The Central Board of Direct Taxes (CBDT) has issued revised ‘safe harbour’ rules, which are being viewed as more realistic and are expected to cut down both transfer pricing litigation and the need to seek the alternate recourse of an advance pricing agreement (APA).
For the IT and ITeS (IT-enabled services) sector, which is reeling under pressure, services can now be provided by such companies to their overseas group companies at lower profit margins (known as the safe harbour margin) without the fear of transfer pricing litigation.
In case of transactions in the nature of routine software development services and ITeS services provided by an Indian company to its overseas group companies, transactions not exceeding Rs 100 crore have been provided a safe harbour margin of 17% and those above this sum, but up to Rs 200 crore, a margin of 18%. The current acceptable safe harbour margin was significantly more at 20% for transactions not exceeding Rs 500 crore and 22% for transactions of a higher value.
Transfer pricing litigation arises when the profit margin charged by the Indian company to its overseas group company is disputed by authorities in India. A higher margin in India would result in a higher revenue and tax outgo.
The revised safe harbour rules come into effect from April 1 and will provide transfer pricing certainty for three years (as opposed to five years under the earlier norms). It also recognises ‘low value added’ services. However, this relates to services received by an Indian company and not to services rendered by it.
In respect of transactions involving provision of knowledge process outsourcing services, a graded structure of three different rates of 24%, 21% and 18% has been provided, based on employee cost-to-operating cost ratio, replacing the single rate of 25% under the earlier rules issued in September 2013. For contract R&D, including in the pharma sector, profit margins stand reduced to 24% from the earlier prevailing 29% and 30% margin rate.
The new safe harbour regime is available for transactions limited to Rs 200 crore for a spectrum of services such as software development, ITeS, knowledge process outsourcing (KPOs), and contract research services.