Since APAs have progressed well while safe harbour has not, sensible to change the rules to make it attractive
The fact that India brought in the transfer-pricing statute on the books in 2001 but brought in both safe harbour rules and Advance Pricing Agreements (APAs) only in 2013, not surprisingly, was an invitation to tax terror, many times more than the celebrated cases of Vodafone and Cairn Energy. That is why, between FY06 and FY15, taxmen added a whopping `264,000 crore to the incomes of MNCs operating out of India and asked them to pay tax on this. In the case of Microsoft’s India operations, for instance, apart from saying the mark-up on costs should be 23.3% instead of the 15% claimed by the company, the taxman added part of the global parent’s profits to its income based on the proportion of R&D professionals in India.
It is to combat situations such as these that the safe harbour rules were brought in. So, if the rules said the profit margin on Indian R&D centres was 20%, any firm like Microsoft that declared a profit margin of at least this much would find its returns getting accepted without a problem. Problem was, though the rules were formulated after extensive industry consultation, the profit margins were seen as excessive. And though it took four years to arrive at what acceptable margins were, the draft rules said they were to be applicable only for the next two years after which another exercise was to be undertaken. The fact that the categorisation was further broken up into various types only made it worse—an annual turnover ceiling of `100 crore was put in cases like software development but not for contract R&D, for instance, and a distinction was sought to be made for ‘core auto components’ and ‘non-core auto components’. Though, at the time of implementation, several of these anomalies were corrected, it was clearly not enough. According to a report in Business Standard, with the profit margins substantially higher than those industry found acceptable, just 30 companies have opted to use this route.
Fortunately, the experience with APAs has been much better—in the case of APAs, firms enter into individual discussions with the taxman, after which rules are agreed upon on how to value various items of expenditure/revenue. Once agreed to, an APA provides certainty to taxpayers for five years and the settlements have also been used to resolve pending cases. While the number of applications has crossed 800, a total of 152 have been signed and 11 of these are ‘bilateral’—this means even the taxman of the country the MNC is located in has participated in the discussion and has agreed to take into account India’s tax-treatment while taxing the MNC at home. While the details of APAs are not made public since they can contain information proprietary information, the taxman has access to them. Based on this, perhaps, the tax department has taken another look at its safe harbour margins and, according to Business Standard, is likely to slash them over the next few weeks—the advantage that safe harbour has over APAs is that, since they are less time-consuming, a lot more companies can adopt them. While some argue that, especially now that the world has accepted the principle of Base Erosion and Profit Shifting, India should be more aggressive in cases like Microsoft where considerable value is being created in India but not being taxed, this would be premature. Rather than focusing on trying to collect more taxes from tech MNCs—and have the cases tied up in court—it would be a better idea to let them expand and create high-quality jobs in the country.