Concept of "Safe Harbour Rules" under Income Tax Act 1961

It is duty of every citizen whether human or corporate to pay applicable taxes levied by Government. These taxes are necessary for development and social welfare of the citizens. The Government of each country depends on taxes paid by their citizens and formulate its expenditure for welfare, hospitality, social and security of their citizens. A taxpayer is generally called an assessee and is required to pay taxes on total income earned during previous year.

The tax liability will be calculated according to the provisions of Income Tax Act,1961 and applicable the Income Tax Rules, 1962. An assessee can avail exemptions and deductions provided under various provisions of Act,1961, while calculating his/her income tax liability.

An assessee is required to plan his/her activities within the ambit of provisions of Act,1961, he is not allowed to evade or conceal tax. The tax evasion is against the provisions of Act,1961 as well as against Public Policy. There is strict penalty and even imprisonment on evasion of tax liability.

We know that due of globalisation and opening of India market for foreign companies, many multinational companies have established their business in India and are working through their WOS/Subsidiaries all over world. They have their presence in many countries. The tax rates of each country are differed from another company. These multinational companies generally try to shift their profit from high tax country to low tax country to evade tax. They are generally engaged themselves with their WOS/Subsidiaries or Associates Enterprises for dealing and manipulate the business transition to evade taxes in India or shift profit from India to another country such as Mauritius or other tax heaven countries.

It means that transfer pricing is business transactions between associate enterprises such as between a company and its subsidiary or with its associates company not at Arm's Length Price. These associated enterprises are under common control.

These Transfer Pricing Transactions also helps in Base Erosion and Profit Shifting (BEPS) in which these multinational companies used tax planning strategies to plan their transaction such as to shift profit base from higher tax country to lower tax country/ tax heaven country.

Base erosion and profit shifting (BEPS) refers to tax planning strategies used by multinational enterprises that exploit gaps and mismatches in tax rules to avoid paying tax. Developing countries' higher reliance on corporate income tax means they suffer from BEPS disproportionately.

"Base erosion" refers to the practice of reducing the taxable base. An example is deducting large interest payments in order to lower the taxable profits. "Profit shifting" refers to the practice of shifting taxable profits from high-tax countries to low-tax countries

Base erosion and profit shifting (BEPS) refers to corporate tax planning strategies used by multinationals to "shift" profits from higher-tax jurisdictions to lower-tax jurisdictions, thus "eroding" the "tax-base" of the higher-tax jurisdictions.

WHAT IS TRANSFER PRICING

Transfer pricing is a technique used by multinational corporations to shift profits out of the countries where they operate and into tax havens that involves a multinational selling itself goods and services an artificially high price.

By using its subsidiary in a tax haven to charge an inflated cost from its subsidiary in another country, e.g., buying boxes of pens from the tax haven-based subsidiary for Rs 200(actual cost of pen suppose in India is Rs. 100) for a pen, the multinational corporation "moves" its profits out of the country where it genuinely does business and into a tax haven where it has to pay very little or no tax on profit.

Another example: Let's say it costs a multinational corporation Rs. 100 to produce a Shirt in India. It then sells that shirt to an affiliate located in a tax haven for Rs. 100, leaving no profits in India. The tax haven affiliate immediately sells that shirt on to an affiliate in US for Rs. 300, leaving Rs. 200 profits in the tax haven. That US affiliate sells the shirt at the genuine market price of Rs. 300 to a supermarket, leaving no profits in US.

As a result, the multinational pays no tax in India and no tax in US, and the Rs. 200 in profits shifted to the tax haven do not get taxed.

In this way, multinational corporations avoid their responsibility to pay tax and fail to contribute to the societies in which they operate

WIKIPEDIA - In taxation and accounting, transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort taxable income, tax authorities in many countries can adjust intragroup transfer prices that differ from what would have been charged by unrelated enterprises dealing at arm's length (the arm's-length principle).

Transfer pricing is an accounting and taxation practice that allows for pricing transactions internally within businesses and between subsidiaries that operate under common control or ownership. The transfer pricing practice extends to cross-border transactions as well as domestic ones.

