SAFE HARBOUR RULES

[Mr. M. GOVINDARAJAN]

In order to reduce the increasing number of transfer pricing audits and prolonged disputes, the Finance (No.2) Act, 2009 w.e.f 1.4.2009 inserted a new section 92CB to provide that determination of arm’s length price under section 92C or Section 92CA shall be subject to safe harbour rules. Vide this amendment the Government of India had empowered the CBDT to make Safe Harbour rules.

The Prime Minister on July, 30, 2012 approved the constitution of a Committee to Review Taxation of Development Centers and the IT sector consisting of Shri N. Rangachary, Chairman of the Committee and three others. The Government of India vide OM dated 12th September, 2012 approved the considered suggestion of the Rangachary Committee that it may finalize the Safe Harbour Rules in the following sector/ activities:

(i) IT Sector

(ii) ITES Sector

(iii) Contract R&D in the IT and Pharmaceutical Sector

(iv) Financial transactions-Outbound loans

(v) Financial Transactions-Corporate Guarantees

(vi) Auto Ancillaries-Original Equipment Manufacturers

The Committee submitted its reports. Many of the recommendations have been accepted by the Government.

Section 92C and 92CA deal with the arm’s length price. Section 92CB provides that the determination of arm's length price under section 92C or section 92CA shall be subject to safe harbour rules. The said section gives powers to Board to make rules for Safe Harbor. “Safe harbour” was defined to mean circumstances in which the income-tax authorities shall accept the transfer price declared by the assessee.

Vide Notification No. 73/2013, dated 18.09.2013 the CBDT amended the Income Tax Rules, 1962 and inserted Rules 10TA to 10TG for the purpose of Safe harbor Rules. The Rules came into effect from 18.09.2013.

Non application

Nothing contained in rules 10TA, 10TB, 10TC, 10TD or rule 10TE shall apply in respect of eligible international transactions entered into with an associated enterprise located in any country or territory notified under section 94A or in a no tax or low tax country or territory.

Where transfer price in relation to an eligible international transaction declared by an eligible assessee is accepted by the income- tax authorities under section 92CB, the assessee shall not be entitled to invoke mutual agreement procedure under an agreement for avoidance of double taxation entered into with a country or specified territory outside India as referred to in sections 90 or 90A.’;

Eligible assessee

According to this Rules, the eligible assessee is to give option under Rule 10TB. Such assessee-

• 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 enterprise (foreign principal);
• has made any intra-group loan;
• has provided a corporate guarantee;
• is engaged in providing contract research and development services wholly or partly relating to software development, with insignificant risk, to a foreign principal;
• is engaged in providing contract research and development services wholly or partly relating to generic pharmaceutical drugs, with insignificant risk, to a foreign principal; or
• is engaged in the manufacture and export of core or non-core auto components and where ninety per cent. or more of total turnover during the relevant previous year is in the nature of original equipment manufacturer sales.

Eligible international transaction

Rule 10TC defines the terms ‘eligible international transaction’ as an international transaction between the eligible assessee and its associated enterprise, either or both of whom are non-resident, and which comprises of:

• provision of software development services;
• provision of information technology enabled services;
• provision of knowledge process outsourcing services;
• advance of intra-group loan;
• provision of corporate guarantee, where the amount guaranteed,-
  • does not exceed one hundred crore rupees; or
  • exceeds one hundred crore rupees, and the credit rating of the associated enterprise, done by an agency registered with the Securities and Exchange Board of India, is of the adequate to highest safety;
• provision of contract research and development services wholly or partly relating to software development;
• provision of contract research and development services wholly or partly relating to generic pharmaceutical drugs;
• manufacture and export of core auto components; or
• manufacture and export of non-core auto components, by the eligible assessee.

For the purpose of eligible international transaction, the definition of the transactions is to be known.

Contract research and development services wholly or partly relating to generic pharmaceutical drugs is defined under Rule 10TA (a) which are the following:

• research and development producing new theorems and algorithms in the field of theoretical computer science;
• development of information technology at the level of operating systems, programming languages, data management, communications software and software development tools;
• development of Internet technology;
• research into methods of designing, developing, deploying or maintaining software;
• software development that produces advances in generic approaches for capturing, transmitting, storing, retrieving, manipulating or displaying information;
• experimental development aimed at filling technology knowledge gaps as necessary to develop a software programme or system;
• research and development on software tools or technologies in specialized areas of computing (image processing, geographic data presentation, character recognition, artificial intelligence and such other areas) ;or
• up gradation of existing products where source code has been made available by the principal;

