The Assessment Year (AY) 2013-14 was the first year to be covered under the SHR, but the financial accounts of many taxpayers were closed when the final SHR were notified. Further, a very small two-month window was available for the taxpayers to decide whether to opt for the SHR or not, given the due date of November 30, 2013, for the filing of their income-tax return. Given this, and certain other reasons as mentioned subsequently, it appears that not many eligible taxpayers opted for the SHR in the first year.
A challenge faced by captive software services providers was the categorisation of such services into software development services, knowledge process outsourcing services and contract research and development services wholly or partly relating to software development, with prescribed safe harbour operating margins from 20% to 30% of the operating costs, depending upon the category of services. These margins were perceived to be on the higher side with a potential for double taxation for the Group, given their likely unacceptability in the jurisdiction of the payer of these services, coupled with the unavailability of Mutual Agreement Procedure under the Double Taxation Avoidance Agreements if one were to opt for the SHR. Moreover, in certain situations, given the manner in which the categories were defined, there was ambiguity on the category within which a captive software services provider will fall if the SHR were to be adopted. There was also a requirement that such service providers should be providing services with insignificant risk. While the rules did elaborate that this would inter alia mean that the overseas principal is performing most of the economically significant functions, including managing and controlling of all the significant risks, there were apprehensions amongst some of the captive software services providers, as to whether they at all get covered under the SHR.
As regards auto component exporters, the requirement that 90% or more of the total exports should be in the nature of original equipment manufacturer sales, resulted in a situation where hardly anyone could opt for the SHR, given that there are very few auto component manufacturers in the country exporting directly to related party original equipment manufacturers. Furthermore, the safe harbour rates provided for intra-group loans and corporate guarantees were also perceived to be on the higher side. And finally, the requirement to continue to maintain detailed transfer pricing documentation, including the provision for an audit by the tax authorities to determine SHR eligibility, created a doubt whether the compliance burden of the taxpayers would at all be reduced if they were to opt for SHR.
At this stage, it should be noted by taxpayers that SHR are present in a number of other countries as well. Usually one sees that the rates so prescribed would invariably be a bit higher, since SHR essentially seeks to induce taxpayers (though this may not be explicitly stated anywhere) to pay slightly higher taxes in return for reduced compliance burden and tax certainty. This therefore represents a good opportunity for smaller taxpayers who do not have an appetite for prolonged tax litigation. For larger taxpayers however, the adoption of SHR can cause a considerable financial burden, and a bilateral APA would usually be the answer for tax certainty.
In the next few months, after the close of the current financial year, a number of taxpayers potentially eligible for the SHR would be in the process of finalising their annual accounts. This is therefore an ideal time for the CBDT to evaluate some of their apprehensions as mentioned above. Further, in the next couple of months, the SHR filings of those who have opted for SHR in the first year, could come up for audit by the tax authorities. While the tax authorities would be well within their statutory rights to conduct a detailed audit to determine the eligibility of such tax payers, a pragmatic and a tax payer-friendly approach to such audits, if adopted could go a long way in fostering confidence amongst potentially eligible smaller taxpayers to opt for SHR for the financial year ending March 31, 2014.
With inputs from Amit Dhadphale, senior manager, Price Waterhouse & Co
The author is partner, Price Waterhouse & Co