The Government of India's Central Board of Direct Taxes (CBDT) issued the finalized draft of India's safe harbor rules after considering comments made on its first version from various stakeholders.
Its draft, released in August, outlined the minimum acceptable operating margins for a variety of intercompany services and export of manufactured auto-parts as well as acceptable spreads in terms of basis points for financial transactions. With the intention to benefit India taxpayers, the finalized version revises the minimum acceptable operating margins and transaction amount ceilings. It also states that those who opt into the safe harbor can elect to use it for a period of one to five years, but nothing greater than five assessment years beginning from the 2013-14 year will be applicable.
A safe harbor essentially specifies a transfer price that taxpayers may elect as an alternative and thereby generates a greater level of certainty concerning their tax positions in a given country. Although a safe harbor relieves taxpayers from providing third party comparables, it is necessary for taxpayers to document a functional and risk profile analysis for the respective services provided.
India specifies safe harbors for the following categories of intercompany services:
- Software development services
- Information technology enabled services (iTes)
- Knowledge process outsourcing (KPO) services
- Research and development (R&D) services wholly or partly related to software development
- Research and development (R&D) services wholly or partly related to generic pharmaceutical drugs
In addition, it specifies safe harbors for the following financial transactions: advancing of intra-group loans to wholly owned subsidiary and providing corporate guarantee to wholly owned subsidiary. Lastly, it specifies safe harbors for manufacturing as follows: Manufacture and export of core and non-core auto components.
Although the CBDT's intention is to provide multinational corporations (MNCs) more certainty in their tax positions, these corporations may encounter an increase in scrutiny from other foreign income-tax authorities, as safe harbors are not necessarily considered arm's length prices on the corresponding side to any intercompany transactions with an India-based party affiliate. The CBDT's revisions to its draft safe harbor rates are certainly more appealing to taxpayers than its original proposal. However, the revised amounts are still considerably higher than the margins produced by third party comparables.
As a result, MNCs will need to assess the cost and benefits of opting into India's safe harbor policy, i.e. will the simplification of documentation, increased tax position certainty, and avoidance of audit controversy merit the potential increase in scrutiny from corresponding foreign tax jurisdictions?