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After receiving a lukewarm response to safe harbour rules, aimed at providing certainty on taxation of transactions abroad between related parties and reduce transfer pricing litigation, the finance ministry is considering reducing the profit margins as industry found the mark-ups too high.
The deadline for providing details of international transactions under which a safe harbour had been opted was December 5 but the Central Board of Direct Taxes (CBDT) has not found many takers for the rules, announced in September, after getting feedback from industry.
A safe harbour is defined by the Indian Income-tax law as circumstances in which the tax authority shall accept the transfer price declared by the taxpayer.
“We are compiling the data from various field formations and may review the mark-ups if the response is bad across the sectors,” said a finance ministry official, who did not wish to be identified.
Under the rules, CBDT had prescribed profit margins between 20 and 25 per cent for various sectors. In other words, in a cross-border transaction with an associated company, the department would not question the income of the Indian unit if the operating profit margin declared was 20-25 per cent, depending on the sector.
The grouse of the industry is that very few companies would be making these kinds of margins in today’s market and hence, the mark-ups have been lower.
A transfer pricing expert with a multinational consultancy said only a handful of his clients have opted for safe harbour as they thought it would be better to contest the income tax department’s claims in court rather than declaring higher margins than they actually made and pay higher tax.
He said the margins proposed by authorities under Advance Pricing Agreements (APAs), which are pacts between the taxpayer and the tax department, were much lower than safe harbour. For instance, for software development services, the safe harbour is 20 per cent but in some APAs, a margin of 14 per cent was proposed by the APA authority. The CBDT, however, has not yet accepted it.
“Safe harbour rules were announced to give an opportunity to taxpayers who did not want to fight it out in court. The margins were kept deliberately high as we were giving them certainty. On the other hand, APAs involve a lot of fact finding and that’s why margins are lower,” justified another official.
The official said the mark-ups were in line with recommendations of the Rangachary committee and derived after looking at recent cases where taxpayers had agreed to margins of 15 to 17 per cent.
Other concerns of the industry are that safe harbour rules continue to impose the burden of maintaining transfer pricing documentation on taxpayers opting for it. Also the rules exclude taxpayers transacting with low tax or no tax countries.
Sometimes, companies suppress profits arising out of transactions with their foreign subsidiaries to reduce tax liability in India. Safe harbour rules were announced as a result of increased transfer pricing disputes between the tax department and these companies. Last year, notices were sent to Shell, Vodafone, Essar, Bharti Airtel, Microsoft, and IBM, among others.
Of about 3,200 cases taken up for transfer pricing auditing in 2012-13, an adjustment of Rs 70,000 crore was made in 1,600 cases. In 2011-12, an adjustment of Rs 44,531 crore was made in 1,343 cases. This represented an increase of 57 per cent.
