The finance ministry is set to issue a circular to this effect soon. The ministry's reasoning is that the presumptive profit margins stipulated last week under the safe harbour rules for exempting MNCs from a tax audit were anyway higher than actuals and hence could not be a norm for others.
Cross-border transactions of associated enterprises have to be on an arms length basis or non-preferential basis as if it is between unrelated parties.
The Central Board of Direct Taxes will issue circular clarifying that the safe harbour margins (of operational profit and commissions) shall not be taken as a benchmark for assessing the arms length price. In the past, transfer pricing adjustments in some cases have been a bit on the higher side. The government is committed to reducing tax disputes in the future, said a person privy to the Board's thinking.
The ministry wants to ensure that field officers, some of whom have in the past, attributed sharply higher profits to MNC units and demanded extra tax, do not ignore the principle that safe harbour is a presumptive or compromise tax that companies accept to avoid meticulous documentation and rigorous auditing.
The attempt is to address industry concerns and make the approach to cross-border taxation more explicit and certain. In this regard, the government had in June this year withdrawn a controversial circular that gave the impression that profit split was the most appropriate method of computing arms length price in certain transactions. The Board clarified to field officers and to companies that profit split method that assumes the Indian captive unit has a right in a share of the global profits of the parent was not the default method in taxation of cross-border deals.
Rahul K Mitra, partner, Price Waterhouse & Co. said safe harbour rates are not arms length prices, but a compromise. If a taxpayer wants to go ahead with meticulous transfer pricing benchmarking with similar transactions by unrelated parties, he may get to lower the operational profit numbers but it could lead to protracted litigation. Instead of that, under safe harbour rules, the Indian Revenue has set a rate (of operational profit on which tax is to be paid) higher than the arms length price, suggesting that the tax payer could avail of it if he wants, explained Mitra.
The Board is likely to clarify that the safe harbour rates aimed at reducing litigation has been arrived at after studying actual business transactions in each of the ten categories for which minimum profit margins have been specified to avoid a transfer pricing audit.
The final safe harbor norms brought out by the CBDT last week allows all information technology and related (ITES) businesses, KPOs and MNCs extending corporate guarantees to wholly owned subsidiaries to avoid a transfer pricing audit by declaring the specified minimum profits and tax liability from Indian operations.