lending rate of SBI as on the 1st April of the relevant
previous year plus:
* 175 BPS where CRISIL rating of Associated Enterprise (AE)
is between AAA to A or its equivalent;
* 325 BPS where CRISIL rating of AE is BBB-, BBB or BBB+ or
its equivalent;
* 475 BPS where CRISIL rating of AE is between BB to B or
its equivalent;
* 625 BPS where CRISIL rating of AE is between C to D or
its equivalent;
* 425 BPS where CRISIL rating of AE is not available and
the amount of loan advanced to the AE including loans to all AEs does not
exceed Rs.100 crore as on 31st March of the relevant previous year (PY);
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Interest rate should not be less than the base rate of SBI
as on 30th June of the relevant previous year plus 150 basis points (BPS)
where the loan amount is less than or equal to Rs. 50 crore and
300 BPS where the loan amount is exceeding Rs. 50 crore
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Remarks:
(i) Intra-group loan is defined in clause (f)
of the Rule 10TA. It covers loans advanced to Wholly Owned Subsidiary (WOS)
in Indian rupees. Banking and Financial Institutions are excluded.
(ii) In Rule 10TA (f) ironically, the definition
of Intra-group loan is not amended which refers to only WOS whereas, the SHR
makes a reference of AE.
(iii) It is good that the rate of interest is to
be determined based on the credit rating of the borrower. However, provision
of obtaining CRISIL rating for all borrowers may put them in undue hardships.
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8
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Advancing of intra-group loans in Foreign Currency (FC)
[Rule 10TA(f)] read with
[Rule 10TC (iv)]
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Interest rate is not less than 6 months LIBOR of the relevant foreign
currency as on 30th September of the relevant PY plus:
* 150 BPS where CRISIL rating of AE is
between AAA to A or its equivalent;
* 300 BPS where CRISIL rating of AE is
BBB-, BBB or BBB+ or its equivalent;
* 450 BPS where CRISIL rating of AE is
between BB to B or its equivalent;
* 600 BPS where CRISIL rating of AE is
between C to D or its equivalent;
* 400 BPS
where CRISIL rating of AE is not available and the amount of loan advanced to
the AE including loans to all AEs does not exceed Rs. 100 crore as on 31st
March of the relevant previous year (PY);
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No such distinction between intra-group loans in INR or FC.
The rates prescribed above were applicable for all types of
intra-group loans.
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Remarks:
(i)
The determination of lending rate based on the currency of a loan is a
best international practice. However, the tenure of the loan and other terms
are not considered in determining the rate of interest.
(ii) Requirement to obtain CRISIL rating for
all borrowers may put them into undue hardships.
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9
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Providing corporate guarantee
[Rule 10TA (c)] read with
[Rule 10TC (v) (a) (b)]
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Guarantee commission or the fee charged should be minimum
1% per annum on the amount guaranteed.
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Guarantee commission or the
fee charged should be minimum
(i) 2% per annum of the amount
guaranteed where the amount guaranteed does not exceed Rs. 100 crore.
(ii) 1.75% per annum where the amount guaranteed exceeds
Rs. 100 crore.
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Remarks:
(i) The reduction of guarantee commission up
to 1% is a welcome change.
(ii) However, in number of decisions2 Tribunals have upheld 0.5% as the arm’s
length guarantee commission.
(iii) Corporate Guarantee is defined to mean
explicit corporate guarantee extended by a company to its WOS being a
non-resident in respect of any short-term or long term borrowing.
(iv) Unlike SHR for intra-group loans, which are
now extended to AEs and not just WOS, corporate guarantee continues to apply
only in respect of WOS.
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10
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Receipt of Low value-adding intra-group services
[Rule 10TA (ga)] read with
[Rule 10TC (x)]
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The entire value of the
International Transaction, including a mark-up not exceeding 5%, should be
less than or equal to Rs. 10 crore.
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Not There.
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Remarks:
(i)
A new Clause (ga) is inserted in Rule 10TA to define the meaning of
“Low Value-Adding Intra-group Services”. (Refer paragraph 3.4 below for
further details)
(ii)
It is also provided that SHR provisions would apply only if the method
of cost pooling, the exclusion of Shareholder costs and duplicate costs from
the cost pool and the reasonableness of the allocation keys used for
allocation of costs to the assessee by the overseas AE, is certified by an
accountant. A new clause (a) has been added to Rule 10TA to define the
meaning of “accountant”.
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3.0 Other
Important Changes in the new regime
3.1 Employee Cost in relation to KPO
Services
Employee
cost has been defined in the newly inserted clause (ca) of Rule 10TA which
besides normal employee expenses also includes expenses incurred on contractual
employment of person performing tasks similar to those performed by the regular
employees. Outsourcing expenses, to the extent of employee cost, wherever
ascertainable, which are embedded in the total outsourcing expenses should also
be considered as a part of the total employee cost. Wherever, the extent of
employee costs is not so ascertainable, they will be deemed to be 80 per cent
of the total outsourcing expenses.
