1. Amendment of section 90 :-The Finance Bill (No. 2) 2009 proposes to replace the existing Section 90 with a new section 90. The new section 90 is substantially the same as earlier section 90 except that the proposed amendment seeks to empower the Central Government to enter into an agreement with the Government of any country outside India or a specified territory outside India, inter alia, for avoidance of double taxation of income. For this purpose, the Central Government may, by notification in the Official Gazette, make such provisions as may be necessary for implementing the said Agreement and would also notify the specified territory outside India.

Earlier, the Central Government was empowered to enter into an agreement only with foreign countries and after the amendment it shall be empowered to enter into such an agreement with any specified territory outside India.

Media reports indicate that the Government is set to track the unaccounted wealth stashed away by Indians in tax havens, with the proposed double-taxation avoidance treaties, or a Tax Information Exchange Agreement, with what it describes as ‘non-sovereign’ jurisdictions.

According to one estimate, over trillion dollars (roughly the size of our GDP) may be lying in undisclosed, offshore bank accounts held by Indians. Jersey, Isle of Man and Guernsey, which also falls in this category, are dependent on the British Crown. Despite the ‘non-sovereign’ tag, these territories have complete autonomy over their internal affairs and certain external affairs.

Although the Finance Bill does not specifically say so, such specified territories outside India could also include special administrative regions and non-self governing territories. Hong Kong and Macau are Special Administrative Regions of the People’s Republic of China, while tax havens, such as British Virgin Islands and Cayman Islands, are non-self governing territories though they have attributes of sovereignty including control over monetary policy.

Double-taxation treaties are essentially agreements between two countries that seek to eliminate the double-taxation of income or gains arising in one country and paid to residents or companies of the other country. The idea is to ensure that the same income is not taxed twice. But such pacts need concurrence of both countries. Alternatively, India is also looking at a Tax Information Exchange Agreement with non-sovereign nations. The trigger for such a move is to get information on Indians who could be holding illegal accounts in some of these countries.

Indians featured in the list of account holders with LGT Bank in Liechtenstein, a tax haven bordering Switzerland and Austria. The government secured the list of Indians having unreported bank accounts and sent over 50 notices asking why action should not be taken under the Indian Income-Tax Act against these account holders. A copy of the list was also sent to Enforcement Directorate, which is probing the flight of capital from India.

The tax havens have attracted the attention of political establishments in Europe and the US. The new-found focus on wealth stashed away from these countries to offshore banks was partly driven by the ongoing recession that compelled the fiscal managers to look for extra resources.

The concern over the impact of tax havens on the European and the US economies was also voiced at the last G-20 meet held in London. US President Barack Obama also raised the issue at every forum that discussed the global financial crisis.

It is a moot point whether such Tax Heavens would be willing to enter into such agreements with India, which will adversely impact their economies.

2. Proposed changes to the transfer pricing provisions

The recent transfer pricing audits have resulted in significant tax demands and long drawn time consuming litigation and uncertainty. The proposed measures in the Finance Bill, 2009 attempt to reduce the hardship of going through the present appellate process and reduce litigation cost, administrative burden and bring in certainty for tax matters.

3. Some of the proposals have been discussed below

i) Determination of the arm’s length price shall now be subject to the “safe harbour rules”. The Central Board of Direct Taxes (CBDT) is empowered to formulate safe harbour rules i.e. to provide the circumstances in which the revenue authorities shall accept the transfer price declared by the tax-payer.

ii) The ‘Safe Harbour’ rules have been proposed with an objective of reducing the impact of judgemental errors in determining the transfer price. The Finance Bill has proposed to introduce a new section 92CB in the Act, which deals with the ‘safe harbour’ rules. The administrative procedure and conditions for availing the benefits of the ‘safe harbour’ rules would be separately notified by the Central Board of Direct Taxes (‘CBDT’).

iii) The new provisions define ‘safe harbour’ to mean ‘certain circumstances in which the Revenue Authorities shall accept the transfer price as declared by the tax-payer’.

iv) Safe Harbour rules will help achieve the objectives of compliance relief, administrative simplicity and certainty for tax-payers and tax administrators.

4. Concept of Safe Harbour

i) Safe harbour rules in transfer pricing are to reduce uncertainty and administrative cost involved in the application of the arm’s length principle. The rules provide the circumstances in which the tax authorities will automatically accept transfer prices. The administrative requirement of safe harbour may vary from a relief from obligation to comply with a country’s transfer pricing regulations to the obligation to comply with various procedural rules. However, safe harbours have limitations as they may not be in adherence of the arm’s length principle. Further, there is a possibility of negative impact on the tax revenues of counties adopting safe harbour as well as on the countries whose enterprises have transactions with such countries.

ii) The OECD guidelines suggest the use of certain provisions under which taxpayer could follow a simple set of rules, whereby the transfer price would automatically be accepted by the tax authorities. To seek the advantages of safe harbour certain countries like Australia and Mexico have introduced such rules known as “safe harbours” for certain service providers.

