When transfer pricing provisions were introduced in India in the year 2001, no tolerance limit was prescribed for adjustment in arm's length price (ALP). Thus any difference between the ALP, as calculated by adopting an appropriate prescribed method, with the actual transaction price of the assessee was eligible for addition to income of the assessee.
Since calculation of ALP is merely an estimate, the ALP is bound to vary in different situations and circumstances. Therefore, a reasonable tolerance margin should be provided to take care of normal variations. The government realised its slip-up and the I-T Act was amended vide Finance Act, 2002, prescribing the tolerance limit of ± five per cent under section 92C.
The margin of five per cent was not found appropriate in many cases because of varying nature of transactions. That gave rise to litigation. The government took note of this fact in the year 2009 when the Memorandum to Finance Act, 2009, stated, "section 92C of the Income-tax Act provides for adjustment in the transfer price of an international transaction with an associated enterprise if the transfer price is not equal to the arm's length price. As a result, a large number of such transactions are being subjected to adjustment giving rise to considerable dispute. Therefore, it is proposed to empower the Board to formulate safe harbour rules i.e. to provide the circumstances in which the income-tax authorities shall accept the transfer price declared by the assessee."
Thus, by way of the above amendment, CBDT was empowered to frame safe harbour rules. Safe harbour rules are basically a set of directives or guidance on activities or margins whereby the revenue authorities should accept the transfer pricing declared by the taxpayer without demur. The purpose of introduction of safe harbour concept was to give assurance to the taxpayers that proper leverage will be allowed to them in given situations and circumstances.
The safe harbour rules have not yet been prescribed till date. On the other hand, Finance Act, 2012, has done away with the tolerance margin of ± five per cent and provided that tolerance limit shall be such percentage of the latter as may be notified by the central government, but not exceeding three per cent. In this context, the government has issued notification dated April 15, 2013, which provides for tolerance margin of only one per cent in case of wholesale traders and three per cent in all other cases. The notification is applicable for assessment year 2013-14.
The significance of safe harbour rules has been realised by many countries and such rules have already been implemented in their tax structure. Recently, the Organisation for Economic Co-operation and Development (OECD) issued a draft guidance on safe harbour rules in September, 2012.
It has also been noted that in the absence of "Safe Harbour Rules" and suitable instructions from the Board, TPOs are taking grossly unreasonable view like applying TP Provisions even on those transactions which do not affect the profit or loss of the assessee, such as increase in the Share Capital, temporary loans from a holding company to a subsidiary company, etc.
Some TPOs are taking grossly arbitrary view on the rate of interest on loans, rate of Bank Guarantee commission, rejecting the most appropriate method applied by the assessee for computation of ALP, etc.
DRP is hardly effective to curb the aforesaid harsh views.
It is felt that in the absence of safe harbour rules, the issuance of notification dated April 15, 2013, which has reduced tolerance margin from five per cent to one per cent or three per cent, assessees will have to face an unrealistic arbitrary position, which will certainly fuel a lot of avoidable litigation.
It is, therefore, urged that the government should withdraw notification dated April 15, 2013, amend the Act and issue a fresh realistic balanced notification which should provide for an appropriate tolerance margin.
In the meantime, the government should expedite framing safe harbour rules.
Government is reminded of its own statement that: "However, this is a new legislation. In the initial years of its implementation, there may be room for different interpretations leading to uncertainties with regard to determination of arm's length price of an international transaction. While it would be necessary to protect our tax base, there is a need to ensure that the taxpayers are not put to avoidable hardship in the implementation of these regulations."
Since calculation of ALP is merely an estimate, the ALP is bound to vary in different situations and circumstances. Therefore, a reasonable tolerance margin should be provided to take care of normal variations. The government realised its slip-up and the I-T Act was amended vide Finance Act, 2002, prescribing the tolerance limit of ± five per cent under section 92C.
The margin of five per cent was not found appropriate in many cases because of varying nature of transactions. That gave rise to litigation. The government took note of this fact in the year 2009 when the Memorandum to Finance Act, 2009, stated, "section 92C of the Income-tax Act provides for adjustment in the transfer price of an international transaction with an associated enterprise if the transfer price is not equal to the arm's length price. As a result, a large number of such transactions are being subjected to adjustment giving rise to considerable dispute. Therefore, it is proposed to empower the Board to formulate safe harbour rules i.e. to provide the circumstances in which the income-tax authorities shall accept the transfer price declared by the assessee."
Thus, by way of the above amendment, CBDT was empowered to frame safe harbour rules. Safe harbour rules are basically a set of directives or guidance on activities or margins whereby the revenue authorities should accept the transfer pricing declared by the taxpayer without demur. The purpose of introduction of safe harbour concept was to give assurance to the taxpayers that proper leverage will be allowed to them in given situations and circumstances.
The safe harbour rules have not yet been prescribed till date. On the other hand, Finance Act, 2012, has done away with the tolerance margin of ± five per cent and provided that tolerance limit shall be such percentage of the latter as may be notified by the central government, but not exceeding three per cent. In this context, the government has issued notification dated April 15, 2013, which provides for tolerance margin of only one per cent in case of wholesale traders and three per cent in all other cases. The notification is applicable for assessment year 2013-14.
The significance of safe harbour rules has been realised by many countries and such rules have already been implemented in their tax structure. Recently, the Organisation for Economic Co-operation and Development (OECD) issued a draft guidance on safe harbour rules in September, 2012.
It has also been noted that in the absence of "Safe Harbour Rules" and suitable instructions from the Board, TPOs are taking grossly unreasonable view like applying TP Provisions even on those transactions which do not affect the profit or loss of the assessee, such as increase in the Share Capital, temporary loans from a holding company to a subsidiary company, etc.
Some TPOs are taking grossly arbitrary view on the rate of interest on loans, rate of Bank Guarantee commission, rejecting the most appropriate method applied by the assessee for computation of ALP, etc.
DRP is hardly effective to curb the aforesaid harsh views.
It is felt that in the absence of safe harbour rules, the issuance of notification dated April 15, 2013, which has reduced tolerance margin from five per cent to one per cent or three per cent, assessees will have to face an unrealistic arbitrary position, which will certainly fuel a lot of avoidable litigation.
It is, therefore, urged that the government should withdraw notification dated April 15, 2013, amend the Act and issue a fresh realistic balanced notification which should provide for an appropriate tolerance margin.
In the meantime, the government should expedite framing safe harbour rules.
Government is reminded of its own statement that: "However, this is a new legislation. In the initial years of its implementation, there may be room for different interpretations leading to uncertainties with regard to determination of arm's length price of an international transaction. While it would be necessary to protect our tax base, there is a need to ensure that the taxpayers are not put to avoidable hardship in the implementation of these regulations."
This article has been co-authored by Alok Gupta