-Kunj Mehra[1]
Background
The last few decades have witnessed significant globalization, which has led to the drastic growth of international transactions between parties situated in different nations. However, with this vast geographical network of transactions, comes the problem of keeping up with the different tax rates at which different countries operate. This unruly scenario allows big multinationals to shift their profits from high-tax jurisdictions to low-tax jurisdictions with the malafide intention of reducing their tax burden to the possible least.
Essentially, Transfer Pricing rules combat such situations by ensuring that profits are taxed in the jurisdiction where the actual value was created and there is no tax leakage. In addition to that the transfer pricing provisions also aim to ensure that related parties transactions are maintained at an arm’s length price.[2]
Considering the gigantic scope of the concept of transfer pricing, the author for the purpose of this paper will attempt to decode one of its extensions, i.e. Safe Harbor rules. In simple layman terms, a Safe Harbor is a legal provision which accords protection against liabilities in certain conditions, if certain specific conditions are simultaneously met.[3] However, besides the wide horizon of safety guaranteed to the taxpayers, the Indian taxation system further expands the scope of safe harbor rules by handing the onus of declaring the transfer price with the taxpayers, which is to be duly accepted by the revenue authorities.[4][5] This decisive power of declaring the transfer price is vested in the taxpayers under Section 92CB of the Income Tax act, which goes on to show that the Central Board of Direct Taxes (CBDT) introduced the transfer pricing safe harbor rules with the intention of safeguarding the ultimate interest of the taxpayer.
Due Course of Safe Harbor Rules in India
The Safe Harbor rules (SHRs) were first proposed by the CBDT in the year 2013 with the limited applicability of 5 financial years till FY 2016-17. The Ministry of Finance (MoF) under rule 10TA and rule 10TG of the Income tax rules, 1962 inserted the Safe Harbor rules with an intention of providing much required certainty to the big multinationals in regards to the eligibility of cross-border transactions.[6]
Since then, the CBDT has ensured consistent applicability of the SHRs over the years. After the expiration of the first 5 financial years the applicability of SHRs was extended with the help of regular notifications, firstly till FY 2018-19 and then consecutively till FY 2019-20.[7] The last notification by CBDT extended the applicability of SHR to FY 2021-22 without any legal modifications with an objective of growing the taxpayer’s acceptance towards the aid offered by the SHRs. The initiatives by the apex tax authority towards SHRs showcase that the provisions has the potential and the administerial backing to become a suitable dispute resolution system when it comes to transfer pricing issues.
From the first adoption of SHRs in 2013, over the years the rules have transformed for the overall betterment of the taxpayers. As per the last notification, the rates have been revised to a preferable 17-18% for ITeS (Information Technology Enabled Services) and BPOs from 20-22%, even the operating profit margin was reduced from a staggering 30% to a comparative 24% for research and development purposes.[8]
Since the start, the tax experts have been in constant appreciations of the Safe Harbor rules. Mr. Dinesh Kanabar, Deputy CEO, KPMG India expressed his take on introduction of SHRs by saying, “This is a very positive development. This should help overcome massive potential TP litigation and create a right tax environment.”[9]
Tax experts also did not miss out on acknowledging the attempt of CBDT to lower the tax rates, especially during the devastation caused by Covid-19 pandemic. It has been duly noted that the reduced tax rates will not only induce industries to get back on track post pandemic, but also offered a push to this alternate dispute resolution which has come up in the disguise of Safe harbor rules. Crediting the gravity of this unprecedented situation, Mr. Nitin Narang, Partner- Nangia & Co LLP said that, “Given the businesses are amidst an unprecedented economic situation and the past year have been severely impacted due to the pandemic, any lowering of the rates in line with the current economic circumstances would have gone a long way to make it more attractive and lowering of threshold, or adding more transactions, may add more willing taxpayers.”[10]
These regular initiatives by CBDT in the process of extension of the applicability of SHRs, the undeniable scope of alternate dispute resolution offered by SHRs and the unconditional appreciation posed by prominent tax experts of the country, showcase that Safe Harbor rules have the potential of wide acceptance amongst the taxpayers due to its paramount intention of safeguarding taxpayer’s interest and reducing Transfer pricing litigation.
Safe Harbor Rules on Arm’s Length Price
The concept Arm’s Length Price (ALP) promotes the idea of independent relation between independent parties.[11] The OECD (Organisation for Economic Co-operation and Development) basically defines ALP as a valuation principle that ensures that all transactions, whether a business transaction between related parties or a transaction in an open market, are valued as if they are carried out between unrelated parties for their own best interest.[12]
Section 92C of the Income Tax Act, 1961 clearly prescribes different methods for the computation of the Arm’s length price for the purpose of international or specified domestic transactions.[13] However, it is important to note the scope of Section 92CB that defines safe harbor rules. The said provision not only defines SHRs as a concept under which the income tax authorities would accept the transfer price declared by the taxpayers, but more importantly it also overrides the scope of S. 92C by mentioning that determination of Arm’s length price shall be subject to the SHRs.[14] This intertwining of provisions indicates that SHRs vest the power to determine Arm’s length price computation, but it is also to be noted that the taxpayer holds the discretion to opt for SHRs and thus, SHR’s can only influence ALP computation if the taxpayer has opted for it. Therefore, this situation raises a relevant question regarding the scope of SHRs over ALP computation, onto which some light can be put through a relevant case law.
