Executive summary
A “safe harbor” is defined in the Indian Income Tax Law (ITL) as circumstances under which the tax authorities will accept the transfer price declared by the taxpayer. India’s Central Board of Direct Taxes (CBDT), the apex Indian tax administration body, first issued transfer pricing (TP) safe harbor rules (SHR) on 18 September 2013, applicable for five years from financial year (FY) 2012-13 to FY 2016-17. The CBDT through notification dated 7 June 2017 amended the SHR, which were applicable for three FYs from FY 2016-17 through FY 2018-19. For FY 2016-17, taxpayers had the option to elect the rule which was more beneficial. On 20 May 2020, the CBDT issued a notification amending the SHR to extend the applicability to FY 2019-20, without any modifications.
On 24 September 2021, the CBDT issued a new notification extending the applicability of SHR to FY 2020-21, without any further modifications. Taxpayers opting for SHR for FY 2020-21 would need to file the return of income for the year on or before the date of furnishing the prescribed Form 3CEFA for opting for the SHR. The due date for filing is 28 February 2022.1
Further, the CBDT has yet to prescribe SHR for attribution of profits to a business connection or permanent establishment (PE) of a nonresident, which was introduced under Finance Act 2020.
Detailed discussion
Background
The Finance Act 2009 introduced provisions in the ITL that authorized the CBDT, to establish a TP SHR. On 18 September 2013, the CBDT issued the SHR, applicable for five years from FY 2012-13 to FY 2016-17. The SHR provided the procedure for adopting a safe harbor, the transfer price to be adopted, the compliance procedures upon adoption of a safe harbor and circumstances in which a safe harbor adopted may be held to be invalid.
On 7 June 2017, the CBDT issued notification 46/2017 amending the SHR by extending the applicability to an additional category of international transaction as well as revising the applicable price/margins that would be accepted as arm’s length. The amended rules were applicable for three FYs from FY 2016-17 through FY 2018-19. For FY 2016-17, as the amended rules overlapped with the prior rules, the taxpayers had the option to opt for the rule which was more beneficial. The CBDT then extended the applicability of the SHR to FY 2019-20, without any modifications.
The CBDT has now issued a notification on 24 September 2021 extending the applicability of SHR to FY 2020-21, without any further modification.
International transactions and applicable safe harbor transfer price
A summary of the safe harbor transfer price declared by an eligible taxpayer that shall be accepted by the tax authorities for FY 2020-21 is as follows:
| Eligible international transaction | Threshold limit value | Safe harbor margin | |
| Provision of software development services other than contract research and development (R&D) services, with insignificant risks | Up to INR1 billion | 17% or more on total operating costs | |
| Above INR1 billion up to INR2 billion | 18% or more on total operating costs | ||
| Provision of information technology enabled services, with insignificant risks | Up to INR1 billion | 17% or more on total operating costs | |
| Above INR1 billion up to INR2 billion | 18% or more on total operating costs |
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| Provision of Knowledge Process Outsourcing services, with insignificant risks | Up to INR2 billion | Margin on total operating costs | Employee cost to operating costs |
| 24% or more | 60% or more | ||
| 21% or more | 40% or more but less than 60% | ||
| 18% or more | 40% or less | ||
| Advancing of intra-group loan to a nonresident wholly-owned subsidiary (WOS) where the amount of loan is denominated in Indian Rupees (INR) | The Interest rate declared in relation to the international transaction is not less than the one-year marginal cost of funds lending rate of SBI as on 1 April of the relevant previous year plus, | ||
| Basis points | CRISIL2 credit rating of associated enterprise (AE) | ||
| 175 | between AAA to A or its equivalent | ||
| 325 | BBB-, BBB or BBB+ or its equivalent | ||
| 475 | between BB to B or its equivalent | ||
| 625 | between C to D or its equivalent | ||
| 425 | credit rating of AE is not available, and the amount of loan advanced to the AE including loans to all AEs in INR does not exceed INR 1billion in aggregate as on 31 March of relevant previous year | ||