Rule 10TA(b) defines "core auto components" as-

• engine and engine parts, including piston and piston rings, engine valves and parts cooling systems and parts and power train components;
• transmission and steering parts, including gears, wheels, steering systems, axles and clutches;
• suspension and braking parts, including brake and brake assemblies, brake linings, shock absorbers and leaf springs;

Rule 10TA(h) defines "non-core auto components" as auto components other than core auto components;

Rule 10TA(c) defines “corporate guarantee" as explicit corporate guarantee extended by a company to its wholly owned subsidiary being a non-resident in respect of any short-term or long- term borrowing. Explicit corporate guarantee does not include letter of comfort, implicit corporate guarantee, performance guarantee or any other guarantee of similar nature.

Rule 10TA(e) defines "information technology enabled services" as following business process outsourcing services provided mainly with the assistance or use of information technology, namely:-

• back office operations;
• call centres or contact centre services;
• data processing and data mining;
• insurance claim processing;
• legal databases;
• creation and maintenance of medical transcription excluding medical advice;
• translation services;
• payroll;
• remote maintenance;
• revenue accounting;
• support centres;
• website services;
• data search integration and analysis;
• remote education excluding education content development; or
• clinical database management services excluding clinical trials, but does not include any research and development services whether or not in the nature of contract research and development services;

Rule 10TA(f) defines "intra-group loan" as loan advanced to wholly owned subsidiary being a non- resident, where the loan-

• is sourced in Indian rupees;
• is not advanced by an enterprise, being a financial company including a bank or a financial institution or an enterprise engaged in lending or borrowing in the normal course of business; and
• does not include credit line or any other loan facility which has no fixed term for repayment;

Rule 10TA(g) defines "knowledge process outsourcing services" as the following business process outsourcing services provided mainly with the assistance or use of information technology requiring application of knowledge and advanced analytical and technical skills, namely:

• geographic information system;
• human resources services;
• engineering and design services;
• animation or content development and management;
• business analytics;
• financial analytics; or
• market research, but does not include any research and development services whether or not in the nature of contract research and development services;

Rule 10TA(m) defines "software development services" as-

• business application software and information system development using known methods and existing software tools;
• support for existing systems;
• converting or translating computer languages;
• adding user functionality to application programmes;
• debugging of systems;
• adaptation of existing software; or
• preparation of user documentation, but does not include any research and development services whether or not in the nature of contract research and development services.

Circumstances in respect of eligible transactions

Rule 10TD(2) provides that the following are the circumstances in respect of eligible transactions:

Sl. No	Eligible International  Transaction	Circumstances
(1)	(2)	(3)
1.	Provision of software development services referred to in item (i) of rule 10TC.	The operating profit margin declared by the eligible assessee from the eligible international transaction in relation to operating expense incurred is - (i) not less than 20 per cent., where the aggregate value of such transactions entered into during the previous year does not exceed a sum of five hundred crore rupees; or (ii) not less than 22 per cent., where the aggregate value of such transactions entered into during the previous year exceeds a sum of five hundred crore rupees.
2.	Provision of information technology enabled services referred to in item (ii) of rule 10TC.	The operating profit margin declared by the eligible assessee from the eligible international transaction in relation to operating expense is - (i) not less than 20 per cent., where the aggregate value of such transactions entered into during the previous year does not exceed a sum of five hundred crore rupees; or (ii) not less than 22 per cent., where the aggregate value of such transactions entered into during the previous year exceeds a sum of five hundred crore rupees.
3.	Provision of knowledge process outsourcing services referred to in item (iii) of rule 10TC.	The operating profit margin declared by the eligible assessee from the eligible international transaction in relation to operating expense is not less than 25 per cent..
4.	Advancing of intra-group loans referred to in item (iv) of rule	The Interest rate declared in relation to the eligible international transaction is not less
	10TC where the amount of loan does not exceed fifty crore rupees.	than the base rate of State Bank of India as on 30th June of the relevant previous year plus 150 basis points.
5.	Advancing of intra-group loans referred to in item (iv) of rule 10TC where the amount of loan exceeds fifty crore rupees.	The Interest rate declared in relation to the eligible international transaction is not less than the base rate of State Bank of India as on 30th June of the relevant previous year plus 300 basis points.
6.	Providing corporate guarantee referred to in sub-item (a) of item (v) of rule 10TC.	The commission or fee declared in relation to the eligible international transaction is at the rate not less than 2 per cent. per annum on the amount guaranteed.
7.	Providing corporate guarantee referred to in sub-item (b) of item (v) of rule 10TC.	The commission or fee declared in relation to the eligible international transaction is at the rate not less than 1.75 per cent. per annum on the amount guaranteed.
8.	Provision of contract research and development services wholly or partly relating to software development referred to in item (vi) of rule 10TC.	The operating profit margin declared by the eligible assessee from the eligible international transaction in relation to operating expense incurred is not less than 30 per cent..
9.	Provision of contract research and development services wholly or partly relating to generic pharmaceutical drugs referred to in item (vii) of rule 10TC.	The operating profit margin declared by the eligible assessee from the eligible international transaction in relation to operating expense incurred is not less than 29 per cent..
10.	Manufacture and export of core auto components referred to in item (viii) of rule 10TC.	The operating profit margin declared by the eligible assessee from the eligible international transaction in relation to operating expense is not less than 12 per cent..
11.	Manufacture and export of non- core auto components referred to in item (ix) of rule 10TC.	The operating profit margin declared by the eligible assessee from the eligible international transaction in relation to operating expense is not less than 8.5 per cent..