In Dana India Private Ltd. vs DCIT, the ITAT (Income Tax Appellate Tribunal) held that Rule 10B(1) which provides for ALP determination under transfer pricing methods and Rule 10TA which defines the purpose of safe harbor rules, are mutually exclusive. The ITAT further clarified that “where an assessee has not exercised option for the safe harbor, the entire set of Rules from 10TA to 10TG gets freezed and cannot be operationalized. In addition to that, the definition clause in rule 10TA has its force only within the ambit if the safe harbor rules and not beyond that.”[15]
Lastly, the ITAT stated that rule 10TA nowhere extends the scope of its ambit over rule 10B, which means that safe harbor rules were not relevant in determination of ALP computation.
On one hand, the combination of Section 92C and 92CB indicates that safe harbor rules can influence the determination the ALP computation method. However, on the other hand, ITAT in Dana India case clarifies that Rule 10TA has no onus on determination of ALP computation method.
Regardless of this confusion there is one common stance, that the taxpayer must have opted the SHRs in order for the provision to hold power. Now, it’s a well versed fact that the entire transfer pricing mechanism lay its basis on computation of income arising out of international transaction which rests on the principle of arm’s length price, it becomes crucial for a taxpayer to have clarity in cases of disputes. Therefore, this makes it very clear that SHRs possess the potential of easing out not only the liability but also the technicalities of ALP computation if opted in time.
Conclusion
It is known that transfer pricing compliance is a complex task which taxpayers all around the world have to go through on regular basis considering the overgrowing network of international transactions. Through the course of this paper it was realised that the tax authorities are putting in extensive work to make Safe harbor rules as full proof as possible. Safe harbor rules if properly drafted and laid out can actually reduce the taxpayer’s burden and also offer great certainty.
Although it was also pointed out that safe harbor rules need further work as they can have undue effect on the pricing decision of controlled transactions between related parties, however, on the brighter side the safe harbor rules can limit the divergence from arm’s length price.[16] In totality, the safe harbor rules might pose the risk of double taxation and in some cases double non-taxation too, however, for small taxpayers the benefits brought in by safe harbor rules outrightly outweigh all its shortcomings.
[1] Kunj Mehra is an LL.M. candidate at O.P Jindal Global University specializing in Taxation laws.
[2] Dharti, All about Safe Harbor Rules in India- Know the Safe Harbor rates in India, EBizzFiling, https://ebizfiling.com/blog/all-about-safe-harbor-rules-in-india-know-the-safe-harbor-rates-in-india/
[3] Adam Hayes, Safe Harbor, Investopedia, https://www.investopedia.com/terms/s/safeharbor.asp
[4] Income Tax Act, 1961, Section 92CB, (India)
[5] Corporate Finance Institute, https://corporatefinanceinstitute.com/resources/knowledge/other/safe-harbor/
[6] Bhavik Timbadia & Ankit Goel, Safe Harbour Rules 2017 – Indian Government walking the talk!, https://www-taxsutra-com.opj.remotlog.com/tp/experts-corner/safe-harbour-rules-2017-indian-government-walking-talk
[7] India Tax Administration extends applicability of transfer pricing safe harbor rules to financial year 2020-21, EY, https://www.ey.com/en_gl/tax-alerts/india-tax-administration-extends-applicability-of-transfer-pricing-safe-harbor-rules-to-financial-year-2020-21
[8]Gaurav Jain & Priya Bhutani, India extends applicability of transfer pricing safe harbour rules for another year, MNE Tax, https://mnetax.com/india-extends-applicability-of-transfer-pricing-safe-harbour-rules-for-another-year-45917
[9] Tax Experts react to final Safe Harbour rules, Taxsutra, https://www-taxsutra-com.opj.remotlog.com/news/tax-experts-react-final-safe-harbour-rules
[10] Gulveen Aulakh, CBDT extends safe harbour rules for AY22 at same rates, The Economic Times, September 25, 2021, https://economictimes.indiatimes.com/news/economy/policy/cbdt-extends-safe-harbour-rules-for-ay22-at-same-rates/articleshow/86505911.cms
[11] What is Arm’s Length Price?, Taxxman, https://www.taxmann.com/post/blog/764/what-is-arms-length-price/
[12] What is an arm’s length transaction in transfer pricing?, Royalty Range,https://www.royaltyrange.com/home/blog/what-is-an-arms-length-transaction-in-transfer-pricing
[13] Income Tax Act, 1961, Section 92C
[14] Income Tax Act, 1961, Section 92CB
[15] ITAT: Determination of ALP under Rule 10B mutually exclusive vis-a-vis safe harbour definitions under Rule 10TA, Taxsutra, https://www-taxsutra-com.opj.remotlog.com/tp/rulings/itat-determination-alp-under-rule-10b-mutually-exclusive-vis-vis-safe-harbour#conclusion
[16] OECD, Revised Section E On Safe Harbours In Chapter Iv Of The Transfer Pricing Guidelines, https://www.oecd.org/ctp/transfer-pricing/Revised-Section-E-Safe-Harbours-TP-Guidelines.pdf
