Safe harbour rules hit rough weather

No consensus on how to implement norms.

The finance ministry is poised to dash the hopes raised by last year’s Budget promise of introducing safe harbour regulations. Safe harbour rules are designed to make life easier for taxpayers as well as tax administrators by providing simplicity and certainty.

Safe harbour regulations allow a certain category of taxpayer to follow a simple set of rules under which transfer prices are automatically accepted by revenue authorities, doing away with stringent scrutiny. They are of special significance to the sectors of information technology (IT) and business process outsourcing, in which most transfer pricing adjustments take place.

Transfer pricing is the price charged by one part of a company for products and services provided to another part to calculate each division’s profit & loss separately.

The need for safe harbour rules was felt because of increasing disputes between the revenue department and taxpayers over understatement of profits in international transactions between two related firms.

“To reduce the impact of judgemental errors in determining the transfer price in international transactions, it is proposed to empower the Central Board of Direct Taxes to formulate safe harbour rules,” Finance Minister Pranab Mukherjee had said in his Budget speech of July 2009.
 

ANCHORED DOWN

What are safe harbour rules?
Norms under which transfer prices are automatically accepted by revenue authorities, doing away with stringent scrutiny

How do they help?
They reduce disputes over the understatement of profits in international transactions between two related companies

Why the delay?
Finance ministry is not in favour of introducing rules as suggested by an internal committee, as there is lack of clarity and unanimity

However, the ministry is now having second thoughts and is taking the view that it is not feasible to have safe harbour provisions in India.

An internal committee of the ministry has recommended safe harbours only for non-core services with international transactions of less than Rs 20 crore. The finance ministry, however, is not in favour of introducing the rules in this form.

The panel has recommended a safe harbour rate of cost plus 20 per cent. It has also suggested picking up a sample of companies for audit. The committee has pointed out that only four countries have safe harbour rules and that, too, in non-core business activities.

Finance ministry officials said there was no broad consensus among the committee members on how safe harbour rules could be implemented in India. The panel did not specify the sectors that should have safe harbour provisions, only that they should be in peripheral activities such as interest on loans, internal support services or small administrative services.

“The idea behind safe harbours is to reduce the cost of compliance and administration. But in this case, a company will still be subjected to transfer pricing adjustment. We will examine the issue afresh. We have to see to what extent we can prescribe safe harbours without compromising revenue,” a finance ministry official, who did not wish to be named, told Business Standard.

Another official said it was not practical to have safe harbours in India because margins in the IT sector vary from 5 per cent to 90 per cent. He said transfer pricing disputes could be tackled with Advance Pricing Agreements, or APAs, which will do away with the need for dispute resolution panels.

In APAs, an ahead-of-time deal is signed between the taxpayer and tax authority to decide the arm’s-length price. APAs are proposed to be introduced as part of the Direct Taxes Code next year. Some experts, however, say APAs are only for large transactions, in which it is difficult to determine the arm’s-length price and, thus, cannot help small taxpayers.

“APAs are for complex transactions within a group. It is a costly process and a deal takes a year or two to conclude,” said Shanto Ghosh, principal economist, Deloitte India. He, however, agreed it would not make sense to introduce safe harbours in the form suggested by the panel, as the rate was too high. Deloitte says 11-13 per cent would be fair.

Even though safe harbours on peripheral activities exist in other countries, it has been argued that in India it may lead to disputes over what comprises core activity. In 2001, for instance, the government came up with a distinction between core and non-core services, but had to withdraw it later.