“Earth is flat like a mat, it’s a disc, not sphere,” says Flat Earth Society. Do you ever wonder which is the last thing that humans unanimously agreed on? We have opinions and they differ, sometimes even radically. Therefore, we raise questions over contrary opinions. Questioning is good for science and our development, however, the same is not the case with the business world; especially if the questions are from the tax authorities, and definitely not, when it comes to transfer pricing. This is because the little debates here result in huge additions to the tax liabilities. Transfer price calculations involve a certain degree of subjectivity and therefore, you may arrive at an arm’s length price using a particular method and a set of comparable transactions, however, the tax officer can also at his liberty, arrive at another arm’s length price, using a different method with a different set of comparables. Both the debates – one with the flat earth society and the other with tax authorities, often end up the same way, except the latter one is called as ‘Tax Litigation’ and can cost you a lot of money. It wouldn’t possible for businesses to operate if tax litigations are around the corner every time. To avoid such situations in transfer pricing, the government introduced Safe Harbour Rules in 2013. When you sail in international borders, make sure you station yourship at the harbour when you return, and rest assured, you will be safe!
What are Safe Harbour Rules of Transfer Pricing?
Safe Harbour Rules are legal provisions under income tax law which aim at reducing international transfer pricing litigations if certain conditions are met. An international transaction with associated enterprises is usually a part of a larger commercial transaction between the enterprise group and other independent parties. Thus, there is a restricted field of play within which the enterprise can play with the transfer price and cannot manipulate beyond the same. If an enterprise has arrived at arm’s length price based on an extensive study, appropriate documentation, and accurate calculations, unless it is manipulating the records, the transfer price would approximately be in a particular range. Even if the tax authorities adopt a different combination of criteria, methodology, or comparables, the arm’s length price would usually lie in this range. Accepting the fact that transfer pricing involves subjectivity, the taxpayers must not be harassed with legal proceedings merely for immaterial differences. Thus, the Central Board of Direct Taxes (CBDT) introduced a set of rules to avoid such litigations referred to as ‘Safe Harbour Rules’. If the transfer price (the ship) of your international transactions (the sail) is within the safe range (the harbour), the tax authorities would accept your proposition and would not question you any further. The safe range is notified by the tax authorities for different types of transactions. However, from the perspective of the corporate tax services authorities, it is a risky venture to allow taxpayers with a range to play around. Thus, this option is restricted and narrowed down, to provide eligibility to –
- only enterprises involved in specified transactions [Rule 10TB]
- for specified international transactions up to a specified threshold [Rule 10TC]
- after maintenance adequate documentation as applicable under section 92D and the reporting requirements laid down by section 94E[Rule 10TD (5)]
- while adhering to the procedures laid down for availing the option [Rule 10TE]
- disqualifying transactions where the associated enterprise is located in specified territories or low/nil tax countries (commonly referred to as tax havens)and [Rule 10TF]
- disqualifying the option to pursue the procedures as per Double Taxation Avoidance Agreements[Rule 10TG]
Who is eligible to avail the option under Safe Harbour Rules?
Rule 10TB and Rule 10TC of Income Tax Act, 1961 defines an eligible assessee and eligible transactions, for the purpose of Transfer Pricing Safe Harbour Rules. Accordingly, an enterprise would be eligible only if it has applied for the safe harbour option, as per the procedures laid down. Further, it must be involved in any of the following transactions –
- provision of software development services, with insignificant risk
- provision of information technology-enabled services, with insignificant risk
- provision of knowledge process outsourcing services, with insignificant risk
- advancing intra-group loan
- provision of corporate guarantee which does not exceed INR 10 million,or where it exceeds, the credit rating of the associated enterprise rated by an agency registered with the Securities and Exchange Board of India (SEBI), is of the adequate to the highest safety
- rendering contract research and development services relating to software development or generic pharmaceutical drugs, with insignificant risk
- manufacturing and export of core or non-core auto components(where at least 90% of the total turnover of the entity is in the nature of original equipment manufacturer sales)
- receipt of low-value addition intra-group services, within the group
An enterprise would be said to be performing transactions with insignificant risk when the foreign associated enterprise –
- performs all significant functions like the conceptualisation of design, providing strategic direction, etc.
- provides a significant portion of the capital, funds or intangibles required
- directly controls and supervises the work
- assumes all significant economic risk contractually and also by the conduct
- assumes the ownership to all intangibles or the outcome generated from the intangibles, provision of services or research work
What is the Safe Harbour Transfer Price?
The transfer price would be said to be in safe harbour i.e. the tax officer would accept it, without further questioning, when the circumstances specified under Rule 10TD of the Income Tax Act, 1961 are satisfied. These conditions are updated and notified by the Central Board of Direct Taxes (CBDT) from time to time. In certain cases, these circumstances further narrow down the eligibility criteria by limiting the value of eligible transactions up to a particular threshold.
What is the Procedure to opt for Safe Harbour?
Rule 10TE of Income Tax Act, 1961 lays down the procedure for transfer price safe harbour. As per the said rule, to exercise the safe harbour option of transfer price, the enterprise must submit Form 3CEFA. This form can be submitted online and requires basic details of the taxpayer and the details of eligible international transactions according to the nature of the transaction as tabulated above. Particulars of each transaction have to be declared separately along with the transfer price charged. The details required in respect of transactions is as follows:
- Name and address of the associated enterprise
- Name of the country where the associated enterprise is located
- Whether such a country is a no tax or low tax country
- Description of the transaction
- The amount received or the amount paid
- Operating profit margin, or the interest, or fee/commission charged and the details of credit rating, or the mark up charged in the transaction
- Whether the transfer price is in accordance with the safe harbour rules
The form has to be submitted by the due date of filing income tax return which is usually November 30. The enterprise has the option to specify the applicability at the time of submitting the form. Once the form has been submitted, it shall be validated by the tax officers. If the option is held valid, then the safe harbour would also apply for a further period of five years or if a lesser period is mentioned in the form then such a lesser period, apart from the year for which the form is submitted. The tax officer has a period of two months to accept the application or to refer the same to the Transfer Pricing Officer (TPO) who would further study the application, give an opportunity to the enterprise to explain the case, request further documentation or information if required, and pass a final order within two months. The enterprise has the right to object the order so passed within 15 days from the date of order.