In what appears to be a step to reduce tax uncertainty for multinational taxpayers, the Central Board of Direct Taxes (CBDT) has issued the long-awaited safe harbour rules (as a draft for public comments). The intention of safe harbour rules is to reduce the number of transfer-pricing disputes that have increased exponentially and spawned a huge amount of litigation over the past few years. Following the introduction of the advance pricing agreement (APA) programme last year, safe harbour rules offer another avenue for taxpayers to avoid litigation.

The concept of ?safe harbour?, while new in the Indian transfer-pricing context, is akin to presumptive taxation in certain respects. Safe harbour refers to the circumstances in which a certain category of taxpayers can follow a simple set of rules under which pricing between the taxpayer and affiliate(s) is automatically accepted by the tax authorities.

Globally, several countries have incorporated safe harbour provisions in their income-tax legislation. For example, the US, Australia and New Zealand provide safe harbour in relation to ?non-core services?. Mexican transfer-pricing guidelines contain safe harbour provisions in relation to Maquiladora operations (akin to contract manufacturing), and Brazil provides safe harbour to exporters. Taxpayers generally find these provisions helpful since they provide simplicity, predictability and relatively low compliance burden.

More importantly, taxpayers are spared from detailed scrutiny by tax authorities and the associated uncertainty, as the transfer prices declared following the safe harbour rules cannot be disturbed.

The draft safe harbour rules cover six categories of sectors or activities including IT, ITeS, KPO, contract R&D and auto-ancillary manufacturing. The rules have proposed a cost-plus mark-up for each of these sectors. For example, if a taxpayer is engaged in IT/ITeS business, bears insignificant risks and has earned an operating profit margin of 20% or more on the operating cost from provision of such services to its affiliate, the transfer price declared by the taxpayer will be automatically accepted by the tax authorities if the transaction value is up to R100 crore. Similarly, operating margin thresholds provided for the other sectors are: KPO (30%), contract R&D relating to software development (30%), contract R&D relating to generic pharma drugs (29%), manufacture and export of core auto components (12%), and manufacture and export of non-core auto components (8.5%). The transaction value threshold of R100 crore is applicable only to IT, ITeS and KPO sectors.

Besides sector-wise safe harbours, the draft rules have also proposed safe harbours for intra-group financing activities. For fixed term loans up to R50 crore, sourced in rupees and given by a taxpayer, which is not a financial institution or a bank, to its non-resident wholly-owned subsidiary, SBI base rate plus 150 bps or more is considered to be acceptable. Whereas for loans above R50 crore, the acceptable interest rate threshold is prescribed as SBI base rate plus 300 bps or more. Also, for explicit corporate guarantee given to a non-resident wholly-owned subsidiary, a commission of 2% or more of the amount guaranteed (where the amount guaranteed does not exceed R100 crore) will be considered to be a safe harbour.

As currently proposed, the eligible taxpayers will have the option to avail of the proposed safe harbours for financial years 2012-13 and 2013-14. It is also proposed that the rules will not apply if the taxpayer?s transactions are with an affiliate which is located in a low-tax territory. It is pertinent to mention that once the option for safe harbour is availed, the percentage mark-ups/interest-rates apply as prescribed?there is no scope for any comparability adjustment(s) and/or the +/-3% variation.

Initial reactions to the draft safe harbour rules point towards several areas of concern that will need to be addressed before final issuance to increase their effectiveness and appeal for taxpayers. The same includes the need to: (1) extend eligibility to taxpayers in the IT/ITeS and KPO sectors with international transactions exceeding R100 crore; (2) rationalise the relatively high expected levels of operating profit margins, interest rates and guarantee fees; (3) introduce rules relating to foreign currency loan transactions; and (4) provide appropriate reduction in documentation and compliance burden, etc.

Considering the prevailing macroeconomic situation and changing global dynamics, India needs to significantly step up efforts to compete for foreign direct investments and, to that end, there is a great need to improve investor confidence. A stable and predictable transfer-pricing regime is one of the factors that will go a long way in softening India?s perceived image as a difficult tax jurisdiction. The safe harbour provisions provide an effective way forward in terms of simple and practical solutions to the transfer-pricing issues faced by some key industries. In particular, clarity on the IT/ITeS sector itself, which alone accounted for exports in excess of $75 billion during the last fiscal year, may help salvage India?s position as a preferred destination for IT/ITeS services.

Considering that the CBDT has invited suggestions/comments on the draft rules, taxpayers could avail this opportunity to make appropriate representations to increase the effectiveness of the safe harbour regime in India.

The author is the deputy CEO of KPMG in India. Views are personal

(This is the first in a weekly column on tax issues by experts)