3.2 The
definition of Operating Expenses in clause (j) of Rule 10TA is amended to
include costs relating to Employee Stock Option Plan (ESOP) or similar
stock-based compensation provided by the AE of the assessee to the employees of
the assessee.
3.3 Reimbursement of expenses to the AE
shall be considered at cost.
3.4 Low Value-Adding Intra-group Services
A new
service, namely, Low Value-Adding Intra-Group Services (LVA-IGS) has included
in the SHR. It is defined in the clause (ga) of Rule 10TA. The salient features
of this definition are as follows:
LVA-IGS refers to services which are:
(i) in the nature of support services;
(ii) not part of the core business of the
multinational enterprise group;
(iii) are not in the nature of shareholder services
or duplicate services;
(iv) do not require use of unique intangibles nor
lead to creation of unique and valuable intangibles;
(v) do not involve assumption or control of
significant risk by the service provider nor give rise to creation of
significant risk for the service provider; and
(vi) do not
have reliable external comparable services that can be used for determining
their arm’s length price.
However, it is specifically provided
LVA-IGS does not include the following services:
(i) research and development services; (ii)
manufacturing and production services; (iii) information technology (software
development) services; (iv) knowledge process outsourcing services; (v)
business process outsourcing services; (vi) purchasing activities of raw
materials or other materials that are used in the manufacturing or production
process; (vii) sales, marketing and distribution activities; (viii) financial
transactions; (ix) extraction, exploration, or processing of natural resources;
and (x) insurance and reinsurance;”
The
definition of LVA-IGS as mentioned above is by and large in sync with the
definition at the paragraphs 7.46. 7.47 and 7.48 of the Base Erosion and Profit
Shifting (BEPS) Action Plan 10 promulgated by the OECD. However, BPO/KPO
services and purchase activities of raw materials or other materials that are
used in the manufacturing or production process are excluded from the
definition of the Indian SHR pertaining to LVA-IGS, which is not so in case of
BEPS Action Plan. It may be noted that BEPS Action Plan excludes “Services of
corporate senior management” from the definition of LVA-IGS, which is not so in
case of Indian regulations.
4.0 SHR on Domestic Transactions
In
2015, SHR 10TH to 10THD were introduced covering to following domestic
transactions:
_______________________________________________________________________________________________
In Bharti
Airtel Ltd (ITA No 5816/Del/201Z) dated 11 March 2014; Reliance Industries Ltd
(I.T.A. No. 4475/Mum/2007) and Four Soft Ltd. vs. DCIT [(Hyd. ITAT) – 62 DTR
308] respective honorable Tribunals upheld non-charging of guarantee
commission/fees.
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S. No.
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Eligible specified domestic Transaction
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Circumstances
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1.
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Supply of electricity, transmission of electricity,
wheeling of electricity referred to in item (i), (ii) or (iii) of rule 10THB,
as the case may be.
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The tariff in respect of supply of electricity,
transmission of electricity, wheeling of electricity, as the case may be, is
determined by the Appropriate Commission in accordance with the provisions of
the Electricity Act, 2003 (36 of 2003).
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2.
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Purchase of milk or milk products referred to in clause
(iv) of rule 10THB. [i.e. Purchase of milk or milk products by a co-operative
society from its members]
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The price of milk or milk products is determined at a rate
which is fixed on the basis of the quality of milk, namely, fat content and
Solid Not FAT (SNF) content of milk; and—
(a) the said rate is irrespective of,—
(i) the quantity of milk procured;
(ii) the percentage of shares held by the
members in the co-operative society;
(iii) the voting power held by the members in the
society; and
(b) such prices are routinely
declared by the co-operative society in a transparent manner and are
available in public domain.
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Rule 10THC further
provides that no comparability adjustment and allowance under the second
proviso to sub-section (2) of section 92C shall be made to the transfer price
declared by the eligible assessee and accepted under sub-rule (1) and the
provisions of sections 92D (relating to Maintenance and keeping of information
and documents) and 92E (submission of Audit Report) in respect of a specified
domestic transaction shall apply irrespective of the fact that the assessee
exercises his option for safe harbour in respect of such transaction.
5.0 Summation/Way
Forward
The
erstwhile SHR did not attract many taxpayers due to high rates. Lowering of
rates in some cases would definitely induce more taxpayers to opt for the same
and avoid litigation.
The significant changes in intra-group
loans will attract many taxpayers. Inclusion of LVA-IGS is a welcome step and
in line with global trends. The acceptable threshold for the Corporate
Guarantee could have further been lowered. Manufacturers and exporters of core
and non-core auto components may continue to avoid SHR due to prescription of
high margins.
All
in all, it is a positive move on the part of Government in the direction of
reduction in litigation, though reduction in the value of the eligible
international transactions will push away many taxpayers out of the ambit of
Safe Harbour Regulations.
