There have been developments that have taken place in the transfer pricing world in relation to safe harbours, especially since 2009 when they were introduced in Indian tax regulations. So, while the provisions relating to safe harbours are already part of the Indian tax regulations and detailed rules are to be notified, it would be worthwhile to discuss some global thought processes that can be considered in the Indian scenario by the Central Board of Direct Taxes while notifying safe-harbour provisions.
Formally, in the context of taxation, a safe harbour is a statutory provision that applies to a given category of taxpayers and that relieves eligible taxpayers from certain obligations otherwise imposed by the tax code by substituting exceptional, usually simpler obligations. Safe harbours could exempt taxpayers from all or part of transfer pricing rules, define thresholds by which transfer prices of such taxpayers are automatically accepted or through an alternative formulation by which mandatory pricing target would be established by a tax authority, subject to a taxpayers right to demonstrate that the target price is inconsistent with the arms length principle when applied in the taxpayers case.
Organisation for Economic Co-Operation and Development (OECD) in its discussion draft on Proposed Revision of the Section on Safe Harbours in the OECD Transfer Pricing Guidelines, issued in June 2012 (discussion draft on safe harbours), has discussed the benefits, concerns and recommendations in relation to safe-harbour provisions in great detail.
Some aspects of safe harbours that could be considered are as under:
(a) Bilateral and multilateral safe harbours: Safe harbours may not necessarily be arms length as discussed by the OECD. Thus, safe harbour provisions have a potential for double taxation as these provisions bind only the issuing tax administration and no one else. Therefore, the effectiveness and attractiveness of safe harbour provisions to taxpayers will depend on their acceptability by foreign jurisdictions with which they have international transactions, necessitating bilateral and multilateral safe harbour provisions. In case the safe harbours are unilateral, the taxpayers will need to evaluate the relative cost savings to the potential cost of double taxation.
(b) Mandatory safe harbours: Whether the safe harbour provisions will be compulsory on the target taxpayer or not, will need to be clarified. In case it isnt mandatory, then the rules should clearly provide that the tax authorities will take an unbiased view of the qualifying international transaction of a taxpayer (without reference to the related safe-harbour provision) by giving adequate and fair opportunity to the taxpayer to demonstrate the arms length nature of the international transaction.
(c) Availability of dispute resolution mechanisms: In case of any double taxation, the provisions need to be clear on the availability of mutual agreement procedures to the taxpayer and its related parties to mitigate the double taxation.
The introduction of a safe harbour mark-up for firms rendering IT and IT-enabled services has been the most watched out for with the Prime Minister constituting a committee to review the taxation of development centres and the IT sector. However, there are some other suggestions in the Indian regulations that could also be looked at. With significant changes in and growth of the Indian economy in the last decade since the introduction of transfer-pricing provisions, the earlier threshold amounts for maintenance of comprehensive documentation and for being selected for detailed scrutiny should be revisited. For example, the limit for taxpayers to maintain comprehensive TP documentation can be increased from international transactions in excess of R10 million to R50 million. An increasing number of tax payers are facing scrutiny and TP adjustments in case of inter-group borrowing and lending transactions. How the loan transactions (received/given) are benchmarked, parameters to be considered and the safe harbour interest rates should be prescribed. Furthermore, interest amount thresholds to exclude the taxpayers from compliance requirements as a safe harbour could be introduced.
Furthermore, the Finance Act, 2012, provided that if the variation between the arms length price as determined and the price at which the international transaction has actually been undertaken does not exceed three percent of the latter, the price at which the international transaction has actually been undertaken shall be deemed to be the arms length price. It is recommended that this tolerance range be restored to 5% as there are no clear reasons for reducing the permitted variation, especially given that the government notified a 5% range for FY12 recently.
Introduction of rational safe harbour provisions will go a long way in providing certainty and relief to taxpayers. Therefore, it is imperative that the government aligns its policies with the international best practices and also from the experience gained in over a decade since introduction of transfer pricing regulations to make the policies investor friendly.
The author is partner & national leader, transfer pricing, Ernst & Young. Vishal Rai, associate director, tax & regulatory services, E&Y, contributed to the article. Views expressed are personal