Announced six months ago, the scheme spares multinational group companies from rigorous audits for income suppression (in relation to cross-border transactions with group companies abroad) if they report profits above specified limits and pay tax on them. The profit threshold for audit exemption varies with the type of cross-border transactions.
According to the sources, a review has been initiated of both the thresholds transaction sizes and minimum profit margins prescribed. The idea is to rationalise them and make the scheme attractive. In most cases, the transaction-size threshold for audit exemption is likely to be raised. Inevitably, the review would necessitate a re-classification of industries as the minimum profits specified are different for each industry category.
The review (of the scheme) is being done in the light of past (assessment) orders passed, courts views on these orders and an independent review of the scheme, said a person privy to the development.
The scheme covers mainly various segments of the IT industry including KPOs, BPOs, contract research as well as the pharmaceutical and auto components industries. It also covers corporate guarantees and loans.
The current schemes flaws came to light as many multinationals preferred to go for meticulous transfer pricing documentation and audits rather than sign up for the scheme and avoid audits, saying profit margins to be reported for audit exemption were unrealistic and way too high. Curiously, there were also instances of firms in certain sectors reporting profits higher than the minimums specified under the scheme, posing questions about the current design of the scheme.
In general, tax experts recommend lowering safe harbour margins to improve the scheme. No one will opt for a scheme which impels him to report such high margins, said Rahul Mitra, national leader, transfer pricing, PwC India.
Some sectors have reported margins higher than the safe harbour margins. It could possibly be an aberration and may not reflect the actual margins, but we need to look into whether the classification is right, said an official source.
As per current norms, local arms of MNCs providing a mix of IT services to their global parents will have to segment their accounts and apply different benchmarks. For instance, the scheme now exempts routine cross-border transactions up to Rs 500 crore in IT and IT-enabled services between MNC group companies from transfer pricing audits if the Indian arm reports a 20% operational profit margin. If the transaction value is above Rs 500 crore, the margin has to be 22% to avoid an audit. In the case of corporate guarantees above Rs 100 crore, a margin of 1.75% has to be reported to escape audit. The scheme stipulates profit margins varying from 20-25% for software development, IT-enabled services and KPOs other than contract research and development. Many experts complain that these profit assumptions are flawed. The I-T department had said these norms would be applicable for financial years 2012-13 and 2013-14.