| Advancing of intra-group loan to a nonresident WOS where the amount of loan is denominated in foreign currency | The interest rate declared in relation to the eligible international transaction is not less than the six-month London Inter-Bank Offer Rate (LIBOR) of the relevant foreign currency as on 30 September of the relevant previous year plus, | ||
| Basis points | CRISIL credit rating of AE | ||
| 150 | between AAA to A or its equivalent | ||
| 300 | BBB-, BBB or BBB+ or its equivalent | ||
| 450 | between BB to B or its equivalent | ||
| 600 | between C to D or its equivalent | ||
| 400 | credit rating of AE is not available, and the amount of loan advanced to the AE including loans to all AEs does not exceed INR 1billion in aggregate as on 31 March of relevant previous year | ||
| Providing corporate guarantee to WOS | No threshold | The commission or fee declared in relation to the international transaction is at the rate of 1% or more per annum on the amount guaranteed | |
| Provision of contract R&D services wholly or partly relating to software development, with insignificant risks | Up to INR2 billion | 24% or more on total operating costs | |
| Provision of contract R&D services wholly or partly relating to generic pharmaceutical drugs, with insignificant risks | Up to INR2 billion | 24% or more on total operating costs | |
| Manufacture and export of core auto components | No threshold | 12% or more on total operating costs | |
| Manufacture and export of non-core auto components where 90% or more of total turnover during the relevant previous year is in the nature of original equipment manufacturer (OEM) sales | No threshold | 8.5 % or more on total operating costs | |
| Receipt of low value-adding intra-group services | Up to INR100 million | Mark-up on costs not exceeding 5%. The cost allocation methodology should be certified by an accountant | |
Key considerations
- The procedural aspects relating to compliance formalities for opting for the safe harbor, eligible taxpayers, verification by the tax officer, assessment procedure and implications where conditions are not met, remain the same as before.
- Taxpayers who have entered into an eligible international transaction and wish to opt for SHR for FY 2020-21 are required to file return of income on or before furnishing of Form 3CEFA to the Assessing Officer, the due date for which is 28 February 2022.
- Taxpayers opting for safe harbor for FY 2020-21 are required to maintain prescribed TP documentation and file Accountant’s report in Form 3CEB by the due date, which is 31 January 2022.
- Where the transfer price declared by the eligible taxpayer is accepted by the tax authorities, the taxpayer shall not be eligible to invoke the Mutual Agreement Procedure (MAP) under the relevant tax treaty. Further, taxpayers electing the safe harbor will not be able to claim any further adjustment to the price, either on account of comparability differences or the benefit of the range as prescribed under the ITL.
Implications
Applying the arm’s-length principle can be a resource-intensive process. It may impose a heavy administrative burden on taxpayers and tax administrations that can be exacerbated by both complex rules and resulting compliance demands. These facts may lead to consideration of whether and when SHR would be appropriate in the TP area. Some of the difficulties that arise in applying the arm’s-length principle may be avoided by providing circumstances in which eligible taxpayers may elect to follow a simpler set of prescribed TP rules in connection with clearly and carefully defined transactions.
The modifications made to the SHR in 2017 had sought to make the option more attractive for taxpayers. It was expected that the SHR may be further rationalized, particularly for international transactions in the nature of provision of information technology and information technology enabled services by increasing the monetary threshold for eligible taxpayers. This may have enabled reducing the pressure on alternative dispute resolution mechanisms, such as MAP and advance pricing agreements. The extension of the SHR for FY 2020-21 is nevertheless a welcome move by the CBDT and taxpayers would need to evaluate feasibility of opting for the SHR for FY 2020-21, as an option for managing potential TP controversy.
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP (India), Mumbai
- Pranav Sayta, National Leader – International Tax and Transaction Services
Ernst & Young LLP (India), Bangalore
- Rajendra Nayak, National Leader – International Corporate Tax Advisory
Ernst & Young LLP (India), New Delhi
- Vijay Iyer, National Leader – Transfer Pricing
For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert
