Captive Service Providers To Benefit From New Safe Harbour Rules  

A revision of ‘safe harbour' rules will encourage smaller captive service providers, especially in the information technology and research and development space, to take the route to avoid transfer pricing litigation, tax experts told BloombergQuint.

The new rules, which came into effect from April 1, are also likely to reduce stress on the lengthy and expensive Advanced Pricing Agreement (APA) process, they said.

Generally, 'safe harbour' refers to circumstances in which the income-tax authorities accept the transfer price declared by the assessee. The safe harbour rules lay down limits within which a transfer price for intra-group transactions is acceptable.

The rules came into effect in 2013 and were intended to fix a minimum operating profit margin for certain international transactions between an Indian company and its overseas affiliate. As long as taxpayers stuck to the profit margins laid down in the rules, the transfer-pricing compliance remained litigation free and simple.

Key Changes

Software and business process outsourcing companies that opt for the safe harbour route will now have to pay tax on a minimum 17 percent operating profit margin, if their turnover is under Rs 100 crore, and 18 percent if their turnover is between Rs 100 crore and Rs 200 crore. Earlier, they had to pay tax on 20 and 22 percent, respectively.

R&D companies operating in the IT, ITes and pharma space, among others, will be taxed on a minimum operating profit margin of 24 percent, down from 30 percent earlier.

Rahul Mitra, partner and head of transfer pricing and base erosion and profit shifting at KPMG, said that the number is still high, but given that the safe harbour route, which was earlier open ended, is now restricted to companies with a turnover of Rs 200 crore or less, the expectation is that bigger companies could be taxed lower under APA or normal assessment since the minimum operating profit arrived at under the safe harbour route is usually a premium number.

Minimum profit for knowledge process outsourcing companies will be determined on an employee costs-to-operating costs ratio under three slabs. A profit margin of 18 percent will be applicable to companies where employee costs are less than 40 percent of operating costs; if the costs are between 40 and 60 percent, the number jumps to 21 percent and for over 60 percent, the profit margin will be 24 percent.

Additionally, low value-added services such as business support services provided by the parent companies to Indian subsidiaries will not be scrutinised under the new rules, provided that the company can submit certified documentation from a chartered accountant that the value of the transaction is not in excess of Rs 10 crore.

Kunj Vaidya, national leader, transfer pricing at Price Waterhouse and Co., said that the rules for the IT and ITeS services companies have been rationalised and are largely aligned to the outcomes experienced in unilateral APAs. This should provide significant relief to small- to medium-sized companies and and it's possible that some companies with pending APA cases would opt for the safe harbour route, he said.