PLEASE NOTE THAT

• Transfer pricing accounting occurs when goods or services are exchanged between divisions of the same company.
• A transfer price is based on market prices in charging another division, subsidiary, or holding company for services rendered.
• Companies use transfer pricing to reduce the overall tax burden of the parent company.
• Companies charge a higher price to divisions in high-tax countries (reducing profit) while charging a lower price (increasing profits) for divisions in low-tax countries.
• The IRS states that transfer pricing should be the same between intercompany transactions as it would have been had the company done the transaction outside the company.

INCOME TAX PROVISIONS GOVERNING TRANSFER PRICING

1. The provisions of Section 92 to 92 F have been enacted with a view to provide statutory framework which can lead to computation of reasonable, fair and equitable profit and tax in India so that the profits chargeable to tax in India do not get diverted elsewhere by altering the prices charged and paid in intra-group transactions leading to erosion on Indian Tax. Any income arising from an International Transaction shall be computed having regard to "Arm's length price".
2. With effect from AY 2013-14 provisions of Section 92BA has been inserted which deals with some specified Domestic Transactions.
3. Income arising from International Transactions is a pre-condition for application of transfer pricing provisions.
4. These transactions do not include capital receipts unless specifically provided.
5. The activity of issue of shares by a subsidiary to its holding company abroad at lower price than the Fair Market Values does not raise and International Transfer Pricing Transactions and hence provisions of transfer pricing are not applicable on this transaction.
6. The International Transactions are subjected to Transfer Pricing only in case of transition between two associated enterprises.

PLEASE NOTE THAT: for applicability of Transfer Pricing provisions, it is necessary that the transaction will be an international transaction and between two associated enterprises.

SECTION 92B(1) For the purposes of this section and Sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.

(2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be an international transaction entered into between two associated enterprises;

i) if there exists a prior agreement in relation to the relevant transaction between such other person and

ii) the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise where the enterprise or the associated enterprise or both of them are non-residents irrespective of whether such other person is a non-resident or not.

PLEASE NOTE THAT the main purpose of Transfer Pricing Provisions of Income Tax Act,1961 are to calculate, fair, reasonable and equitable profits in India in an International Transactions so that profit does not shift from India to another country on the basis of alteration in process, bogus purchases, excess expenditure claimed, inflated purchase price from associated enterprises etc. The dealing between associated enterprises will be calculated on the basis of "Arm's length "price of goods or services involved in the transaction.

ARM'S LENGTH PRICE

Section 92 of the Income Tax Act, 1961- which deals with the computation of income from international transactions lays down that any income arising from an international transaction shall be computed having regard to the arm's length price.

Note that 'arm's length price' means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.

MOST APPROPRIATE METHOD

As per the nature of the transaction, the most appropriate amongst the following methods shall be utilized to compute the arm's length price:

1. Comparable uncontrolled price method;
2. Resale price method;
3. Cost plus method;
4. Profit split method;
5. Transactional net margin method;
6. such other method as may be prescribed by the Central Board of Direct Taxes.

The most appropriate method to be applied for determination of arm's length price shall be applied in the manner as prescribed under rules 10A, 10AB, 10B, 10C and 10CA of Income-tax Rules, 1962.

LET'S DISCUSS SAFE HARBOUR RULES

Section 92C provides for adjustment in the transfer price of an International Transaction with an associated enterprise, if the transfer price is not equal to the "Arm's Length Price". As a result, a large number of such translations are being to be subjected to adjustment giving raise to considerable dispute.

The government has empowered the CBDT by insertion of provisions of Section 92CB by Finance Act, 2009 to formulate "Safe Harbour Rules", i.e., to provide the circumstances in which the Income Tax Authorities shall accept the transfer price.

Safe Harbor refers to a legal provision to reduce or eliminate liability in certain situations as long as certain conditions are met. A safe Harbour is a provision of a statute or a regulation that specifies that certain conduct will be deemed not to violate a given rule.

Safe Harbours provide for circumstances in which a certain category of taxpayers can follow a simple set of rules under which transfer prices are automatically accepted by the revenue authorities.