iii) In Australia, for instance, an enterprise rendering services can be said to meet arm’s length standard, if it has earned 7.5% margin over its cost, subject to certain parameters.

iv) Similarly, Mexico has also released a “Presidential Tax relief Decree in October 2003”, to provide “Maquiladoras” a substantial tax exemption based on a formula applied. The contract manufacturer must declare a minimum taxable profit representing the greater of 6.5% of total costs and expenses (cost base) or 6.9% of manufacturer’s assets (asset base) used in the manufacturing operation.

v) At present, there are no specific safe harbour rules in India. However, proviso to s 92C(2) provides that the tax officer shall not make any adjustment to the arm’s length price determined by taxpayer, if such price is up to 5% less or 5% more than the price determined by the tax officer. This 5% range can be considered as a safe harbour.

5. Advantages and Disadvantages of Safe Harbour.

a) Advantages of Safe Harbours are as follows:

i) Compliance relief for eligible tax-payers in determining arm’s length conditions for controlled transactions;

ii) Assurance to eligible tax-payers that they will not be subjected to further scrutiny in connection with their transfer prices; and

iii) Administrative relief to the tax authorities.

b) Limitations of using Safe Harbours are given herein below:

i) Generally not compatible with the enforcement to transfer pricing law consistent with the arm’s length principle;

ii) Possibility of a negative impact on the tax revenues of countries adopting safe harbour, as well as on the countries whose associated enterprises engage in controlled transactions with the former;

iii) Obtaining relevant information for establishing and monitoring safe harbour parameters may impose administrative burdens on tax administrations; and

iv) Implementations of a safe harbour creates uniformity issues, since there are two distinct sets of rules in the transfer pricing area – one requiring conformity of prices with the arm’s length principle, and another requiring conformity with a different and simplified set of rules.

Thus, the concept of ‘safe harbour’ suggests that the results declared by the tax-payer, who fulfils the prescribed conditions/ circumstances, may be accepted without detailed scrutiny. Though the proposal of ‘safe harbour’ provisions is a move in the right direction, one would need to await for detailed guidelines on this, to see if the desired end result is achieved.
Countries like USA, Mexico, Australia etc. have been effectively using the ‘safe harbour’ rules. It would be interesting to note how the Indian safe harbour rules would be different from those of other countries.

The proposed amendment is retrospective and will apply to year ended March 31, 2009.

6. Variation from the arm’s length price – Amendment to section 92C(2)

i) The existing proviso to section 92C(2) of the Act mandates that while determining the arm’s length price, the arithmetical mean of the comparable uncontrolled transactions shall be considered to be the arm’s length price. The proviso also gives an option to the tax-payer to adopt a price, which varies by not more than 5% of the arithmetical mean, to be the arm’s length price.

ii) In other words, in all cases where there would be a proposed transfer pricing adjustment, the tax-payer could exercise his option and seek to claim the benefit of the 5% variation as a ‘standard deduction’ before applying the arm’s length principle. This interpretation of the proviso to section 92C(2), by the tax-payers, is not being accepted by the Indian Revenue.

iii) However, the following decisions, the Tribunals have upheld the interpretation of the tax-payers that the proviso to section 92C(2) provides a standard deduction of 5%.

• Development Consultants Pvt. Ltd. vs DCIT (115 TTJ 577)(KOL),
• E-Gain Communication Pvt Ltd. vs. ITO (ITA No.1685/PN/2007) (Pune),
• Mentor Graphics (Noida) Pvt. Ltd. vs DCIT (18 SOT 76)(Delhi),
• Sony India (P) Limited vs. DCIT

(2008-TIOL-439) (Delhi)

iv) With a view to resolving this controversy, the proviso is proposed to be amended to mean that if the variation between the ‘price of the controlled transaction of the tax-payer’ and ‘the arm’s length price’ is not more than 5% (of the controlled transaction of the tax-payer), the former would be deemed to be at arm’s length.

The impact of the revised proviso is explained as under:

Particulars Value of




mean of the


Length Price

Adjusted ALP

after 5%

variation Rs.






Sale of


Sale price

of Rs.125

125 x 0.95

= 118.75


= 18.75

Revised proviso (as proposed) Sale of

Rs. 100

Sale price

of Rs. 125

100 x 1.05

= 105

125 – 100

= 25

v) As per the above, under the existing proviso, the tax-payer ought to get the benefit of the 5% variation as a ‘standard deduction’ on the original ALP (i.e., the adjustment would be done using the adjusted ALP of 118.75). However, as per the proposed proviso, if the arm’s length price is beyond 5% of the value of the controlled transaction, the tax-payer would be subjected to a transfer pricing adjustment from the original arm’s length price (i.e., the ALP of 125).

In short, the proposed amendment primarily aims to provide that the benefit of +/- 5% would not be available as a ‘standard deduction’.

The proposed amendment would be applicable for all transfer pricing orders passed on or after 1st October, 2009.

Author: CA. Tarunkumar Singhal

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