Draft safe harbour rules disappoint

In an effort to reduce transfer pricing ('TP') litigation, Section 92CA was introduced by the Finance Act (No. 2), 2009, authorising the Central Board of Direct Taxes (CBDT) to formulate safe harbour rules. By way of the above amendment, CBDT was empowered to frame safe harbour rules.

Safe harbour rules are basically a set of directives or guidance on activities or margins whereby the revenue authorities should accept the pricing of a controlled transaction declared by the taxpayer without demur.

The purpose of introduction of safe harbour concept was to give assurance to the taxpayers that proper leverage will be allowed to them in given situations and circumstances.

After a long wait and on recommendations of the Rangachary Committee, draft of Safe Harbour Rules have now been notified inviting comments from all stakeholders by August 26.

The draft rules provide for an option either to adopt the rules or go for the normal TP provisions. Broadly, the rules notify for categories of the sectors/transactions, subject to certain ceilings, where these rules could be applied:

1) Information technology (IT)/ IT-enabled services sector

2) Contract R&D in IT and pharma sectors

3) Automobile original equipment manufacturer (OEM)

4) Outbound loans and corporate guarantees

According to the draft rules, the transfer price of an eligible transaction declared by an eligible assessee shall be acceptable to income-tax authorities in case of a transaction pertaining to the first three categories, a specified margin of operating profit (OP) over operating expense (OE) is declared, and in case of the last category, i.e., outbound loans/corporate guarantees if the assessee earns a specified rate of interest /commission.

The draft rules specify, for the purposes of the first two categories, an eligible assessee to mean a person who undertakes eligible international transactions and is an assesee having no risk of its own, i.e, the risks are undertaken, functions are performed, capital is provided, intangibles are held by the foreign principal. However, for the remaining categories, an assessee shall be an eligible assessee if it is an auto OEM or advanced an intra-group loan or provided a corporate guarantee.

Under the draft rules, the eligible international transactions alongwith acceptable profit margins are given in the chart. These margins are applicable for 2012-13 and 2013-14.

FY 2012-13 is already over. How can the draft rules on which comments are being sought in August 2013 be made applicable for the year which has already expired on March 31, 2013 ? It shall, however, be noted that in order to qualify as eligible international transaction, the aggregate of a service in the nature of software development, IT-enabled services or knowledge process outsourcing should, in aggregate for each nature, be less than Rs 100 crore during the financial year. It is, thus, obvious that large assessees will not be covered under the safe harbour rules.

Assuming such huge profit margins from an insignificant risk or no risk bearing assessee and that too in the period of recession in the economy is like expecting a fisherman to catch a fish during high tide and that too without a net.

The expectation of such huge profit margins would be unrealistic for the industry which is facing gloomy economic environment.

The safe harbour rules in its current form cannot be called industry friendly particularly for the category of software development, IT-enabled services and knowledge process outsourcing.

(This article has been co-authored by Alok Gupta)
e-mail: hp.agrawal@sskmin.com
a.gupta@sskmin.com