Revised Safe Harbour Rules – Fitting the bill?

June 14,2017
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Ashima Gupta (Partner, International Tax & Transfer Pricing Services, Ernst & Young LLP)

Ankit Bansal (Manager, Ernst & Young LLP)

Continuing its agenda of ushering in a non-adversarial tax regime, the Government recently added another feather to its cap by revising the Safe Harbour Rules[1] (“SHR”). The SHR provide a simplified dispute-avoidance mechanism, wherein a taxpayer’s transactions are accepted to be at arm’s length if they conform to the conditions and margins laid down in the scheme.

In its original form, the scheme did not yield anticipated success. This was largely due to margins set much higher than industry realities. Taking feedback from taxpayers’ tepid response and industry recommendations, the new SHR seeks to address the base of the problem. The margins in the revised scheme are re-aligned closer to business realities and results achieved in recently negotiated Advance Pricing Agreements (“APAs”). The new scheme also provides for a tiered-margin structure for Knowledge Process Outsourcing (“KPO”) services, expands coverage to receipt of low value-adding services, and provides different interest rates for outbound loans denominated in domestic (INR) and foreign currencies.

The authors opine that there are certain aspects in the revised SHR which may require clarifications or lead to interpretational issues, as discussed below:

Low value-adding intra group services (“LV-IGS”)

During transfer pricing (“TP”) audits, taxpayers undergo the onerous benefits test and furnish voluminous information/documents to prove the arm’s length nature of LV-IGS. Bringing such services under the umbrella of SHR certainly provide significant relief to small taxpayers, with value of transactions less than INR 10 crores in aggregate. Interestingly, the allowance has not been linked with recipient’s revenue or profit (as done in Interest Limitation provisions under Section 94B of the Act). It appears that the Government has taken cognisance of the business necessity to avail such services, particularly those in losses or in start-up phase.

To keep key commercial and revenue generating activities out of purview, the Rules also set out an elaborate definition of such services. This definition is broadly in line with Base Erosion and Profit Shifting (“BEPS”) Action Plans (“AP”) 8 to 10 of the Organisation for Economic Cooperation and Development (“OECD”)[2]. The definition also categorically excludes certain services which do not qualifying as LV-IGS. While the intent appears to exclude core functions, unlike BEPS AP no clear differentiation has been made between core and non-core activities.

For example, the SHR has excluded Information Technology (software development) services from the scope of LV-IGS. On the other hand, BEPS AP clearly mention that non-core IT services provided within the group constitute LV-IGS and lists software development along with research and development services, which are core activities in nature. This could lead to unintended consequences, and imply that such services shall remain out of ambit of SHR in all cases, even when such services are non-core/LG-IGS, and the taxpayers availing such services (say remote maintenance from SSC) may not be able to secure SHR on such services.

Further, the SHR prescribe that “(such services) do not have reliable external comparable services that can be used for determining their arm’s length price”.


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