SAFE HARBOR RULES IN INDIAN TRANSFER PRICING REGIME

To put indifferently, from the perspective of Transfer Pricing (‘TP') provisions the Safe Harbour Rules provides a window for the taxpayers wherein in case of defined circumstances the income-tax authorities shall accept the Transfer Price declared by the taxpayer.

In India Section 92CB of the Income Tax Act (‘ITA') defines the term Safe Harbour as circumstances under which the income tax authorities shall accept the transfer pricing declared by the assessee.

BENEFITS OF SAFE HARBOR RULES IN INDIA- TO THE TAXPAYERS AND REVENUE AUTHORITIES

1. Advance information or knowledge about the range of profits or prices to qualify for SHR. This brings certainty in transactions.
2. Elimination of the possibility of litigation between the taxpayers and the revenue authorities.
3. Automatic approvals and self-assessment procedures.
4. Ease in compliance.
5. Reduction in compliance cost.

THE ELIGIBLE ASSESSEES UNDER SAFE HARBOR RULES

1. The eligible assessee under Safe Harbour Rules in India has been defined in Rule 10TB. The eligible assessee is as under:
2. An assessee who is engaged in providing software development services or information technology-enabled services or knowledge process outsourcing services, with insignificant risk, to a non-resident associated enterprises.
3. Who has made any intra-group loan?
4. Who has provided a corporate guarantee?
5. Who is engaged in providing contract research and development services wholly or partly relating to software development, with insignificant risk, to a foreign principal.

ELIGIBLE INTERNATIONAL TRANSACTION CURRENTLY SUBJECT TO SAFE HARBOUR RULES

Safe harbour rates provide arm's length price issued by the CBDT for specified international transactions. In case a taxpayer undertakes certain specific international transactions at the specified safe harbour rates, it will be acceptable by the Income tax authorities and no further transfer pricing audit, and consequent adjustment, will be made for those international transactions.

For the AY 2017-18 to 2020-21 the Safe Harbour Rates or Margins are given below. An assessee by filing Form 3CEFA has option to exercise Safe Harbour Rules. The Transfer Price declared by the assessee in respect of below mentioned transactions shall be accepted by the income tax authorities, if it is in accordance with the circumstances as specified.

PROCEDURE

1. The Safe Harbour Option in Form 3CEFA is required to be filed in paper format with the AO. The AO is required to examine the Form and decide within a period of two months (from the end of the month in which option was filed) as to whether to accept the Safe Harbour Option or to make a reference to the TPO. If no action is taken within the period by the AO, the Safe Harbour Option will be considered as having been accepted and may remain valid for a period of 5 (five) years.
2. in case of any minor defect in the Form filed the AO will provide an opportunity to the assessee to ratify the form and same should be done within a period of 2 moths as mentioned above.
3. the AO is required to verify the eligibility of assessee and the international transactions.
4. The Safe Harbour Rules not apply in respect of eligible international transactions entered into with associated enterprises located in any country or territory notified under Section 94A or in a no tax or low tax country or territory.
5. where reported income is less than Safe Harbour Margin- there can be cases where the taxpayer has opted for Safe Harbour Option but the reported rates or margins less than the Safe Harbour Rates or Margins. In such cases, the income is to be computed on the basis of the Safe Harbour Rates or margins only.
6. the Safe Harbour Margin or Rates specified above are not considered as a benchmark by AO or TPOs in cases not covered by the Safe Harbour Rules. In cases where assessee has not opted Safe Harbour Option (or the Option has not to be found to be valid), and a regular transfer pricing audit will be carried out without regard to the Safe Harbour rates or margins.

CONCLUSION

Safe Harbour Option is a window given by the Income Tax Authorities to an assessee to calculate international transactions on the basis of Arm's Length Price. An assessee opting Safe Harbour Rates or Margins has to apply with the AO and AO is required to verify an accept the Safe Harbour Option applied by the assessee within a period of two months from the end of the month in which option has filed. In cases where Safe Harbour Option not applied then assessee is required to go through Audit Process to determine Safe Harbour Price. The Safe Harbour Rules reduces litigations between an assessee and the department and helps doing business without interference of the department.

DISCLAIMER: the article produced here is only for sharing information and knowledge among readers. The views expressed here are personal views of the author and same should not be taken as professional advice. In case of necessity do consult with tax professionals.