Procedure

• An eligible assessee is to exercise option for safe harbour and he shall furnish a Form 3 CEFA, complete in all respects, to the Assessing Officer on or before the due date specified in Explanation 2 below to Section 239 (1) for furnishing the return of income-
  • the relevant assessment year, in case the option is exercised only for that assessment year; or
  • the first of the assessment years, in case the option is exercised for more than one assessment year:

the return of income for the relevant assessment year or the first of the relevant assessment years, as the case may be, is furnished by the assessee on or before the date of furnishing of Form 3CEFA.

• The option for safe harbour validly exercised shall continue to remain in force for the period specified in Form 3CEFA or a period of five years whichever is less:

The assessee shall, in respect of the assessment year or years following the initial assessment year, furnish a statement to the Assessing Officer before furnishing return of income of that year, providing details of eligible transactions, their quantum and the profit margins or the rate of interest or commission shown;

An option for safe harbour shall not remain in force in respect of any assessment year following the initial assessment year, if –

• the option is held to be invalid for the relevant assessment year by the Transfer Pricing Officer or by the Commissioner in respect of an objection filed by the assessee against the order of the Transfer Pricing Officer as the case may be; or
• the eligible assessee opts out of the safe harbour, for the relevant assessment year, by furnishing a declaration to that effect, to the Assessing Officer.
• On receipt of Form 3CEFA,the Assessing Officer shall verify whether-
  • the assessee exercising the option is an eligible assessee; and
  • the transaction in respect of which the option is exercised is an eligible international transaction, before the option for safe harbour by the assessee is treated to be validly exercised.
• Where the Assessing Officer doubts the valid exercise of the option for the safe harbour by an assessee, he shall make a reference to the Transfer Pricing Officer for determination of the eligibility of the assessee or the international transaction or both for the purposes of the safe harbour.
• No reference shall be made by an Assessing Officer after expiry of a period of two months from the end of the month in which Form 3CEFA is received by him;
• The Transfer Pricing Officer may require the assessee, by notice in writing, to furnish such information or documents or other evidence as he may consider necessary, and the assessee shall furnish the same within the time specified in such notice.
• Where-
  • The assessee does not furnish the information or documents or other evidence required by the Transfer Pricing Officer; or
  • the Transfer Pricing Officer finds that the assessee is not an eligible assessee; or
  • the Transfer Pricing Officer finds that the international transaction in respect of which the option has been exercised is not an eligible international transaction, the Transfer Pricing Officer shall, by order in writing, declare the option exercised by the assessee to be invalid and cause a copy of the said order to be served on the assessee and the Assessing Officer. No order declaring the option exercised.

No order declaring the option exercised by the assessee to be invalid shall be passed without giving an opportunity of being heard to the assessee.

• If the assessee objects to the order of the Transfer Pricing Officer declaring the option to be invalid, he may file his objections with the Commissioner, to whom the Transfer Pricing Officer is subordinate, within fifteen days of receipt of the order of the Transfer Pricing Officer.
• On receipt of the objection, the Commissioner shall after providing an opportunity of being heard to the assessee pass appropriate orders in respect of the validity or otherwise of the option exercised by the assessee and cause a copy of the said order to be served on the assessee and the Assessing Officer.
• The order shall be passed by the Commissioner within a period of two months from the end of the month in which the objection filed by the assessee is received by him.
• In a case where option exercised by the assessee has been held to be valid, the Assessing officer shall proceed to verify whether the transfer price declared by the assessee in respect of the relevant eligible international transactions is in accordance with the circumstances specified in sub-rule of rule 10 TD and, if it is not in accordance with the said circumstances, the Assessing Officer shall adopt the operating profit margin or rate of interest or commission specified in sub-rule of rule 10TD.
• Where the facts and circumstances on the basis of which the option exercised by the assessee was held to be valid have changed and the Assessing Officer has reason to doubt the eligibility of an assessee or the international transaction for any assessment year other than the initial Assessment Year falling within the period for which the option was exercised by the assessee, he shall make a reference to the Transfer Pricing Officer for determination of eligibility of the assessee or the international transaction or both for the purpose of safe harbour.
• The Transfer Pricing Officer on receipt of a reference shall, by an order in writing, determine the validity or otherwise of the option exercised by the assessee for the relevant year after providing an opportunity of being heard to the assessee and cause a copy of the said order to be served on the assessee and the Assessing Officer.
• No order under shall be passed by the Transfer Pricing Officer after expiry of a period of two months from the end of the month in which the reference from the Assessing officer, is received by him;
• Nothing contained in this rule shall affect the power of the Assessing Officer to make a reference under section 92CA in respect of international transaction other than the eligible international transaction.
• Where no option for safe harbour has been exercised by an eligible assessee in respect of an eligible international transaction entered into by the assessee or the option exercised by the assessee is held to be invalid, the arm’s length price in relation to such international transaction shall be determined in accordance with the provisions of sections 92C and 92CA without having regard to the profit margin or the rate of interest or commission as specified in sub-rule of rule 10TD.
• If the Assessing Officer or the Transfer Pricing Officer or the Commissioner, as the case may be, does not make a reference or pass an order, as the case may be, within the time specified then the option for safe harbour exercised by the assessee shall be treated as valid.
• For the purposes of identifying an eligible assessee, with insignificant risk, the Assessing Officer or the Transfer Pricing Officer, as the case may be, shall have regard to the following factors, namely:-
  • the foreign principal performs most of the economically significant functions involved, including the critical functions such as conceptualization and design of the product and providing the strategic direction and framework, either through its own employees or through its other associated enterprises, while the eligible assessee carries out the work assigned to it by the foreign principal;’
  • the capital and funds and other economically significant assets including the intangibles required, are provided by the foreign principal or its other associated enterprises, and the eligible assessee is only provided a remuneration for the work carried out by it;
  • the eligible assessee works under the direct supervision of the foreign principal or its associated enterprise which not only has the capability to control or supervise but also actually controls or supervises the activities carried out through its strategic decisions to perform core functions as well as by monitoring activities on a regular basis;
  • the eligible assessee does not assume or has no economically significant realized risks, and if a contract shows that the foreign principal is obligated to control the risk but the conduct shows that the eligible assessee is doing so, the contractual terms shall not be the final determinant;
  • the eligible assessee has no ownership right, legal or economic, on any intangible generated or on the outcome of any intangible generated or arising during the course of rendering of services, which vests with the foreign principal as evident from the contract and the conduct of the parties.
• For the purposes of identifying an eligible assessee, with insignificant risk referred to in items (iv) and (v) of Rule 10TD(1), the Assessing Officer or the Transfer Pricing Officer, as the case may be, shall have regard to the following factors, namely:-
  • the foreign principal performs most of the economically significant functions involved in research or product development cycle, including the critical functions such as conceptualization and design of the product and providing the strategic direction and framework, either through its own employees or through its other associated enterprises while the eligible assessee carries out the work assigned to it by the foreign principal;
  • the foreign principal or its other associated enterprises provides the funds or capital and other economically significant assets including intangibles required for research or product development and also provides a remuneration to the eligible assessee for the work carried out by it;
  • the eligible assessee works under the direct supervision of the foreign principal or its other associated enterprise which has not only the capability to control or supervise but also actually controls or supervises research or product development, through its strategic decisions to perform core functions as well as by monitoring activities on a regular basis;
  • the eligible assessee does not assume or has no economically significant realized risks, and if a contract shows that the foreign principal is obligated to control the risk but the conduct shows that the eligible assessee is doing so, the contractual terms shall not be the final determinant;
  • the eligible assessee has no ownership right, legal or economic, on the outcome of the research which vests with the foreign principal and is evident from the contract as well as the conduct of the parties.